This article first appeared in Capital, The Edge Malaysia Weekly on April 27, 2020 - May 3, 2020

THE Dow Jones Industrial Average quickly moved back into bull territory on March 26, less than two weeks after US stocks suffered their worst decline since 1987. Although market experts warned that the bear could make a comeback, some bullish investors ignored the caution and rushed into recovery bets.

It turns out that the Federal Reserve’s response of pumping trillions of dollars of temporary liquidity into Wall Street has been rather effective, as it provides a short-term safety net for the market.

But closer to home, the FBM KLCI is up by only about 10%, which means the local benchmark index is still very much in a bear market (see table).

To a large extent, the Covid-19 pandemic and recession fears have overshadowed the stimulus efforts by the Malaysian government, as these factors continue to weigh on the local stock market.

Moreover, the jaw-dropping collapse of oil prices last week could not have happened at a worst time, considering the importance of oil to the country’s finances and economy.

So, is it too soon for us to think about exiting the bear market and re-entering the bull market? Should investors be concerned that the KLCI is currently lagging the Dow?

Maybank Investment Bank head of research Anand Pathmakanthan points out that while the KLCI does not technically fulfil the “20% recovery from recent low” definition of a bull market, it is not too far off either.

“The key drags for the KLCI against other markets, including the US, are the very tight fiscal constraints faced by the government just when the economy needs a massive stimulus due to Covid-19 disruptions,” he tells The Edge.

Anand notes that of the total RM260 billion in economic stimulus measures to date, only RM35 billion — which represents about 2.3% of gross domestic product (GDP) and is a much lower ratio than spending by most other countries, including the US — is direct government spending.

“[The] extremely low oil price is also a major fiscal drag, given that oil contributes about 20% of total government revenues, while a slowing economy will hit corporate tax receipts hard, as corporate tax contributes about 30% of total government revenues,” he explains.

Higher risk premium

Nevertheless, Anand says investors should not be concerned about the KLCI lagging overseas indices.

Instead, they should be aware that the government’s capacity to help the economy is limited and hence should focus on stocks that can “help themselves” through this crisis rather than having to depend on government support.

“The KLCI has already seen a decent recovery from its lows as fears of a ‘world is ending’ scenario — extended lockdowns, mass bankruptcies, shortage of US dollar liquidity — have receded with the massive fiscal and monetary support seen around the world,” he says.

Maybank IB’s current year-end target for the KLCI is 1,490 points, which is 15 times its 12-month forward price-earnings ratio.

AmInvestment Bank research head Joshua Ng highlights that the Dow has retraced over the last few days and may not be in bull territory anymore.

But the fact remains that the KLCI has not gone up as much as the Dow, partly due to the perceived market risk premium for Malaysia, which could stay slightly above average as the dust settles.

“The rout in the oil market could be weighing on the ringgit as Malaysia is one of the few net exporters of oil and gas in the region,” he says.

While the US’ equity and bond markets have recovered substantially from the bottom, Joshua points out that the buying has not been broad-based but, instead, skewed towards tech stocks and investment-grade bonds.

“In other words, the undertone remains cautious and there is still limited appetite for risk assets such as emerging market equities and bonds, including Malaysian equities and bonds,” he says.

Stocks diverge from economy

At times, the performances of the market and economy diverge.

Pheim Asset Management Sdn Bhd founder and chief strategist Dr Tan Chong Koay recalls that during the Asian financial crisis, the KLCI hit its lowest point of 262.70 on Sept 1, 1998, when the economy was worsening.

In the third quarter of 1998, Malaysia’s economy contracted 10.2% and declined further to -11.2% in the fourth quarter, he recalls.

“The KLCI went up 39.95% to 367.64 on Oct 1, 1998, one month after Sept 1, 1998, and up further by 97.47% to 518.75 three months after Sept 1, 1998 when the economy was more than bad,” says Tan.

Therefore, he advises long-term investors to consider buying shares in companies with low gearing and good management — as they stand a better chance of recovering — and at good discounted prices.

“Investment is an art. Investors who read the major trends right will win,” says Tan.

According to him, the big and small to mid-caps that have the least potential to recover or grow may face challenges unless they are priced at huge discounts.

“The KLCI has big caps that do not expect to grow at the higher rate they used to. With Covid-19, we expect earnings will slow down significantly, though I believe the KLCI will do better in 2021 as the world economy recovers,” says Tan.

“Shares that have dropped significantly and are way below their intrinsic value will have a chance to recover to a more normal level or closer to the intrinsic value, offering the opportunity to make some profits,” he elaborates.

Fortress Capital Asset Management (M) Sdn Bhd investment adviser and director Geoffrey Ng Ching Fung says the Dow represents not only a bellwether equity benchmark for the world, but also the world’s reserve currency — the US dollar.

At a time of unprecedented uncertainty such as now, risk aversion causes significant investment liquidity to be kept in US dollars as a safe-haven currency.

“A combination of these factors has generally led to the Dow’s outperforming the KLCI, which is unfortunately still seen as an emerging market index. This is also corroborated by foreign fund outflows from equities, which stood at RM7.6 billion during the first three months of 2020,” he says.

Meanwhile, the fundamentals of the Malaysian economy are not positive, as the domestic economy is falling into recession. This is aggravated by the fact that export receipts are also reduced due to the lower prices of oil and other commodities, slower manufacturing activity and a weak currency.

“Unlike other periods of economic crisis, Covid-19 impacts a much wider segment of the economy, where even the service economy, which historically tended to be defensive, is seeing very significant disruption,” says Geoffrey.

He adds that investors should stay cautious, as it remains to be seen what the effects of the current Movement Control Order (MCO) and trade shocks will have on consumers, companies and the general economy.

“We will start seeing the effects with the quarterly earnings results season over the next few weeks, but the largest impact will only be seen in the next few quarters,” Geoffrey adds.

Bull trap

GrandPine Capital Sdn Bhd head of research Alfred Chen warns that from a technical chart perspective, a big gap emerged on March 13 this year, when the KLCI’s 1,400 support level was broken. In charting, gaps refer to blank spaces in technical price charts when no shares were traded within a certain price range.

Notably, the recent rebound has closed this gap, hence investors need to be careful of the bull trap.

“I would think the recent KLCI movement is a ‘bull trap’ rather than [ a case of] ‘re-entering the bull market’. We lack catalysts to see the return of a bull market. If the current Covid-19 crisis continues to affect business activities, the KLCI may go down to the 1,200-1,000 level,” Chen predicts.

“Frozen business activities due to the MCO and international trade interruption, falling corporate earnings, possible high unemployment rate … how can we expect a bullish market when we are facing a recession?” he asks.

Chen recalls that the KLCI hit its peak of 1,896 points on April 20, 2018, before the 14th general election.

“After Barisan Nasional lost the election, the KLCI has been heading south. On the other hand, the Dow climbed to the 29,500 level in February this year, before the Covid-19 outbreak suddenly hit the US financial market,” he says.

The Dow’s free fall caused panic selling in the US market. However, a sharp fall usually comes with a stronger rebound.

AmInvestment Bank’s Joshua believes the market will continue to tread cautiously until and unless the pandemic is effectively contained or a vaccine is developed and made available, allowing economies around the globe to gradually open up again.

The research house has an end-2020 KLCI target of 1,300 points.

“Technically, we believe that the market is bracing for a consolidation phase over the next one month, with a downside target of between 1,280 and 1,320 points, which represents a 50% retracement from the highs registered during the recent rebound,” he says.

With a stronger base after the consolidation phase, there is a good chance that the market can rally to retest the recent high of 1,428 points, driven by catalysts such as the reopening of global economies as the pandemic subsides, Joshua concludes.

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