Cover Story: Six factors that could derail the market recovery

This article first appeared in The Edge Malaysia Weekly, on July 6, 2020 - July 12, 2020.
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THUS far, 2020 has not been anyone’s year. Equity markets crashed in March, sending shockwaves around the world amid mounting concern that the Covid-19 outbreak would drag the global economy into a recession as severe as that of the Great Depression in the 1930s.

As the outbreak gained pace, policymakers pressed the panic button. Central banks started slashing interest rates in a pre-emptive measure to shield their countries from economic woes.

Cohesive efforts to cut interest rates flooded the financial system with ample liquidity, helping to fuel a strong rebound in equity prices, including on Bursa Malaysia.

The Malaysian stock market bounced back as swiftly as it had fallen. Soon after it hit a 10-year low of 1,219.72 on March 19 during the global rout, the FTSE Bursa Malaysia KLCI regained its upward momentum, rebounding by as much as 29% to a high of 1,575.27 points on June 10.

The benchmark index closed at 1,552.65 points last Friday, down by 2.27% year to date, while some regional indexes are down by over 15%.

The sharp V-shaped rebound in a short span of three months made the FBM KLCI  the top performing index in Southeast Asia.

In the first half of the year, the pandemic ravaged the global economy and changed the way people lived their lives overnight. Governments imposed lockdowns to contain the spread of the virus, which led to the abrupt halt of many economic activities.

But judging by the rally, stock markets do not seem too worried about gloomy economic prospects and the Covid-19 outbreak.

Many stocks have surged to all-time highs this year. They range from Wall Street giants, such as Apple, and Facebook, to glove makers like Hartalega Holdings Bhd and Top Glove Holdings Bhd on Bursa Malaysia.

Rising equity prices have sent valuations in many markets around the world soaring. The benchmark FBM KLCI, already among the most expensive for its size, is now valued at around 20 times earnings — higher than its five-year average of 18.15 times. The local benchmark is almost on a par with major indexes such as the Standard & Poor’s 500, Dow Jones Industrial Average and Nikkei 225.

Is the momentum sustainable as we move into the second half of the year while dark clouds still linger over the global economy, and as a second wave of Covid-19 infections emerges in more countries?

“The rally in the stock market was mostly driven by ample liquidity and the return of retail investors. The level of participation of retail investors in the local market has not been seen since the Asian financial crisis,” says Imran Yassin, senior analyst at MIDF Research.

“If you look at the statistics ... contributions from retail investors have been elevated both in volume and value in April and May.

“There is also a thematic play at hand. Glove players have not only rebounded from the lows, but also gone beyond whatever valuations had been assigned to them previously,” he tells The Edge.

Retail investors and local institutions have picked up good bargains as foreign investors pulled out in the first quarter of the year.

In 1Q2020, net foreign outflows stood at RM7.8 billion. Local investors were net buyers of local equities during the quarter, at a total value of RM7.43 billion, of which RM2.4 billion was from retail investors.

Net buying by local investors continued in the second quarter (2Q2020) as they mopped up a net RM8.55 billion worth of equities, while foreign funds continued to exit the Malaysian market, taking out almost the same amount.

But the world, Malaysia included, is still counting the cost of the pandemic. Economic data has yet to reflect the full impact since the latest numbers available are only up to May.

The rise in unemployment numbers, bankruptcies and overall sluggish demand for goods and services will continue to be felt for months, if not years, to come.

Against this backdrop, will equity bulls remain strong and continue charging to greater heights?

What factors could influence the stock market?

We take a look at six factors that will dictate the market’s direction in the second half of the year.


Factor 1: Anticipation of QE-driven liquidity to lift equity market 

THE rise in the share market in the first half of the year has been attributed to the extra liquidity injected into the domestic market by various stimulus packages, which has perhaps prompted more retail investment, particularly as fixed interest rates are measly.

During the same period, however, major central banks — from the US Federal Reserve to the Bank of Japan — announced asset-buying programmes worth more than US$6 trillion (RM25.7 trillion) to shore up confidence in their country’s assets and currencies.

This has created an expectation that the stock market will see the return of foreign funds sooner or later, as low interest rates in major developed markets could push investors to seek higher yields in the assets of emerging markets.

This anticipation stems from past experience with quantitative easing (QE) launched by the Fed between November 2008 and January 2014.

During this period, the Fed embarked on three rounds of QE, increasing total assets to US$4.5 trillion from US$900 billion by buying up mortgage-backed securities, and debts from home mortgage companies Freddie Mac and Fannie Mae, as well as Treasury securities.

In November 2008, when the US economy was burdened by massive sub-prime problems that almost triggered a worldwide economic crisis, the Fed embarked on an asset-buying programme worth US$700 billion. This was subsequently boosted by US$1.15 trillion of asset-buying in March 2009.

Between November 2008 and August 2009, the FTSE Bursa Malaysia KLCI rallied 30.57% to 1,174.27 points as global investors snapped up emerging-market equities, including Bursa Malaysia’s.

The Fed continued with two other rounds of QE until 2015 and tapered off the purchase of debts and securities only from January 2014, by reducing the amount from US$85 billion a month to US$65 billion.

During the five years of a QE-fuelled rally, the KLCI more than doubled to the 1,872.52 level on Dec 30, 2013 — then the highest point scaled.

Consequently, even though analysts expect more companies under their coverage to disappoint from an earnings point of view, they also expect ample liquidity from both domestic and global sources to support equity prices.

“Bear in mind that we are seeing the markets flush with liquidity, and this liquidity will likely limit the downward pressure on the market, owing to the economic headwinds,” says Jeremy Goh, head of research at HLIB Research, when contacted by The Edge last Thursday.

“With the Fed undertaking an unlimited QE, there is always going to be anticipation that part of this liquidity will find its way to emerging markets, Malaysia included. With the Fed’s unlimited QE arsenal alongside near decade low foreign shareholding, the base now seems more palatable to envision their re-entry.”

He does not discount a pullback in the second half when economic data for the second quarter is fully released. He does not think, however, that the current rally will end as a result.

But its relatively higher premium compared with other emerging markets could pose a problem. Goh says historically, the price-earnings ratio of Bursa Malaysia tended to be 9% higher than that of its peers in Southeast Asia.

But, now, that premium has hit 15.5%, he notes.  “Bursa Malaysia has always been expensive, but it does not derail the liquidity story,” says a confident Goh.


Factor 2: Economic headwinds  

THE stock market cannot run away from economic fundamentals.

The equity bulls are saying that investors should look ahead to next year given that 2020 is already a washout, no thanks to the pandemic. They see economic recovery, corporate earnings growth after the big contraction, improved consumer spending and more job creation. This optimism hinges on the belief that quantitative easing will oil the wheels of economic growth, as it did in the global financial crisis of 2008/09.

By the same token, the equity bears see a gloomy picture before them. They are bracing for an economic contraction, recession, rising unemployment, bankruptcy, dismal corporate earnings, and the collapse of asset prices such as property, and equities.

The World Bank and International Monetary Fund (IMF) have revised their 2020 economic forecasts for Malaysia to account for a larger year-on-year (y-o-y) contraction than previously estimated as the country deals with the impact of the Covid-19 pandemic.

The World Bank said in its June 2020 Malaysia Economic Monitor that Malaysia’s gross domestic product is projected to shrink 3.1% owing to the significant impact of economic disruptions resulting from the Movement Control Order (MCO). Meanwhile, the IMF has revised its 2020 GDP forecast for Malaysia to a 3.8% y-o-y contraction from the previous estimate of 1.7%.

Corporate earnings in the second quarter, which captured two full months of the MCO, will be released next month. Some quarters expect the coming results season to bring share prices back to a more justifiable level.

“The impact from Covid-19 has not fully manifested yet,” Imran Yassin, senior analyst at MIDF Research, tells The Edge.

He cites the example of unemployment. The MCO has caused a large number of retrenchments and if jobs are not created fast enough, the path to economic recovery will be bumpy considering the high household debt.

Bank Negara Malaysia governor Datuk Nor Shamsiah Mohd Yunus has said the unemployment rate will likely surpass the central bank’s projection of 4% made in April. The rate could go up to as high as 5.5%, according to the Department of Statistics.

While the government has allocated a total of RM315 billion in four stimulus packages so far, the measures are aimed at tackling the adverse impact of the pandemic on the economy.

One of the measures in the Prihatin Rakyat Economic Stimulus Package is a six-month loan moratorium. Up to June 12, the total value of moratorium on loans was RM40 billion.

The question most often asked is what will happen after the six-month moratorium period, a temporary shelter for Malaysian households and businesses from the tight cash flow problems they are facing.

Without the moratorium, would businesses have sufficient cash flow to sustain their operations? How will the unemployed individuals service their mortgages and car loans? The domino effect will reach the banks, which will see bad debts creeping up.

Already, S&P Global has revised downwards its outlook on five Malaysian banks from “stable” to “negative” because of expectations of higher non-performing loans.


Factor 3: The pandemic to remain centre stage

THE one clear major headwind for markets today is undoubtedly the Covid-19 pandemic. And it is anybody’s guess when the world will see the end of the outbreak that has cast a shadow over economies and societies around the world.

The pandemic, which crashed like a wrecking ball into markets at the start of this year, is expected to continue impacting economies around the world.

While most markets have adapted well to a “new norm”, observers say they could swing in any direction depending on the outcome of containment efforts.

The consensus among market experts is that the next factor that could result in the return of appetite for risk assets is the containment of new daily Covid-19 cases and the discovery of a vaccine.

On the flip side, there is the risk of a second wave that will cause a broad-based lockdown.

Pharmaceutical companies are racing against time to develop a vaccine, which some say could come as soon as next year.

RHB Group Asset Management managing director and CEO Eliza Ong Yin Suen, however, says if a vaccine is developed in a rushed manner, it could potentially come with side effects.

“It may be too early to celebrate, but having a vaccine is still better than having no vaccine,” she tells The Edge.

The risk of a second Covid-19 wave globally is not improbable as it has already been seen in several countries — including Iran, South Korea and China — so it would be safe to say the markets have priced in that possibility.

Ong says a “worse than anticipated” second wave would be a surprise on the downside for investors to watch out for. She adds that a delay in the development of a vaccine, or if it is only made available for a very small population, would also be a negative variable for the market.

The global tally has been rising and confirmed cases of Covid-19 had reached 10.7 million at the time of writing.

Ong says the new G4 swine flu virus could post a negative surprise as “we do not know the seriousness or the magnitude of this virus”.

Recent news reports suggest the new virus could have “pandemic potential”, but some say there is no need for alarm as “there is no evidence yet of human-to-human transmission”.

Meanwhile, Hong Leong Investment Bank Research head Jeremy Goh says while Malaysia has done well in containing Covid-19, the worldwide count is still rising, led by the US.

The number of new daily cases ranged from 70,000 to 100,000 in April and most of May, but worsened to 150,000 to 200,000 by late June, he notes. This has been driven by a resurgence in cases in the US, Brazil emerging as a hot spot with the second highest number of cases, the worsening situation in India and a second wave of infections in Iran.

Furthermore, risks could be heightened by the widespread Black Lives Matter protests seen in several Western nations, Goh says.

“Summer is supposedly the least contagious season for viruses, and it is already this bad. So, imagine when it goes into autumn — and that would be on top of the [US] election run-up,” he says.

He says the warning by Dr Anthony Fauci, director of the US’ National Institute for Allergy and Infectious Diseases, that the country could see 100,000 daily new cases may not be implausible if the pandemic goes into autumn.

Daily new cases in the US hit a new high of 55,220 last Thursday.

Goh says the markets are pricing in the quick discovery of a vaccine, which, in his view, is a “very optimistic assumption”.

He notes that the vaccine — for mumps — that was developed in the shortest time from scratch took four years. “So, to come out with a vaccine in 12 to 18 months is very optimistic,” he points out.


Factor 4: Political risks may intensify in the second half 

MALAYSIA faces a two-pronged challenge this year: politics and pandemic.

The first emerged in late February when discord over the leadership succession of the Pakatan Harapan (PH) government led by Tun Dr Mahathir Mohamad resulted in a political coup of sorts and the forming of a new coalition government called Perikatan Nasional (PN), led by Tan Sri Muhyiddin Yassin.

From a political perspective, Malaysia is undergoing one of its most unstable periods, given that PN only holds a slim majority of three seats in Parliament.

Before the political dust could settle, the country was hit by the Covid-19 pandemic, requiring the concentration of effort, resources and focus on containing the virus.

PN’s position in Parliament hangs on just three seats — the lowest any coalition has ever had in the country’s 63-year history. Should three parliamentarians switch camps, it will result in a hung Parliament. As things stand, Muhyiddin has yet to obtain his own mandate and prove his mettle.

Because the pandemic appears contained in Malaysia, political pundits expect the manoeuvring to intensify. Already, there has been talk of a proposed no-confidence motion against the prime minister as well as snap polls in the second half of the year.

“The political situation in the country does have a much larger impact (than a geopolitical crisis) on market sentiment. That is because politics is very much a part of corporate policies in Malaysia,” says Fortress Capital Asset Management (M) Sdn Bhd investment adviser and director Geoffrey Ng Ching Fung.

“If and when the political storm arises, and if a snap election is called, then market sentiment will be impacted. The political situation in the country has also led to a change in the mix of investors in the market.

“Year to date, foreign funds have seen a net outflow, partly due to the higher political risk premium that investors place on the country,” Ng says.

A recent revision on the outlook of Malaysia’s foreign currency and local currency long-term sovereign credit ratings to negative from stable, also partly reflects this concern.

Investors’ wariness may have been further spooked by PN replacing top leaders at government-linked corporations and statutory bodies regardless of their performance, with the coalition’s own appointees.

Political analysts say investors are also watching closely the outcome of current criminal cases involving politicians, including former prime minister Datuk Seri Najib Razak and Umno president Datuk Zahid Hamidi.

As we enter the second half of the year, will the government emerge stronger through the defection of more PH lawmakers, or will PN collapse?


Factor 5: Souring geopolitical tensions

APART from the ongoing political drama being played out locally, the re-election campaign of US President Donald Trump and his rhetoric are other factors that may determine where our local market is headed.

“Trump has a great impact on the global market. I believe to win re-election, he has to ensure there are some feel-good factors for Americans to support his campaign,” says TA Securities chief investment officer Choo Swee Kee.

A steady stock market could indicate he has done a great job, Choo says. “At the same time, ‘creating’ a hated enemy like China could rally local support behind him.”

In short, confidence on Wall Street could spill over to emerging markets, including Bursa Malaysia.

Meanwhile, Hong Leong Investment Bank head of research Jeremy Goh believes that “with Trump seeking re-election in November, we reckon US-China geopolitical relations will remain shaky”. The “worsening tensions” between the world’s two largest economies is not going to be good for markets, he observes.

Goh notes that tensions had ratcheted up following a number of developments, including the Covid-19 blame game, Huawei ban, Hong Kong’s new security law and the issue of Uighur human rights.

“While it is in Trump’s interest to see the fulfilment of the Phase 1 deal to bolster the economy amid the Covid-19 outbreak, his hard-line stance on China will likely persist in attempts to shore up support from the right wing electorate, his key base,” he says.

On the other hand, Fortress Capital Asset Management (M) Sdn Bhd investment adviser and director Geoffrey Ng Ching Fung says while the US elections will undoubtedly draw a lot of attention, he does not think the markets’ performance would hinge on the outcome. Rather, it would depend on policies put in place by the government of the day.

He says Trump’s external policies have been good for the US markets, which have led to the US markets being seen as safe havens.

Allianz Global Investors director and co-portfolio manager Stephen B Jue says the US-China trade war “is not going to go away, regardless of who is the president” as the views of the Democratic candidates on China are similar to Trump’s.

“So, I don’t think that there will be too much change from a policy perspective. It is unclear if there is going to be a lot of change. But right now, the support from the Senate and Congress is on the economy, in getting it to recover.

“So, regardless of who wins, everyone is aligned on the recovery scenario of the economy, such as providing jobs, providing stimulus and support for certain industries and keeping rates low.”


Factor 6: The oil and gas factor

THE steep fall in oil prices this year certainly does not bode well for Malaysia, a net exporter of crude oil and gas. Brent crude plunged 71% between Jan 2 and April 21, hitting a low of US$19.33 per barrel. On April 20, the West Texas Intermediate contract for May delivery fell into negative territory, diving to -US$37.63 per barrel.

The government had based its 2020 budget on an average oil price of US$62 per barrel. So far this year, Brent crude has averaged US$42.30 per barrel.

For every US$1 drop in crude oil price, Malaysia loses an estimated RM300 million in revenue. This means that so far this year, the government’s revenue is down by RM5.9 billion. This does not include the shortfall in revenue due to the shutdown of the economy during the Movement Control Order period.

Nevetheless, as more countries reopen their economies, the demand for crude oil will return, predicts Imran Yassin, senior analyst at MIDF Research.

At the same time, the decision by the Organization of the Petroleum Exporting Countries (Opec) and its partners to cut production by 9.7 million barrels per day, which started in May, will support crude oil prices in the short term, he says.

“I don’t expect oil prices to hit record lows again in the second half. However, at the same time, don’t expect oil prices to rise in the second half either. There is still ample supply of crude oil in the market, and the sluggish economy means that demand will not increase very much,” he adds.

One of the factors that differentiate Bursa Malaysia from its peers in Asia is the high number of oil and gas stocks it has. The movement of crude oil prices will influence the share prices of O&G companies on the local stock market.

Petroliam Nasional Bhd (Petronas) has already announced capital and operational expenditure cuts of 21% and 12% respectively this year. This will impact the awarding of contracts to Malaysian O&G operators, as the national oil corporation is the largest source of jobs for the sector.

In the first quarter of the year, new contract awards to local O&G operators had dropped 74% quarter on quarter, and 70% year on year, to RM569 million, says AmInvestment analyst Alex Goh. The worst is yet to come from 2Q2020 onwards.

In a July 1 report, Goh writes that he expects oil producers to proceed with their planned production cuts this year, given that demand for oil and oil products remains depressed globally amid the prolonged movement restrictions and social distancing measures.

“We maintain our view that most participants in the sector, except those in storage and recurring maintenance services, will be adversely impacted.

“Those with upstream production-sharing contracts such as Sapura Energy and Hibiscus Petroleum will suffer from lower prices and offtake, followed by fabricators such as MMHE and offshore support providers Bumi Armada and Velesto Energy,” Goh says in the report.

“However, the earnings of service providers involved in maintenance and tank storage facilities such as Dialog Group and Serba Dinamik will be resilient against the cyclical nature of industry dynamics,” he adds.





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