• What’s happened in 9M18: Divergence in Global Growth; Global Liquidity Tightening; US-China Trade Disputes
• Market Outlook: Positive on Japan; Positive on Asia and EM Equities; We Like Malaysia Small-Cap
• What to watch out: US-China Trade Dispute; Federal Reserve Policy; US Mid-term Election; Brexit Talk & Italian Budget; Malaysia Budget 2019
Although we are almost getting to the end of 3Q 2018, the global financial market hasn’t been good to investors. On YTD basis, as of 25th September 2018, only the US and Japan equity markets have managed to deliver rather respectable returns of 11.0% and 6.8% respectively in MYR term. On the flipside, the Asian and Emerging Market equities posted disappointing returns of -6.8% and -8.4% respectively over the same period. The on-going trade war dispute between US and China, tightening liquidity in the global financial system as well as the recent emerging market currency crisis have resulted in the longest emerging market rout since 2008. With all these uncertainties and volatilities in the global financial market, investors might be getting more anxious than ever. Hence, in this article, we will be discussing on what investors can expect and should watch-out in the last quarter of the year.
|Figure 1: Global market performance
The First Nine Months of 2018
In the first two quarters of 2018, we have seen a divergence in global growth, with the US economy advancing at an annualised rate of 4.2% in the second quarter of 2018 while most of the Asian countries saw their growth slowing down over the same period. The US economic growth was mainly driven by the domestic factors – resilient private consumption owing to the support provided to disposable income by the tax cut as well as the improving government spending.
On the monetary front, US Federal Reserve has lifted the interest rate by 3 times this year while the consensus is expecting one more hike in 2018 and 3 more in 2019. In Europe, the European Central Bank (ECB) has confirmed that it will completely halt the bond-buying program by the end of this year while keeping the interest rate at their present record low for at least until summer 2019. Elsewhere, the environment of monetary tightening can also be seen in some of the Emerging market (India, Indonesia, Argentina, Turkey and others) as a tool to curb foreign outflow and to defend its currency.
Over the past couple of months, the US-China trade dispute has gone way beyond our expectation, with US imposing tariff on a total amount of $250bn worth of Chinese imports while China has retaliated with tariffs on total $110bn worth of US goods. In fact, the trade issue between US and China could be one of the factors that caused the earnings downward revision in Asian equities.
Similarly, we do observe that majority of the investors tend to concentrate their exposure in the equity space with the objective of achieving higher returns. No doubt, although there is a higher chance that investor could generate higher investment return by having a concentrated portfolio, investors should bear in mind that the similar portfolio could also deliver hefty losses to investors during a market downturn, therefore, having a concentrated portfolio might not be an ideal investment strategy.
I. Developed Market
Within the developed market, we are of the opinion that the Japanese equity would be a better buy as compared to its other developed counterparts. The Japanese equities is likely to be supported by the decent earnings momentum as we saw more than half of the Nikkei 225 companies posting revenue above the consensus estimate while close to two-third of them have beaten the earnings targets in their latest quarterly earnings. In fact, we also saw healthy earnings upgrade in Japanese equities which underpinned by the improving economic backdrop and the rather stable political environment.
II. Asia & Emerging Market
In regards to the Asia and Emerging market (EM), we believe that the recent sell-off presents a good buying opportunity to investors. On the fundamental front, most of the Asia and EM countries appear to be much healthier with increasing foreign reserves, improving current account as well as lower external debt to GDP ratio. Hence, they are now at a more comfortable position to weather the external uncertainties.
On the valuation front, both the Asian and EM markets are trading at attractive level with annualised returns of more than 25% and 19% respectively over the next couple of years despite the recent earnings’ downward revision.
For the local equity market outlook, we continue to hold a positive view in the local small cap segment given the recent strength in US Dollar. Although we don’t expect further sharp depreciation in Ringgit like what we have seen in Indonesia Rupiah, Turkish Lira, Argentina Peso and other emerging market currencies, if we assume it to stabilise around RM4.10/USD in the second half of 2018, it would represent about -4% of depreciation as compared to the first half of 2018. Hence, this would translate into higher revenue and earnings for the small to mid-cap companies where most of them tend to source majority of their revenue oversea.
Not to mention the robust global semiconductor demand, according to some of the sector’s leaders, the Malaysia technology sector with majority of the players being the semiconductors companies, they are likely to benefit from the on-going trade war between US and China due to the US trade diversion as well as production relocation. As such, we see a higher chance for the local technology sector to outperform the others.
What to watch-out?
a) US-China Trade Dispute
Although China has cancelled the recent trade talks with US which increased the trade tensions between the world’s two largest economies, we believe that the two giants are likely to re-enter into a more meaningful discussion in near future as the recent trade agreement between US and South Korea as well as the constructive trade negotiation between US and Japan spurred hope for China agreements.
b) Federal Reserve Policy
In the recent FOMC meeting, the US Fed increased the interest rate for the third time this year, sending the federal fund rate to the range of 2.0-2.25% while the dot plot is signalling another hike in 2018 and 3 more in 2019. Although US Fed is adopting the same measure and prudent approach, communicating to markets their expectation and allowing time for adjustments to take place, we believe that the monetary policy misstep still remains as one of the top risks to the global financial market.
c) US Mid-term Election
The US mid-term election is approaching and it should be one of the key events that investors should watch in November. Although the decent economic data in US (strong economic growth, improving business confidence and consumer sentiment, robust corporate earnings) could pave the way for the Republican midterm victory, the recent polls showed that the Democratic Party is gaining uptick in support ahead of the 2018 midterm elections. If the Democrats were to win back control of Congress, it would translate into higher political uncertainty as the Democrats are likely to launch impeachment proceedings against President Trump.
d) Brexit Talk & Italian Budget
In Europe, the biggest concern to investors would be the development of Brexit negotiation as well as the proposal of Italian Budget which is expected to take place by end of this month.
Looking at the timeline, there is just about six months left before the Brexit due date in end of March 2019, but, so far, there is still no clarity on the terms for the divorce. Hence, as we move closer to the deadline, it indicates a grater chance that there won’t be a deal.
Besides the Brexit talk, another event that under investors’ watchlist would be the budget for Italy. With the current debt standing at about 132% of the country GDP, it would be extremely difficult for the Italian government to fulfil its campaign pledges while meeting the budget deficit limit set by EU.
e) Malaysia Budget 2019
Back to the local front, investors might want to shift their focus to the upcoming budget 2019 that will be tabled by the Finance minister in November. The national budget 2019 will be the first budget under the Pakatan Haparan government. One of the biggest challenges to the new government is to maintain the targeted budget deficit in 2018 as well as in the coming years. Hence, the prime minister has previously given an early indicator that the 2019 budget will entail many sacrifices as the priority for the new government is looking out for ways to save money for the repayments of RM1 trillion debt.
All in all, in such a volatile financial market environment where nothing seems impossible, investor should always asses their portfolio to ensure that they are not taking too much of excessive risk or overexposed to a single country exposure.
For investors who are looking for investment opportunity, they can consider the Japanese equities, Asia ex Japan, Emerging market equities well as the Malaysia small cap sector which are currently trading at an attractive valuation with higher upside potential.