Why Nomura advises investors to sell on Malaysia

This article first appeared in The Edge Financial Daily, on January 10, 2019.
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KUALA LUMPUR: Expressing concerns over a possible sovereign ratings downgrade and disappointment with the pace of reforms, Nomura Global Research advises its clients to ‘underweight’ on Malaysian equities.

This is the second downgrade by Nomura after the 14th general election on May 9 last year. It revised its outlook on Malaysia to ‘neutral’ after the poll, and it is now even less positive on the slow pace of reforms. “Our economists believe there is a high risk of fiscal slippage and the possibility of a sovereign ratings downgrade that could trigger more capital outflows,” the Japanese stockbroker said in a note yesterday.

Nomura anticipated that the federal government will have a fiscal deficit of 3.7% in the country’s gross domestic product (GDP) compared with the official forecast of 3.4% in the National Budget 2019, noting that the fact the crude oil prices have come off from the recent peak and the shortfall of public revenue after the zero-rating of the goods and services tax (GST).

“Despite Petronas’ large dividends, our team believes there is still likely to be a fiscal hole from the zero-rating of the GST, which will only be partially filled by small new measures and spending cuts announced in the budget.

“Another major issue is that oil prices are no longer high,” Nomura commented. Its economist Euben Paracuelles estimated that 30.2% of federal revenue in 2019 would come from oil-related sources.

Brent crude oil prices were trading at US$59.26 (RM243.81) per barrel at press time. Nomura notes that this is “much below” the US$70 per barrel assumption for Budget 2019. Slowing growth and inflation may force the Bank Negara Malaysia to slash the overnight policy rate by an expected 25 basis points this year to 3%, Paracuelles noted.

“On balance, we are downgrading the market to ‘underweight’ on poor earnings growth prospects amid higher valuations and on lack of major expansionary reforms so far,” said Nomura. It said Malaysia’s earnings growth was one of the worst in the region, and although the strong domestic investor base could offer some defence of equities, Khazanah Nasional Bhd’s intention to hive off non-strategic assets could lead to “some overhang on the market,” Nomura said. “For us to get more constructive, we need to see either improving macro momentum and/or reforms coming through which can lead to rerating of market multiples, and/or improvement in earnings growth,” it added.

Nomura said there has not been a significant reform push which can potentially lead to expansionary economic activities. It said it had hoped the government would do more to improve efficiency, reduce corruption as well as reduce its presence in certain areas to “create a level playing field with the private sector.” “So far, we have only seen some ‘easier’ initiatives such as closing of several government agencies, [putting] some agencies ... under direct parliamentary supervision, (and) cost reduction for megaprojects,” it said.

Rising political risks seem to be appearing — Nomura mentions the discontent at Parti Keadilan Rakyat defections and the media’s “obsession” with the prime minister’s succession timeline. “(These) seem to be unnerving some investors as it takes the government’s focus away from delivering on the reform agenda,” it noted.

Nomura had slashed its GDP growth forecast for Malaysia to 4% in 2019 on Jan 4, lower than a consensus estimate of 4.6% polled by Bloomberg. Yesterday, Moody’s Investors Service projected a 4.7% GDP growth rate for Malaysia this year, matching the World Bank’s unchanged forecast in their latest Global Economic report released on Tuesday. Across Asean, Nomura noted that markets have not priced in a possible recession despite rising risks, leading to possible selldowns of equities this year.

“The other key risk remains how Sino-US trade tensions unfold,” Nomura said. While it opined that the two countries are unlikely to reach a comprehensive agreement by a March 1 deadline, the threat by US President Donald Trump to impose additional tariffs would not occur. Nomura upgraded the Philippines to ‘overweight’ from ‘neutral’ due to stabilising earnings revisions and supportive valuations, and maintained its ‘overweight’ call on Indonesia.