This article first appeared in Capital, The Edge Malaysia Weekly on November 29, 2021 - December 5, 2021

FOREIGN funds have been net buyers of Malaysian equities for seven straight weeks, although their net buying narrowed sharply to RM66.61 million for the week ended Nov 19 from RM359.14 million in the previous week.

This comes on the heels of a change in government two months ago, which investors generally took to be a positive. However, the prospect of higher interest rates in developed markets (DMs) and a stronger US dollar could weigh on fund flows to emerging markets (EMs), including Malaysia.

Since early this year, foreign funds have been net sellers to the tune of RM1.68 billion, according to MIDF Research. Retailers were the only net buyers to the tune of RM11.59 billion during the period, while local institutions sold a total of RM9.9 billion.

Foreign shareholding of Malaysian equities fell 0.2 percentage points month on month to 20.2% as at end-October, according to CGS-CIMB Securities’ Nov 22 note.

“Some funds are facilitated by cheap borrowing costs in the US, so the tendency will be greater for carry traders to borrow and invest in the EMs. When US interest rates start to increase, it may close the window for fund inflows into EMs,” Kenanga Research head Koh Huat Soon tells The Edge.

Another factor to watch out for is currency risk.

“The market is expecting a stronger US dollar. So, generally, it is not so good for fund flows to EMs. Foreign investors came in because the rate cycle is still friendly, with surprises from commodity prices. When US interest rates rise and the US dollar strengthens, then there could be a reversal in fund flows.”

In the past few days, the ringgit has slipped further, shooting past the 4.20 level. As at 7pm last Thursday, the local currency was trading at 4.2260 against the greenback.

Koh says when US interest rates rise too fast, it is likely to have a negative impact on the equity market.

“There is a likelihood that bond yields will follow suit. Obviously, the cost of capital will increase, then valuations will have to come down. This is the general case. Note that the Malaysian Government Securities are highly correlated to US Treasuries.”

Having said that, he says investors can expect a mixed impact on the equity market if interest rates were to rise to contain aggressive inflation.

“In sectors where companies are able to pass on cost increases to consumers, then these companies will be able to outperform. Companies that are highly geared and with high borrowing costs will suffer, whereas companies with a healthy balance sheet and cash levels will benefit relatively.

“If commodity prices remain elevated, it will be good for plantation and oil and gas companies.”

Overall, Koh thinks the less exciting corporate earnings outlook has been priced in, and Malaysia is still attractive, underpinned by high commodity prices.

Loui Low, head of research at Malacca Securities, believes, however, that the foreign inflows will be sustainable, as the local equity market is still considered cheap.

“The FBM KLCI’s 14.3 times price-earnings ratio (PER) is lower than the long-term PER of 17.7 times, though we have seen foreign selling in the past few days, following the budget.

“The PE discount may attract foreign funds to come in, which will then help window-dressing activity in December,” says Low.

Year to date, the FBM KLCI has fallen 6.7% to close at 1,517.60 points last Thursday.

Low also believes the Melaka election has given investors some clues on the political scene going forward. “Next year is potentially an election year, thus there may not be so much of foreign buying.”

Inter-Pacific Securities head of research Victor Wan highlights that Malaysia’s equity market remains under-owned by foreign funds, which explains why there have been net foreign buying in recent months.

“They see a value here and they are coming in. Most of them are long-term funds, so they probably stay longer.”

Given that corporate earnings are not expected to register strong growth next year, Wan thinks the foreign buying momentum will slow down, with a small buying amount.

Nonetheless, as US markets continue to break record highs, leading to high valuations, Wan does not rule out the possibility of some switching of funds to EMs and the European market.

While big local corporates will be affected by the implementation of the prosperity tax next year, Low believes corporate earnings growth will remain intact and prove attractive to foreign investors.

Despite the potential for US rate hikes next year, he is not overly concerned because of the continued economic recovery.

On the local front, he suggests that the economic recovery be further assessed before a rate hike decision is taken, noting that monetary policy normalisation in regional countries may even benefit Malaysia’s exports.

“Other currencies will be strengthened if their interest rates are raised, and it will help our exports [which will be rendered cheaper]. Although US rate hikes may dampen market sentiment, they may lift corporate earnings.”

Low says US tapering will result in a minor impact on local equities. “Over the past years, the US Federal Reserve has been buying a large number of bonds and injecting liquidity into the market. This round is just to unwind the impact of Covid-19.”

Wan concurs, saying the impact of US tapering and interest rate hikes have already been expected. “We are an outward-looking economy, so we need to worry more about inflation and supply shortages. There will still be economic growth next year, but not as strong as what we have seen this year.”

Low says inflationary pressure could be well contained after 2022. “We need to take note that it might be just transitory. Right now, there is a lot of disruption here and there. That is why we are seeing inflationary pressures. When demand-pull inflation takes place, then it will be a different story.”

Meanwhile, Wan observes that the election factor has diminished in Malaysia. “Those days, we would look at politically linked stocks. Today, it is not so obvious and not going to be significant. I don’t expect the election factor to be very strong, [and] that could push the market significantly higher.”

At a media briefing last Tuesday, Fitch Solutions global emerging market economist John Ashbourne said that, in most regions, EM growth will slow in 2022 as base effects fade and with policy tightening.

He also believes commodity prices will ease, with the oil bull run expected to run out of steam soon.

“We expect that most acute energy problems — sparked by the short-term supply issues — will soon pass. Oil production will rise sharply, pulling prices down. Despite the recent talk of a super cycle, we think commodity prices will trend down over the coming years.”

Unlike some DMs, he said inflationary shocks in EMs had been primarily driven by supply-side factors. Thus, when these factors ease, inflation will follow suit eventually.

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