This article first appeared in The Edge Malaysia Weekly, on May 30 - June 5, 2016.
THE saying “sell in May and go away” seems to ring true this year. The FBM KLCI began its slide late last month and while it has stabilised somewhat, Bursa Malaysia, overall, saw its market capitalisation fall 2.6%, wiping out RM42 billion up to May 23.
The benchmark index was down 3.4%, underperforming Bursa’s smaller caps and other emerging markets.
After climbing to a high of 1,727.99 points in April, the FBM KLCI began its decline later in the month on news that 1Malaysia Development Bhd might default on its loan repayment. Shortly afterwards, emerging market indices plunged, swiftly erasing all gains accumulated in the previous months (see Chart 1).
On May 2, the US dollar rebounded from its one-year low on higher expectations of a rate hike by the Federal Reserve in June. Consequently, the ringgit reversed its upward trend and breached the psychological level of 4.0 against the greenback three days later, which, in turn, accelerated foreign selling of the big caps.
News that Malaysia will see its weighting in the MSCI Emerging Markets Index fall to 3.09% from 3.36% — the steepest decline in Southeast Asia — on June 1 did not help either. Credit Suisse estimates that this will result in a net outflow of US$399 million from the country as passive index-linked funds adjust their portfolios on May 31.
Of the RM42 billion lost in market value, the telecommunications services sector accounted for more than half (see Chart 2), on expectation of rising dividend risks with the upcoming spectrum payments. The other four sectors that brought down the overall market performance were materials (15%), energy (13.5%), healthcare (11.9%) and information technology (7.2%).
The underperformance of the materials sector was mostly due to two companies — Petronas Chemicals Group Bhd, one of the companies most impacted by the MSCI review, and Cahya Mata Sarawak Bhd, which posted a staggering 98% drop in 1Q net profit to a mere RM1 million.
Energy stocks continued to perform poorly every month this year, although Brent crude has recovered from a multi-year low of US$28 per barrel in January to US$50 a barrel currently. Investor sentiment on the sector, particularly in the upstream space, is probably still overshadowed by cuts in capital and operational expenditure by industry leader Petroliam Nasional Bhd.
Export-oriented glove makers, a subset of the healthcare sector, and information technology companies have been the worst performers so far this year. After a spectacular rally last year, they became easy unwinding targets for investors who wanted to realise handsome gains when the ringgit strengthened in the first quarter.
In absolute terms, telecommunications companies have seen RM27.1 billion in market value evaporate since the beginning of the year — more than the combined losses of the rest of the underperforming sectors (see Table 1). How did the telecommunications services industry, a textbook example of defensive business, become the primary sector that drove down overall market performance?
Apart from dividend risks and heightened competition, the root cause could be government fiscal stress constraints amid declining oil revenue. A foreign bank analyst explains that telecommunications spectrum reallocation, like the Goods and Services Tax, foreign worker levy increase and cigarette excise duty hike, is a result of the government transferring the fiscal pain to the private sector and consumers.
Table 2 shows a list of companies that lost most market value year to date. Telcos (Maxis Bhd, Axiata Group Bhd, DiGi.Com Bhd) and the Petronas group of companies (MISC Bhd, Petronas Chemicals Group Bhd, Petronas Gas Bhd) top the list with RM26.7 billion and RM17.9 billion wiped out respectively so far this year.
However, it is not all doom and gloom. Financials, utilities, industrials, consumer staples and discretionary outperformed the FBM KLCI. Thanks to kitchen-sinking exercises last year, trough valuations and subdued non-performing loans, financials were the best performers with a 1.7% year-to-date gain. Utilities and food and beverage companies too outperformed as investors went defensive and sought comfort in their earnings visibility.
Having slumped to multi-year lows, commodity prices have somewhat recovered this year, leading to a rise in the share prices of metal companies across the board. Producers located at the lower end of the global cost curve are likely to be the prime beneficiaries. That said, all were not spared in the broad market selldown in the past month as liquidity exited Malaysia.
Based on the 1Q results, corporate earnings have yet to recover. While banks, by and large, delivered a relatively good set of results, the 544 non-bank companies that have reported their results saw their net profit drop 4.3% from a year ago. The sectors that dragged down corporate earnings were consumer discretionary, utilities, property and oil and gas (O&G) services. As a result, analysts are likely to revise downwards their earnings estimates.
Chris Eng, head of research at Etiqa Insurance & Takaful, says brokerage houses are likely to cut their FBM KLCI year-end targets following poor 1Q earnings. “After the recent selldown, I would say the valuation of FBM KLCI is fairly balanced now. The key indicators that will drive market performance going forward are US interest rate hikes, currency and oil prices,” he observes.
“The ringgit could fluctuate within a 10% band in the near term but foreigners are likely to come back to Malaysia once it hits 4.2 against the US dollar. Sector-wise, the only bright spot at the moment is construction. Banks and property companies are still facing economic headwinds while the positives for airlines have already been priced in.
“As for market strategy, buy on weakness. The volatility could present opportunities for investors to buy quality stocks at lower prices.”
Danny Wong, CEO of Areca Capital Sdn Bhd, opines that earnings are still on a downward trend but there are signs of improvement. “Banks, for instance, posted better earnings this quarter due to cost-control measures implemented last year. In general, Malaysian corporate leaders took measures to control costs late last year as they expected global and domestic demand to slow down,” he says.
“As it could take six to nine months for the measures to translate into an improvement in the bottom line, we hope to see better earnings in the second half of the year. If commodity prices continue to recover, this will be good news for the government’s budget and ringgit. Although consumer sentiment remains weak now, it may recover by the fourth quarter of the year, judging by the experience of other countries that implemented GST before us.
“The key indicators to watch include the strength of US recovery, China’s debt market and how well China manages the bad loans, as well as Japan’s economy. At home, the interest rate is worth watching. If it remains at the current level, that is, below 3%, there is a possibility that Bank Negara Malaysia will release liquidity by cutting the statutory reserve requirement (SRR) or lowering interest rates to boost growth.”
Note that the central bank cut the SRR in January to 3.5% from 4% to add liquidity to the banking system.
“In terms of market strategy, we think banks are suitable for long-term investors now, although the returns in the short term may not be exciting. Growth investors can look at plantations and O&G because commodity prices are strengthening. Glove makers and technology firms are worth a revisit in 2H2016 due to their battered-down share prices. As for consumer product stocks, they could be worth a look if consumer sentiment improves in 4Q,” says Wong.