Lead Story: Value emerges after panic selling over fears of a US recession

This article first appeared in Capital, The Edge Malaysia Weekly, on April 1, 2019 - April 07, 2019.
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LAST week, a torrent of recession- themed news reports, coupled with the US’ inverted yield curve — a huge development according to Bloomberg — prompted a swift retreat from the markets. The FBM KLCI was not spared, crumbling to its worst week of the year so far.

But on the bright side, analysts say that the heavy selldown has resulted in value emerging.

“It is true that the inverted yield curve has triggered some concern over a potential recession in the US, but we do not think that alone is conclusive in predicting a recession. We think that the market selldown amid the uncertainty could create buying opportunities for some traders as well as long-term investors as share prices [have] come down to attractive values,” says Rakuten Trade Sdn Bhd vice-president of research Vincent Lau.

Even before the US Treasury yield curve inverted, Maybank IB Research head of research Wong Chew Hann was advocating Malaysian equities following a sharp decline in the market in March. 

The potential was highlighted at the recent Invest Malaysia 2019 Capital Market Forum. 

“With the FBM KLCI having fallen so much, there is definitely value for investors,” she tells The Edge, noting that some foreign funds look at the stock market from a top-down approach while others prefer a bottom-up approach.

“For those who wanted to exit Malaysia, I think they would already have done so by the end of last year. In February, there was selling but it was likely due to profit-taking after January’s net buy into the equity market.

“What has happened recently [in March] is likely to do with the rebalancing of the MSCI Index, where China has a higher allocation. We see that foreign funds are also selling in Thailand,” Wong observes.

Affin Hwang Asset Management portfolio manager Lim Chia Wei believes it is too early to conclude that a US recession is imminent. “The US yield curve inversion (10-year against 3-month) is a useful indicator to measure recessionary risk. However, there are cases when yield curve inversion is temporary and does not lead to a recession. It is important to monitor if the curve inverts further or reverts to a positive curve in the coming months.

“Apart from the yield curve, the US Leading Economic Index (LEI) is also a good indicator of recessionary risk. The US LEI is healthy and is not indicating an imminent recession. It is best to look at various indicators as a whole instead of looking at each indicator in isolation. At the moment, it is not conclusive that a US recession is imminent in the next 12 months.”

He also points to the pickup in China’s credit impulse amid signs of economic stabilisation and green shoots of recovery. “Optimistically, if China’s stimulus takes form and if there is a resolution to the trade dispute, global trade could then pick up and lead to improved growth.

“We believe that the majority of stock market participants are reading the yield curve as an indication of higher recessionary risk, but that is not conclusive by itself. After the knee-jerk decline on March 22, stock markets have recovered in the following days.”

He says Affin Hwang AM will continue to monitor recessionary risks closely and reposition as the global environment shifts. “Global growth has slowed down and in such an environment, sectors with structural-growth stories that can deliver above-average returns tend to do well despite higher valuations. These include the internet and software sectors, which we like.”

CIMB Investment Bank Bhd head of Malaysia research and regional head of agribusiness research, Ivy Ng, also shrugged off talk of a US recession. “We are not expecting a recession in the US. While US gross domestic product growth is slowing in line with expectations as fiscal stimulus fades, steady demand in the private sector, positive labour market developments and, more recently, a more dovish and patient US Federal Reserve are likely to provide support for continued economic expansion,” she says.

She adds that the bank’s preferred sectors include glove manufacturers, oil and gas (O&G) and healthcare, as well as companies that have defensive earnings and good dividend yields.

“In our strategy report, we provided six investment themes for 2019, which are M&A (mergers and acquisitions), the US-China trade war, GLC (government-linked companies) reform, companies that offer defensive earnings, companies that offer high dividend yields and stocks that may have been oversold,” Ng says, adding that the bank is “underweight” on construction and building materials at the moment.

The small cap space is also attractive in terms of valuations owing to the small-cap index’s underperformance against the FBM KLCI last year — the potential exploited by savvy investors who jumped in late last year or earlier this year to boost the small-cap index.

What is holding investors back?

Maybank IB Research’s Wong believes investors may be cautious due to subdued earnings growth as well as policy risks.

“As for those who look to take positions in the bigger cap stocks or those within the FBM KLCI, I think there are two main issues. First is the subdued corporate earnings growth. In fact, for our research universe, market earnings for last year were actually on a decline. Growth was negative.

“It [earnings growth for the market] was flattish in 2014, 2015 and 2016 and we saw a bit of a rebound in 2017 at about 6% to 7% but it fell back into negative territory last year.”

Foreign investors also want policy stability, which to them is still lacking even though the Pakatan Harapan government has been in power for nearly a year.

“We saw what happened last year to the telco sector, construction and even casino operators. I think there are a few more policy decisions pending that the government will need to sort out this year, and that people are watching closely to see how they unfold,” Wong says.

Maybank IB Research is “overweight” on the O&G sector.

Wong says year to date, the crude oil price has rebounded and the bank expects it to stay at an average of US$65 per barrel for the year. Moreover, the Petronas Activity Outlook report for 2019-2021 indicates that activities in various O&G segments are expected to be better, which should benefit service providers.

There are a few stock picks in the automotive sector that she likes as some new model launches will help drive demand. Resetting foreign exchange rates with overseas dealers could also enlarge margins.

While construction stocks may have seen some recovery, Wong cautions investors to be careful of slimmer margins even if mega-infrastructure projects, such as the East Coast Rail Link ultimately get the go-ahead.

“If the value [of the project] is lower, I think the margins will come off as well. If you actually win a job with very thin margins, your margin for error is very small. If anything goes wrong, it can be negative for the companies. Whether to take positions, I think investors should be more cautious moving forward,” she says.


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