Cover Story: How FBM KLCI fell behind regional peers

This article first appeared in The Edge Malaysia Weekly, on November 27, 2017 - December 03, 2017.
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ASIAN emerging markets have been enjoying a bull run but clearly not Bursa Malaysia.

Even higher-than-expected quarterly economic growth, consistent double-digit export growth and a stronger ringgit have not been able to stoke interest in the FBM KLCI.

The local benchmark had, in fact, moved in tandem with the general upward trend in the global markets in the first half of the year but diverged towards the latter half.

It is one of the worst performers in Asia-Pacific, recording a one-year gain of only 5.57% as at last Thursday compared with more than 20% by some of its regional peers.

Singapore’s Straits Times Index saw an 20.55% gain in the same period while Japan’s Nikkei 225, Hong Kong’s Hang Seng Index and South Korea’s KOSPI grew 24.01%, 31.01% and 27.63% respectively.

Interestingly, the star performers among the Asian emerging markets are the Philippine Stock Exchange Composite Index, which posted a 21.7% one-year gain, and the Ho Chi Minh Stock Index, which rose 37.95%.

Other indices that saw sub-20 percentage point growth were Indonesia’s Jakarta Composite Index (16.33%) and Australia’s S&P/ASX 200 (9.15%).

The robustness of most markets around the globe has been mainly driven by economic growth in the US and Europe, thanks to healthy corporate earnings and economic numbers.

“The FBM KLCI also saw some improvement due to the global factors but sadly, this has been offset by foreign selling,” says TA Securities Holdings Bhd head of research Kaladher Govindan.

MIDF Amanah Investment Bank Bhd’s Nov 20 fund flow report indicates foreign fund selling of RM297.1 million in the third week of November — the highest weekly attrition in seven weeks.

A reason for the foreign selldown could be the impending 14th general election, says an analyst with a foreign research house, as it is unclear when it will be held and how it will be run this time around.

He adds that Malaysia seems to be heading down the same path as Thailand, the US and the UK, in that there will be an increasing divide between the rural and less-educated population and the urban and better-educated population.

“In this country, the urban population will vote against the government while the rural population will vote for it, which raises issues about stability and unity. How will the government deal with this?”

He notes that although the ringgit has gained some ground, a run on the currency over the last few years has made some foreign funds wary of Malaysia.

“Malaysia slipped off their radar because of the underperforming currency, racial issues and 1MDB saga. Corporate results in the last few years have also been generally disappointing.”

He says some of the local institutions have also been selling, worsening the impact of the foreign fund outflow. But he notes that the Malaysian market is relatively cheap in terms of valuation and foreign exchange rates, which has seen the return of some foreign funds.

TA Securities’ Kaladher says the selldown is overdone because Malaysia’s economic fundamentals and growth still look positive, especially with Bank Negara Malaysia’s announcement of 6.2% GDP growth in the third quarter of the year, bringing average growth for the first three quarters to about 5.9%.

“The underlying economic fundamentals are still good. It’s probably just a case of perception and uncertainty over the election,” he says, adding that the local benchmark could see a rally in the first half of next year to the 1,800 to 1,900-point level but thinks the market may see a correction in the second half if the US pushes through more rate hikes.

Kaladher points out that most are expecting at least four hikes by the US Federal Reserve by the end of 2018.

“A 25 basis-point-hike of four will amount to a one percentage point increase. This will narrow the yield gap between their 10-year treasury and the 10-year Malaysian government securities, which would make Malaysian equities less attractive,” Kaladher says, adding that this would encourage selling.

There could be some pressure amid the US’ fiscal tightening and planned tax cuts, further supporting the possibility of rate hikes, he observes.

Meanwhile, ICM Research Pte Ltd general manager Jonathan Chi says growth in the emerging economies will have a lot to do with domestic demand and confidence in the country and economy.

“Domestic demand is driving countries like Vietnam and the Philippines and investors are piling in because of the potential in these countries, such as low levels of homeownership in Vietnam, low levels of smartphone penetration in the Philippines and deregulation and infrastructure spending in Indonesia.”

He adds that 2018 could be generally positive for the FBM KLCI, assuming positive corporate performance.

JP Morgan head of Asia ex-Japan equity research James R Sullivan says the rally in emerging markets has been largely driven by strong and broad-based earnings growth across many sectors.

The research house expects a 15% upside for emerging market equities in 2018 with 12 percentage points of the upside to stem from earnings revisions and only three percentage points from valuation expansion.

“We are anticipating a shift, moving away from external, export-oriented sectors towards companies that capture domestic-oriented growth. Furthermore, while we are ‘overweight’ on the tech sector and will continue to be so, we are downgrading our view of the consumer demand-driven Apple supply chain. Instead, we see revenue leadership in the tech sector coming from enterprise, like semiconductor players,” says Sullivan.

In its Emerging Markets Investment Strategy note, JP Morgan says the potential for emerging markets to continue to outperform is high, forecasting 2018 GDP growth for emerging markets at 4.9% compared with 2.1% for developed markets.

The higher growth expectation is based on a solid pickup in global trade amid a rise in private sector confidence and the emerging market credit impulse turning positive for the first time since 2011.

The policy rates are expected to see a marginal decline to 4.73% by June 2018 from 4.82% at present. “Our economists’ base views are that in the event of renewed US dollar strength, emerging market central banks are likely to accommodate it rather than contain it with either foreign exchange intervention or rate hikes,” the note says.

For emerging markets, JP Morgan has an “overweight” rating on China, South Korea, Brazil, Russia and Peru, and a “neutral” on Malaysia. The research house is “underweight” on South Africa, Mexico, Turkey and Colombia.

In terms of sectors, it is “overweight” on technology, financial, consumer discretionary and material and “underweight” on energy, utility, industrial, consumer staples and telecommunications services.

The research house expects global growth to be sustained above trend amid “a self-reinforcing dynamic of rising sentiment, supportive financial conditions and synchronisation”. It adds that a rebound in capital expenditure is expected to be the fuel for growth in 2018, supported by strong profits, high confidence and low rates.

Key external risks include possible restrictive trade policies by the US, a strengthening of the US dollar, a correction in emerging market technology stocks and inflation dynamics.