Lead Story:What does NIRP mean for investors?

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This article first appeared in Capital, The Edge Malaysia Weekly, on February 22-28, 2016

IN just two months, a world weaned off quantitative easing has swung from saying hallelujah to the US Federal Reserve’s lift-off on Dec 16 last year to discussing the possibility of sub-zero interest rates in China, which is still seeing decent economic growth and has the largest foreign reserve pile in the world despite recent capital outflows. Can one be blamed for suffering from monetary policy fatigue?

Thanks to the Bank of Japan’s surprise interest rate cut to -0.1% in January and the stock sell-off that ensued, NIRP (negative interest rate policy) is the new four-letter word. It is seen as another form of QE, which technically should depreciate one’s currency and nudge investors to seek better returns elsewhere. In that sense, assets that provide better yields should benefit, experts say.

Yet, the fact that countries accounting for nearly a quarter of the world’s economy — the EU, Switzerland and Japan — are in a so-called “sub-zero” environment is seen as a sign of desperation on the part of central bankers. Some even think the US might stop or reverse “normalisation”, especially as China works out the right place for its currency, heightening concerns that policymakers are running out of options.

What does the new frontier of negative interest rates in the global arena mean for investors?

For RHB Research Institute executive chairman and chief economist Lim Chee Sing, NIRP “can only be seen as a temporary expedient to hold up financial markets”, albeit one that has little room to push for more economic growth in this relatively mature stage of the growth cycle.

“That means rising investment premiums and heightened market volatility will likely be the order of the day in the days ahead. Portfolio investors may have no choice but to build some degree of defensiveness into their portfolios to balance out the risks. This implies rising appetite for high-yield stocks,” Lim says.

Even dividend stocks have caveats in the days ahead, largely due to their rich valuations vis-à-vis tougher conditions to grow at the same rate as before. For example, sin stocks might have to contend with higher taxes; the fees for telecommunications spectrum refarming have yet to be revealed; and consumer stocks have to contend with the possibility of a further tightening of consumer spending. Then, there is the higher labour cost.

“The focus should be on stocks with an improved business model, reasonable earnings visibility, strong cash flow, a dividend policy and, thus, sustainable dividend payments. Of course, one cannot ignore valuations but rich valuation stocks are still susceptible to a selldown should the global economy take a turn for the worse,” Lim adds.

Gerald Ambrose, CEO of Aberdeen Islamic Asset Management Sdn Bhd, too, noted expensive valuations after a good run in recent years.

“We are keeping a close eye on notable high-yield companies, like the cellular phone companies, the brewers, tobacco companies and the REITs (real estate investment trusts). We’re currently about halfway though the 4Q2015 results season and to be honest, a lot of the better-managed companies have been able to find efficiencies to enable dividend payout to remain high. However, after outperforming for over a year, a lot of the high dividend yield companies are hardly cheap,” he says.

Vincent Khoo, who is head of research for Malaysia at UOB Kay Hian, for one, believes “there’s still a handful of quality high-yield stocks to get exposure in. It’s not too late [to enter]” — referring to companies with defensive cash flow that offer more than 5.5% yield on prevailing stock prices.

He counts Malayan Banking Bhd (target price: RM10, trough target price: RM8.21), Hong Leong Industries Bhd (target price: RM6.85), Sunway REIT (target price: RM1.70) and Carlsberg Brewery Malaysia Bhd (target price: RM12.50) as “compelling, quality high-yield dividend stocks”. His Feb 17 note did not provide specific dividend forecasts for 2016.

“Also notable are ‘buy’-rated Berjaya Sports Toto Bhd and Guinness Anchor Bhd, and ‘hold’-rated IGB REIT,” Khoo says in the note, which lists seven stocks with at least 6% yield and another two with at least 5.6% for 2016.

“Quality high-yield stocks should stage a better outperformance in 2016 in terms of capital appreciation as investors price in a more modest US interest rate hike cycle. In 2015, only seven of the 13 high-yield stocks within our coverage (expected to deliver yields of 5% or higher at the beginning of 2015) registered positive capital gains as their performances were dampened by US rate hike concerns or earnings downgrades.”

But the fact that UOB Kay Hian’s updated trough assessments of individual stocks indicate that “most companies are not yet trading at compelling bargain prices”. This points to sizeable downside potential should there be another round of global crisis.

For now, the research house continue to assume “a mildly negative market trough of 1,560 [points] for the FBM KLCI, which explicitly assumes a lower corporate earnings growth of 2% and market PER of 0.5 times standard deviation below the historical mean PER” as the probability of a financial crisis re-emerging globally or domestically remains low.

UOB Kay Hian also maintained its end-2016 FBM KLCI target of 1,750 points, which implies 15 times 2016 earnings, just above the 14.7 times long-term mean PER, “supported by sufficient domestic liquidity”.

To be sure, the ringgit’s direction in the months ahead remains a wildcard but seasoned fund manager Ambrose, for one, points out that Malaysia still has positive real interest rates.

“Yes, it has an effect. However, Malaysia is one of the few economies where a deposit in a bank can receive a positive return after inflation — Bank Negara does not wish to punish savers in the same way that they do in some developed economies. Like almost every investor, we believe that the ringgit is fundamentally undervalued versus the US dollar and other currencies and that over time — no idea how long — it will revert to its correct value. This has to be borne in mind when investing in Malaysia, as it acts as a discount for investors, in our view,” Ambrose says.

RHB’s Lim reckons that the local bourse “will likely be in a range-bound trading pattern with limited upside in the period ahead”. “A potential re-rating catalyst for foreign investors is a stable ringgit with a slight strengthening bias adding to its appeal,” he adds.

At the time of writing, the ringgit was hovering at 4.20 to the US dollar, an improvement from as low as 4.4415 intraday on Jan 7 but below 4.0953 intraday on Feb 11. Brent crude oil, meanwhile, fetched US$34 a barrel, about 8.8% lower than the US$37.28 a barrel seen at end-2015.

Whether or not the ringgit and oil prices have bottomed out, long-term investors would likely look beyond monetary policy to the fundamentals of companies to determine which ones to keep when the growth path gets tougher.