This article first appeared in Capital, The Edge Malaysia Weekly on May 16, 2022 - May 22, 2022

NEARLY one-third of the market value of the tech-heavy Nasdaq has been wiped off since its recent peak in November 2021, making it the first index in the US to fall into bear territory, which is defined as a 20% drop from the peak. Not surprisingly, there are fears that the contagion could spread to other US indices and global markets as well.

The S&P 500 — which tracks the performance of the top 500 companies in the US — is on the brink of a shift to bear territory as it has slipped 18% from its peak early this year. At the same time, the Dow Jones Industrial Average — which tracks the top 30 blue-chip stocks — was down 13.5% over the same period.

As the Nasdaq is more sensitive to interest rate hikes, its fall was relatively sharper.

Closer to home, the Bursa Malaysia Technology Index has not been spared either, having tumbled 34.3%. This has pushed the industry price-earnings (PE) ratio to 25 times from slightly more than 30 times in 1Q2022.

The head of a bank-backed research house who declined to be named says the downside risk in US markets should not be underestimated from the valuation perspective.

“If you look at the S&P 500, on a trailing PE basis, it is trading at close to 20 times compared with just 10 times during the stagflation period in the 1970s and 1980s. So, if you want to be very brutal about valuations, we have a long way down to go. Note that the S&P 500 has just broken the 4,000-point level,” he tells The Edge.

Shrinking liquidity is another bane for equities amid an environment of quantitative tightening by the US Federal Reserve and rising interest rates, he adds. “The fund flows in the capital market have become weaker. That does not help the situation when earnings growth in the US could disappoint in the upcoming quarters.”

That said, he believes that when a bear market hits, the Fed is likely to step in by trimming interest rates and this will eventually attract investor interest in equities again.

Given the uncertainties in the US markets, Kenny Yee, head of research at Rakuten Trade Sdn Bhd, does not rule out a further drop in the S&P 500 and Dow Jones.

“Interest rate hikes are the major factor. Although the Fed said it will not be very aggressive in tightening, high inflation could push up raw material prices.”

Last Wednesday, Bloomberg reported that Fed officials reinforced chairman Jerome Powell’s message that half-point interest-rate increases are on the table in June and July, and that a larger 75 basis point hike could be warranted later in the year. US consumer prices remained at a 40-year high, rising at an annual pace of 8.3% last month.

While the local bourse may see a knee-jerk reaction to the slump in US equities, Yee is confident that global funds will reposition themselves back to Asia when the headwinds ease.

He stresses that the correlation between the US and local market is not strong — for example, the FBM KLCI only gained 12.8% in the past two years against a much bigger 34% jump in the Dow Jones.

“In the next few weeks, the FBM KLCI is likely to trade in a tight range. Foreign fund flows have been improving, so I don’t think there will be a major sell-off by foreigners.”

The most recent bear market for the FBM KLCI was in March 2020. It was the result of a slew of unfavourable events, including the Covid-19 outbreak, crude oil price plunge and political uncertainty.

During the same period, the Dow Jones, S&P 500 and Nasdaq slumped 34%, 32% and 29% respectively. Nonetheless, global markets swiftly rebounded on ample market liquidity.

During the 2008/09 global financial crisis, the US saw its second-worst bear market in history as half the market value of its three key indices was wiped out.

Looking at the current situation, Victor Wan, head of research at Inter-Pacific Securities, believes that companies listed on the S&P 500 and Dow Jones that are more diversified will continue to register growth, notwithstanding the slump in the Nasdaq.

“The drop we saw in the pandemic period is not going to be repeated anytime soon. We are certainly on track for recovery. With growth available, the stock market will react accordingly.

“Nonetheless, upside may be limited because US stocks are still the most expensive in terms of valuation. Comparatively, European and Asian equities have corrected a lot. So, I think the sell-off is not on a global scale. But if oil prices shoot [up] again, that could exacerbate the cautious outlook,” he notes.

Although US recession fears are growing, analysts generally believe the risk is not imminent, at least in the near term.

“If you look at the US, the probability of recession is just 25%, so it is relatively low. I don’t see that being a problem yet. The GDP (gross domestic product) forecast, according to Bloomberg estimates, is still positive. It takes more than an inverted yield curve to signal a recession. Although growth has slowed down, it doesn’t mean that we are going into a recession,” explains Wan.

The head of the bank-backed research house agrees, noting that the US economy still looks positive with high employment and housing prices, as well as expected strong GDP numbers.

However, rising interest rates will result in higher borrowing costs, hence discouraging investment and business expansion. High inflation is also a deterrent to consumer spending.

Overall, the head of the bank-backed research house says Malaysia has been a relatively good market owing to its exposure to commodities. His advice is to go for defensive blue-chip plays rather than small-cap stocks.

“Banks so far are not bad, with no signs of worsening non-performing loans (NPLs). The asset quality of banks is still very much under control. Investors are expecting the reopening of the economy and business activity expansion to give some lift to banks. Earnings will be there, but because of the external environment, the risk has gone up.”

He is cautious about the business outlook for tech stocks as some are facing component disruptions owing to China’s lockdowns.

“That’s why some of them may disappoint in this earnings season. It is not because orders are coming down, but due to supply bottlenecks. It is very much dependent on whether investors are patient enough to ride through this situation,” he opines.

Wan is concerned about tech players’ margins given the lack of raw materials to capitalise on higher prices. “Companies that are dependent a lot on China and Taiwan for their parts will also be impacted.”

Meanwhile, the bank-backed research house head warns that plantation stocks — which have been the top performers on Bursa Malaysia with a 25.7% gain year to date — are trading at toppish valuations. In the event that Indonesia lifts its export ban, it may trigger a big sell-off in plantation stocks.

Indonesia had announced on April 22 that it was restricting the export of palm products in a bid to ensure the availability of food products at home.

Despite choppy trading, Wan observes that the FBM KLCI has found near-term technical support at the 1,550-point level, which corresponds with the 200-day moving average.

“In any case, it will try to hold at that level. Our valuations are looking fairly attractive. There shouldn’t be too much downside anymore. We are backed by commodities and the very strong manufacturing sector,” he adds.

Year to date, the FBM KLCI has slipped a mere 0.7%.

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