HOW should one invest in a period of low interest rate and rising inflation? For one, do not keep cash, The Edge Media Group executive chairman Datuk Tong Kooi Ong advised the 600-strong audience at The Edge 2015 Economy and Investment Outlook Forum.

The Edge Media Group publishes The Edge Malaysia, The Edge Financial Daily, Personal Money, Haven, The Edge Singapore, The Edge Review and The Malaysian Insider.

“Because you will end up losing money,” said Tong, drawing laughter from the crowd at the event on Nov 1.  

But this is the reality with central banks the world over keeping interest rates low and currencies cheap. In Malaysia, the negative real interest rate conundrum is already a reality, with higher inflation on the back of subsidy cuts. For the most of this year, inflation was above 3%, which is higher than the 12-month fixed deposit rate, or about 3%, prior to the rise in the overnight policy rate (OPR) by 25 basis points in late October.  

The implementation of the Goods and Services Tax in April next year is also expected to push up inflation.  

“We don’t believe the central bank will increase the domestic rates by much because it will hurt the highly leveraged government, and the government will hurt the highly leveraged Malaysian households [with household indebtedness at 86.8% to the gross domestic product last year]. [Bank Negara Malaysia] will also not want to do it because it’s not in Malaysia’s interests to see a declining ringgit vis-à-vis the US dollar,” said Tong.

“Eventually, someone has to pay, and who will that be? It’s the person who saves money [in the bank].”

It is telling by looking at economists’ projections for inflation this year and the next, at an average of 3.2% and 3.6% respectively, Bloomberg data shows. This compares with 12-month fixed deposit rate of 3.3% and the OPR of 3.25%.

The US Federal Reserve is not expected to raise its near-zero interest rates anytime soon despite ending the third iteration of quantitative easing (QE3) in October. The unemployment rate has gone down to a six-year low of 5.9%, leading many to suggest the world’s largest economy is already back on its feet.

Tong said interest rates in the developed economies will stay low for the next 24 months because the global recovery is still “anaemic”.

While economists continue to debate on whether the QE programmes actually helped the US’ recovery from the recession brought about by the subprime crisis, the fact remains that the US$4.5 trillion pumped into the system had found its way to this side of the world. As Tong pointed out, this was manifested in the inflated foreign holdings of Malaysian Government Securities since QE began.

However, he argued that today’s Keynesian approach of having governments step in to boost economic growth is not yielding the desired results so far. He surmised that it is because the velocity of money — or the rate of money being used to purchase goods and services — is still weak despite an influx of money supply.

“Remember, the 2008 [global] financial crisis was triggered by debts. When people have debts, what do they do when they get money? They pay down debts. If they start paying down debts, that money remains in the bank. If the banks don’t lend, then velocity will fall. Thus, high indebtedness creates low-rate velocity,” Tong explained.

“Will [the velocity of money] go up again? Yes, everything is going to go back to normal at some stage. But it is not happening anytime soon.”
The muted economic activity will then lead to fears of deflation. And this, Tong said, is why he thinks interest rates will be kept low for the next two years. “[Central banks will want to] get inflation to go up. To do that, they will keep the interest rates down.”

Moreover, he thinks that most countries will tend to keep their interest rates low in order to boost export competitiveness with cheaper currencies, effectively waging a new round of currency war.

Rising against the low interest rate regime

Tong’s argument leads to his conjecture that Malaysia is set to experience a negative real interest rate environment for the next 24 months. Eventually, he thinks this trend will permeate other countries — creating a “low interest rate regime” — because many countries are highly indebted.

“How does a government reduce its debt? It increases taxes, reduces economic growth. It reduces spending? Unlikely, right? No politician will do that because they will get voted out. The only option for them is to tax the savers; by depreciating the currency and allowing negative real interest rates,” he says.

While the FBM KLCI has seen a 2.85% decline to 1,813.79 points so far this year, Tong echoed fund managers’ views that the local stock market is already expensive compared with its historical valuations, although he sees this as “justifiable”. Meanwhile, US markets repeatedly made headlines this year for breaking all-time records.

“Despite whatever people have been saying about markets’ high valuations, this will be sustained because we have entered a ‘low interest rate regime’,” he said.

“You can see the inverse relationship. Market price-earnings ratio goes higher when interest rates are lower and vice versa. When the world believes the interest rate regime is to go lower, market valuations will go higher.”

Nevertheless, equities will still be the choice of asset class to invest in when the world is in a prolonged state of low interest rates, he said. “Investing in properties … in Malaysia, it may not be the best time because there is a lot of excess supply and lack of liquidity.”

Tong advised investors to invest in fundamentally sound and fairly valued small-cap stocks, which are off the radar of stockbroking houses that typically go for big-cap stocks.

More importantly, investors should look for stocks with high yields that will help beat negative real interest rates.  

To do this, he recommended to investors the newly launched theedgemarkets.com to help them in their investment decisions. “What The Edge wants to do is actually teach investors how to fish,” he said.

Tong has two portfolios — Tong’s Value Investing Portfolio, which is featured in this paper, and Tong’s Momentum Portfolio, which is featured in The Edge Financial Daily.

This article first appeared in The Edge Malaysia Weekly, on November 17-23, 2014.

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