IN THE last week of October, news that the US Federal Reserve was ending its third quantitative easing (QE3) programme was somewhat dwarfed by the Bank of Japan (BOJ) announcement that it would increase its qualitative and quantitative easing programme (QQE2) to some ¥80 trillion (RM2.32 trillion) annually, starting next year. This is an increase from the previous target of ¥60 trillion to ¥70 trillion.
BOJ’s news was followed by Japan’s Government Pension Investment Fund’s (GPIF) announcement that it would increase its asset allocation to foreign equities to 25% from 12% previously and foreign bonds to 15% from 11%. The GPIF, which manages assets worth ¥130 trillion, said it will, over the next five years, trim its domestic bond holding to 35% from 60% previously and boost domestic equity holding to 25% from 12%.
The announcement sparked excitement in the global equity markets, including Malaysia’s, with most bourses ending on a high note that day.
Previously, concern mostly revolved around whether the ending of QE3 would cause an outflow of foreign funds from the emerging markets when, or if, the US raises its interest rates. An outflow of funds to the US has largely been anticipated due to the narrowing interest spread between the emerging markets and US. Interest rates in the US have been hovering at near-zero levels since 2007.
But now, the expansion in BOJ’s asset purchase programme and the GPIF’s reshuffled asset allocation has thrown another variable into the picture and many are curious to see whether the Japanese stimulus programme will flow into other financial markets.
“We are expecting to see net withdrawal of funds if and when the interest rate differential between Malaysia and the US becomes narrower pursuant to interest hikes in the latter. However, as the withdrawals are not unforeseen and for as long as the manner of the exit is not disorderly, we do not anticipate the situation to result in market turmoil,” says MIDF Research in an email reply to The Edge. Malaysia’s overnight policy rate stands at 3.25%.
The research house also adds that the BOJ’s stimulus would partly neutralise the risk of a “hollowing out” effect caused by the ending of the Fed’s QE3 and that Japan’s QQE2 could help support global equity in the short term, especially for Asia-Pacific markets, including Malaysia.
However, DBS Group Research opines that capital outflows from Japan could be a long-term story and would depend on the interest rate differentials between the country and other markets as well as its negative growth situation. The research house highlights in a report that Japan was a net seller of foreign equities in 2013 after the country launched its first QQE programme. It believes that Japanese investors’ home bias sentiment will remain strong in the near future as the movements in the Nikkei and the Japanese yen are similar to those seen in 2013.
“The outperformance of the Nikkei kept Japanese investors in the domestic market. And the sharp depreciation of the yen prompted them to sell foreign assets in order to convert the proceeds into yen,” it says.
However, with GPIF’s asset reallocation, which includes increasing foreign equity holdings, DBS says markets with strong growth prospects and high yields should be able to benefit from the fund flows from Japan.
TA Securities chief investment officer Choo Swee Kee comments that the QQE2, like the US’ QE programmes, will not directly impact Malaysia’s equity market.
“Markets will benefit from the inflow of liquidity, but as to where the liquidity will go, it will depend on the attractiveness of the market. The Malaysian market’s price-earnings ratio is trading at a slight premium to some neighbouring countries such as Thailand,” says Choo.
Interpac Securities head of research Pong Teng Siew says Malaysia is not one of the favourite destinations for Japanese equity funds because of the expensive valuations.
“This is a result of the success of our local pension funds, where most of the funds are locked up domestically. Looking at our benchmark index, it is not cheap for an economy of this size,” he adds.
It is noteworthy that foreign investors have been net sellers in the local equity market for most of 2014. According to data from Bursa Malaysia, foreign investors were net sellers of some RM3.64 billion over the last 10 months. As a comparison, Bursa saw net foreign inflows of RM13.64 billion and RM2.57 billion for 2012 and 2013 respectively.
“For Malaysia, foreign money flow has been erratic this year. There had been a pronounced money outflow in September and in the first three weeks of October. However, the tide appears to be reversing, based on the numbers last week. After seemingly bucking the regional trend, foreign liquidity is flowing into Malaysia again. Investors classified as ‘foreign’ purchased Malaysian equities in the open market on Bursa last week, amounting to RM460 million, compared with RM351 million sold the week before,” says MIDF Research in a Nov 3 report.
Pong opines that in the event of a foreign selldown, local institutional players would have enough financial muscle to lend support to the equity market, as has been the case in previous instances.
No reason for massive selldown in MGS
Foreign bondholders make up about 46.9% of the total outstanding Malaysian Government Securities (MGS). Outstanding MGS total RM319.63 billion while foreign holdings in MGS amount to RM149.82 billion, according to Bank Negara Malaysia statistics.
In mid-2013, there was a massive selldown in the bond market across the emerging markets on news that the US Fed would start tapering bond purchases. Malaysia was not spared.
However, AmBank Group currency strategist Wong Chee Seng does not think that the outflow of funds from the bond market will be significant when the US raises interest rates. He opines that in terms of yield, the differential still looks more attractive for the MGS.
“There will probably be 1% or 2% of selldown when interest rates are raised in the US. That is not significant. The conditions now are different from the ones we faced in 2013. Then, we had concerns over fiscal deficit and current account. The government looks committed to reducing fiscal deficit now, although it looks like it may miss the target this year, and the current account position is in a surplus.”
“There is no reason for a massive selldown to occur,” he adds.
CIMB Regional Fixed Income Research director Nik A Mukharriz concurs, saying that even if the outflow occurs, it would not be significant. “Foreign speculators will need to put their ringgit somewhere, so they usually park it in bonds or MGS because of the low risk profile. We expect some volatility [in the MGS], but we are not sure of the magnitude. On a monthly basis, I’ve seen net outflows ranging from RM5 billion to RM10 billion at its most extreme, which, in terms of investable amounts, look quite comfortable for domestic funds to pick up,” he says.
Nik adds that bond funds are partly driven to stay invested in Malaysia because the MGS makes up part of the Citi World Government Bond Index that funds would want to follow as closely as possible.
As for the Japanese stimulus, Wong says its nature is different from the US’ QE.
While the US QE triggers strong buying in financial assets, he believes that the QQE2 would result in more foreign direct investments instead as the aim of QQE2 is to provide support for export-oriented industries. He believes that this would be a positive for Malaysia, as evident from the increase — from 35% to 40% — in foreign direct investments in the last two quarters.
This article first appeared in The Edge Malaysia Weekly, on November 10 - 16, 2014.