This article first appeared in The Edge Malaysia Weekly, on February 1 - 7, 2016.

OUR cautious approach to 2016 seems to be right on the money.

Global markets tumbled to one of the worst starts to a year in January before recovering some poise in the last few trading days of the month. 

Investor confidence was battered by weakness in the oil market as well as persistent worries over China’s slowdown and its cascading impact on the rest of the world.

Having fallen from US$100 in mid-2014 to a little over US$37 per barrel at end-2015, one would have thought that oil prices would stabilise — maybe even recover a little. But oil just kept sliding — to as low as US$27 per barrel before recouping some lost ground. This follows speculation that Russia and Opec could reach some sort of agreement to cut production, which likely triggered short covering. Brent futures recovered to around US$34 per barrel at the point of writing.

Key producers have made half-hearted comments of cutbacks intermittently over the past year but none have materialised, so far. In fact, most are pumping flat out to make up for lower prices. Scepticism abounds that this time will be any different.

Daily production continues to outweigh demand by some distance. Oil market weakness has prompted many analysts to revise down their forecast for the rest of the year. 

In a nod to the new reality of “lower for longer”, our government announced a revised budget for 2016. After all, the original budget, tabled last October, was based on an average price of US$48 per barrel for oil, which no longer appears realistic. 

The revised budget now assumes a price of US$30-US$35 per barrel and spending cuts as well as deferment of development projects are expected to offset the revenue shortfall. The devil, though, will be in the details. 

At the same time, employee contributions to EPF will drop from 11% to 8% (till December 2017). This will put money into consumer pockets, which the government hopes will boost consumption and make up, at least partially, for its own spending cuts.

The official budget deficit forecast was maintained at 3.1% — even though the GDP growth forecast was revised down to 4%-4.5% from 4%-5% range previously. This appears optimistic and remains to be seen if achievable.

Otherwise, we suspect the ringgit, which has been gaining strength on the back of the oil price rebound in recent days will come under renewed pressure.

The rather underwhelming budget revision underscores the lack of fiscal options to address the prevailing sluggish economic conditions, not just at home but on a global scale.

That’s why markets have, basically, been hanging all their hopes on central banks to boost flagging growth — be it for the US Federal Reserve to slow its rate hikes or for the European Central Bank (ECB) and Bank of Japan to expand their QE programmes.

Indeed, markets reacted positively after the BOJ announced that it would charge interest for excess reserves parked with it — following the script of the ECB. The jury, though, is still out on the actual effectiveness of such aggressive monetary policies on underlying economies.  

Bank Negara Malaysia cut the statutory reserve requirement from 4% to 3.5% in January, adding some RM6 billion in liquidity to the domestic financial system. 

The additional liquidity will help alleviate some pressure on banks competing for shrinking deposits — their loan-to-deposit ratios have been creeping higher — and keep a lid on their cost of funds. This, in turn, will keep lending costs — to individuals and corporate — from rising and doing further damage to the broader economy.

The move will provide short-term respite. But it does underscore the underlying issue of persistent capital outflows, which is not limited to repatriation by foreign investors. On this note, foreign selling in the stock market is still heavy. For the first three weeks of January, net foreign selling totalled over RM2.2 billion.

The current environment only hardens our belief that 2016 will be a very difficult year for consumers and businesses. 

Nevertheless, we remain confident that our defensive Income portfolio will continue to outperform.

Our basket of stocks fared slightly worse than the broader market in January. Total portfolio value declined 2.4%, compared against the FBM KLCI and FBM EMAS’s 1.5% and 1.9% declines, respectively.

Last month’s losses pared our total returns since inception — 8 months — to 13.3%. Nevertheless, our portfolio continues to outperform the broader market by a long, long distance. Over the same period, the FBM KLCI was down 4.6%.

We kept our portfolio unchanged.

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