Will Malaysia be at risk when easy money ends?

This article first appeared in The Edge Financial Daily, on July 10, 2017.
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As global growth appears to be gathering some steam, central banks are expected to remove their hangover cure of easy money for the last global financial crisis in 2008. However, the risks now posed by higher rates and reduced global liquidity should not be taken lightly.

“The equity market is finally waking up to that possibility. Two years ago, they still party on but within 12 months it (easy monetary policy) is going to come to an end,” said Inter-Pacific Securities head of research, Pong Teng Siew, when commenting on the end of the ultra-low interest rates environment and active bond buying by central banks.

Recall that the ultra-low interest rate environment and bond purchase exercise, better known as quantitative easing (QE), aimed to ease the liquidity crunch after the onset of the global financial crisis in 2008.

Conventional wisdom saw it as a necessary response to unusual, desperate circumstances, and the programme of asset purchases was extended through QE2 in 2010 and then again in 2012, with QE3.

It is unlikely that the post-financial crisis bull market would have climbed so far and fast if not for the availability of ample liquidity.

Now more central banks have been indicating that it is time to wind up the party, with further “data-dependent rate hikes” being considered by the US Federal Reserve (Fed) with the European Central Bank’s (ECB) head, Mario Draghi, indicating “adjustments” to monetary policy.

Further ahead, the Fed’s chairman, Janet Yellen, has to do what no others have done before, the unwinding of the US$4.3 trillion (RM18.5 trillion) in bonds on its balance sheet, coined the “Great Unwind”.

But with the end of the easy-access -to-credit era, will tighter liquidity hurt Asian equity markets, including Malaysia? Will more global investment money flow back into the developed markets, like the US where the benchmark indices are already at a record high?

Pong told The Edge Financial Daily that on the local front, there was not that much of liquidity in the market, highlighting Lotte Chemical Titan Holding Bhd’s initial public offering (IPO) of its retail portion as being undersubscribed as evidence of it.

“I think there is not enough liquidity in the market to support such a huge IPO,” he said.

Against this backdrop, Pong shared that in the second half of the year, the Malaysian equity market is likely to see a flattish performance without much excitement.

However, the head of equity strategies and advisory of Affin Hwang Asset Management, Gan Peng Eng, doesn’t think liquidity will be drying up anytime soon.

“Indication by the ECB and the Fed at QE tapering are pushing fixed income yields back up, but this should not translate into a big liquidity driven selldown in the equity space, although a mild correction is to be expected,” Gan said.

He also does not think that the lack of liquidity in the market was what caused Lotte’s IPO to be undersubscribed, pointing to the fact that there was more than sufficient demand to cover the repriced shares.

“Bear in mind that Lotte’s IPO came shortly after the big RM1.6 billion placement of Maxis in late June, which was done over a short period of time, indicating strong and available liquidity,” Gan explained.

Nonetheless, Gan noted that a quieter trading period was to be expected due to the summer lull period when the market’s direction could be neutral to down, following the rather strong rebound in the first half of 2017 (1H17).

Some quarters reckon the fact that Lotte slashed its institutional offering could be an indication of weak foreign interest although official statistics show that foreign money had made a comeback to the domestic capital market.

Political uncertainties and confidence deficit are still there to keep foreign investors at the sidelines of the Malaysian market, according to a foreign fund manager.

Chris Eng, head of research at Etiqa Insurance and Takaful, also foresees a weaker third quarter (3Q) due to the summer break in the Northern Hemisphere, projecting that the FBM KLCI will retract back to 1,700 level in the coming months before rallying in the 4Q.

“[Investors] are likely to be taking profit after the strong 1H17,” Eng said over the phone, adding that his team would have to reconsider their views if the market does not wind down by August.

However, he noted that the impact from the “Great Unwind” is uncertain and investors may have to take a wait-and-see approach.

“I think the rate hikes itself won’t shock the market since the central banks have been guiding towards it (rate hike) since 2015. However, we are 50-50 on when the Fed and the ECB could shrink their balance sheets, which could be as early as September,” Eng said.

That said, some quarters opine that it might be too early to talk about the end of the low-interest-rate era.

The response to these global changes, however, is likely to remain muted in 2H17 as the interest rate environment is still considered low, according to Choo Swee Kee, executive director of TA Investment Management Bhd.

Choo highlighted that the market might face strong resistance to climb higher due to domestic factors, such as already high valuations in 1H17.

Both Pong and Edmund Tham, Mercury Securities’ head of research, agreed that domestic issues are likely to take centre stage on the local bourse in the near term.

Similarly, a fund manager pointed to an anticipated early general election in the 4Q of this year.

“The market tends to see a rally before the election and I think that would play a more important factor than the liquidity concern,” he said.

The MSCI World Index stood at 1,920.32 on July 5, not far away from its all-time high of 1,936.52 recorded on June 19 this year, indicating that the world market generally is close to its all-time high. In comparison, the index’s highest level before 2008 was only at 1,682.35 on Oct 31, 2007.

Meanwhile, the FBM KLCI has been trickling downwards since it reached its one-year high of 1,792.35 on June 14. It closed at 1,759.93 points, up 7.2% year-to-date. Recall that the local market was not spared at the end of last year when it slumped along with regional bourses following the Fed’s decision to resume its interest rate hiking cycle.

It might be difficult to gauge if Bursa Malaysia could sustain the current rally. One thing is certain — the end of easy money could be just a matter of when, not if. Nonetheless, some believe that the large domestic government-linked institutional funds, such as the Employee Provident Fund and Permodalan Nasional Bhd, will provide the usual safety net.