After a strong kick off for 2017, the local equity market posted unexciting performance since the beginning of third quarter. As such, some investors might have started to worry on the sustainability of the local stock market’s rally. Also, there was a disconnect between several economic data and the performance of the local stock market over the past few months which caused investors to be more skeptical regarding the accuracy of the data that captured the overall economic conditions. Hence, in this article, we will be discussing the story behind the several local economic data and potential outlook for the local equity market for the rest of the year.
Robust Second Quarter GDP growth
Malaysia economy registered 5.8% y-o-y GDP growth rate, outperforming the consensus estimates for 5.4% of expansion (see figure 1) and previous quarter’s 5.6% of growth. The local economy posted broad-based expansion with all sectors (construction +8.3%, services +6.3%, manufacturing +6.0%, agriculture +5.9%, mining & quarrying +0.2%) registering positive growth rate on year-on-year basis.
Chart 1: Malaysia GDP Growth Rate
On the expenditure approach front, the private sector was the main driver for the robust second quarter GDP growth where both private consumption and private investment marked high single digit growth rate of 7.1% and 7.4% respectively. The growth in the private sector (private consumption and private investment) is in line with the improving consumer sentiment and business condition in the second quarter. According to Malaysian Institute of Economic Research (MIER), both consumer sentiment index and business confidence index strengthened to 2-year high of 80.7 and 114.1 point respectively (see figure 2 & 3). Both indices suggested that the local consumers and business owners are turning positive on the local economic outlook for the next 3 to 6 months. As such, we continue to be optimistic on the growth of the private sector in the following months.
Chart 2: MIER Malaysia Consumer Sentiment Index
Chart 3: MIER Malaysia Business Condition Index
Besides that, although the government spending grew at a low single digit growth rate of 3.1% in the second quarter, we believe that the government expenditure is likely to pick up in the second half as the
local election is not far away. Moreover, referring to figure 4, the WTI Crude Oil price is hovering around USD 49 per barrel, well above our government budget assumption of USD 45 per barrel. As such, it might enhance the spending power and flexibility of our government.
Chart 4: WTI Crude Oil Price
Strong Exports Growth
Looking at the external trade data, Malaysia’s exports grew faster than imports for 3 consecutive months (see figure 5). Unlike in the first quarter where growth in imports outpaced the growth in exports for 3 successive months. As such, with the stronger exports growth and slowdown in local imports, the local net exports growth turned positive in 2Q2017. In July, Malaysia’s exports expanded strongly at 30.9% year-on-year, after the slowdown in growth in June (+10.0%). Electrical and Electronic products which accounted for 35.5% of the total exports remained as the main driver for local exports, registering 28.3% year-on-year of growth in July 2017. The sector is expected to remain strong in the second half of the year following the launch of Samsung Note 8 and the new iPhone’s anniversary edition which are expected to drive the global demand for E&E products.
Chart 5: Malaysia's Exports and Imports
Manufacturing Sector Resumes Expansion
Malaysia’s manufacturing sector returned to expansion territory with Purchasing Managers’ Index surging to 50.4 points from the previous month’s 48.3 points (see figure 6). The August’s data portrayed a strong picture for the Malaysia manufacturing sector with overall operating conditions improving for the first time since April 2017. The growth was supported by stronger external demand with improving new demand orders particularly from China, South East Asia and Middle East. Moreover, the manufacturing output also increased at the fastest rate since February this year amid highest business optimism in August since December 2013. As such, given the improving consumer sentiment (MIER Consumer Sentiment Index at 2-year high level) in 2Q2017 which might help to drive the domestic demand for the second half coupled with the strong external demand, Malaysia manufacturing sector is likely to remain at the expansion territory in the following months of 2017.
Chart 6: Malaysia's PMI
Monetary Policy Stays Accommodative Amid Moderated Inflation Rate
Unlike some other country who imports the US monetary policy, Malaysia’s central bank (Bank Negara Malaysia) is focusing on local economic growth and financial stability when deciding the local monetary policy. Therefore, given the moderation in local inflation rate to 3.2% in July (see figure 7), we believe the pressure for our central bank to hike Overnight Policy Rate (OPR) has abated. As such, we still maintain our view that the central bank will keep the OPR remain unchanged for the rest of year. Hence, the still accommodative monetary policy will continue to provide support to the local economic growth as well as the local equity market.
Chart 7: Malaysia's CPI and OPR
Approaching The End Of Seasonally Weak Quarter
Technically speaking, third quarter was the weakest quarters for over the past 30 years, with an average return of -3.57% (see table 1). In addition, based on our findings, fourth quarter was the top performing quarter within a year. As such, given the improving economic outlook coupled with the end of seasonally weak quarter, the local equity market is likely to continue its strong momentum that we have seen in the first half of this year.
1: KLCI's Quarterly Returns
Source: Bloomberg, iFAST compilations. Data as of 20
Ringgit’s Outlook Remained Positive
On currency front, Ringgit has posted decent performance since our call in February (Where is the Ringgit heading to?), strengthening by about 7.1% as of 15 September 2017. Despite the strong recovery in Ringgit, it is still trading at a discount of 14.03% against its fair value as of end of July 2017 (see figure 8). Furthermore, it is also currently trading well below its 10-year average level, suggesting that the currency is attractive from valuation perspective.
Chart 8: Ringgit's Real Effective Exchange Rate
On top of that, we believe that the implementation of the new FEA rules has started to bear some fruit as one of the factors that led to the appreciation of Ringgit is probably the implementation of FEA rules that required local exporters to convert 75% of the exports proceeds into Ringgit. As such, the strong performance of local exports which has been growing at double digit growth rate for 8 consecutive months was one of the drivers to the robust performance of Ringgit. As we are expecting continuing growth in the exports sector, it is likely to provide further support to the local currency.
Given the above mentioned improving economic outlook especially the better than expected GDP growth rate in 1Q and 2Q 2017, the local assets (equities and bonds) has turned out to be attractive to foreign investors. From a foreign investor perspective, Malaysia’s assets will even be more attractive given the potential upside of the local currency which has depreciated about 22% over the past 3 years. Hence, on top of the improving fundamental which might offer investors returns in term of valuation expansion, foreign investors are poised to enjoy additional currency translation gain should the Ringgit appreciate.
Another factor that might drive the Ringgit lower would be the aggressiveness of FED to tighten the monetary policy which might lead to the appreciation of US Dollar. As all of us might know that the FED rate hike decision is very much data-dependent, hence the disappointing wage growth might have contributed to lingering doubts that a lack of inflation could lead to a more dovish tone from the US Central Bank. If one look at the consensus estimates for the probability of interest rate hike in December 2017, it has dropped significantly from the previous 94.2% in June to 46.7% as of 18th September 2017. This indicates that market participants are expecting a lower chance of rate hike by the end of this year. As such, with the expectation of moderated pace for monetary policy tightening, it could be a positive catalyst to the Ringgit.
Threats to Malaysia Equity Market and The Local Currency
Large Bond Maturity in 3Q
One of the possible threats to the local currency is the huge maturity profile for MGS in September, October and November 2017 (see figure 9). Foreign investors are now holding about 41% of total MGS. If these investors do not reinvest the maturity proceeds and repatriate them instead, we might see huge selling pressure for Ringgit (like what we have seen during March 2017).
However, according to the source of information that we have obtained, most of the maturity of the sizable MGS in September was rolled over, with most of the foreign funds reinvesting instead of repatriating the money out from Malaysia. Hence, the remaining downside risk on Ringgit has reduced substantially.
Chart 9: MGS Maturity Profile
2Q’s Earnings Mixed Results
For the second quarter ended June 2017, on aggregate, the top 30 companies listed on Bursa Malaysia posted a tepid earnings growth of close to 3.3% on year-on-year basis. However, on quarter-on-quarter basis, the total earnings delivered by the top 30 companies declined by -4.5%. As such, the disappointing quarter result was one of the reasons for the unexciting performance in the local equity market in the third quarter.
However, as the mixed results in 2Q earnings have been factored into the stock prices, we believe that the 3Q and 4Q earnings might be one of the drivers for the local equity market as both quarters' earnings are likely to appear to be much encouraging on a year-on-year basis, given the impressive global recovery which led to strong demand and the promising recovery in domestic demand, both domestic focus and exporting companies would likely to see positive growth in their earnings. On top of that, in 2016, there are numerous big companies’ earnings hit by foreign exchange losses such as IOI Corp, Axiata, TNB and so on. However, as Ringgit has appreciated about 7.1% against USD as of 15th September 2017, those companies that experienced huge one-off foreign exchange losses last year, might see decent y-o-y profits growth in coming quarters.
Malaysia as one of the emerging countries is more susceptible to the external uncertainties especially the geopolitical issue. This can be seen during early August, with numerous geopolitical issues making to the headlines such as the tension between US and North Korea and the Barcelona’s terror attack. These ratcheting political tensions have weighed on the investors risk appetite, causing the foreign investors to dispose Malaysia’s stocks for 3 consecutive weeks. With regards to this issue, we would like to reiterate that investors should emphasize on the fundamental of the economy and corporate earnings which we believe are the ultimate drivers for stock market. Although the stock prices might be affected by these uncertainties, investors should be aware that some of the
best returns follow the worst periods, hence investors should avoid
timing the market as it can be very costly for them to do so.
All in all, the disconnect between some of the economic data and stock performance might be due to the increasing external uncertainties which caused temporary volatility in the equity market. However, if we analyse it from the fundamental angle, we believe that the local equity market is likely to trend higher moving forward with the expectation of improving corporate earnings in the following quarters coupled with robust economic growth and its current fair valuation. In addition, we are likely to see continuing foreign fund inflow as global investors regained risk appetite and the attractive valuation for Ringgit. As such, for investors who share the same view with us, they can consider
Kenanga Growth Fund or
Eastspring Investments Equity Income Fund. For investors with greater risk appetite, they might consider KAF Vision,
KAF Tactical, InterPac Dana Safi and
InterPac Dynamic Equity Fund which are investing into the small cap space. However, for these small cap funds, investors should limit their exposures for not more than 20% of their total equity risk budget.