This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on Nov 23 - 29, 2015.

WHEN asked about the fact that most Malaysians feel the country is headed for a financial crisis, he says, this is not borne out by fundamentals yet. “They are probably basing it on the fact that the ringgit has lost a tremendous amount of value and the growth rate in the economy, which — by the way — is still much better than most countries at 4.7%.”

Altman has done a preliminary analysis on the average Malaysian listed company, and seems to think that they are doing pretty well in terms of credit scores. “Now, some of that is artificial — if the stock price is somehow maintained by either government or major shareholder influence. In other words, is the stock price overvalued? But having said that, my models show that Malaysia is not a high sovereign risk country.”

But there are some worrying factors, he admits, such as the fact that the ringgit has lost so much value relative to other countries and that Malaysia is experiencing a relatively lower growth rate. “But still, though you may not realise it, you are growing faster than most of the world. What I read was that growth this year would be about 4.7% and very few countries have higher growth than that. To what extent that has been motivated by borrowings from banks, that could be a big negative factor.”

The good news is that the Altman Z-score of Malaysian listed companies are sound. What is a Z-score? “The Z-score is a model that looks at the financial characteristics of companies and weights them according to this model I built a long time ago that is still being used today. It has five financial indicators, measuring the liquidity, solvency, profitability, leverage and activity of a company,” says Altman. 

“Each of those five factors is weighted by coefficients that I built with a computer programme and over the years, it has been quite accurate in predicting bankruptcy.” You can look up the Z-score of any listed company online, he adds.

Which asset classes are going to be most affected by a looming crisis? “Oil and gas and mining. And that, of course, has been from the slowdown in China. It is going to affect the overall economy. In fact, it already has,” says Altman.

Another sector that has been impacted, not by defaults but by low interest rates, has been the real estate sector, he adds. “And a question that has come up, not so much here, but in Hong Kong, Australia, the UK and the US, is whether there is a bubble in the real estate sector. It feels like a bubble, but most people in the industry say prices are not nearly as high as they will go. But people were saying the same thing about real estate in 2007.”

Altman says it is tricky because even if the country is going through a slowdown, artificial demand can still be created by foreigners looking to take money out of their own slowing economies and parking it somewhere else. 

“The best way to do that is to put it in real estate. There is an artificial demand in some countries. A lot of the condominiums and some houses in the US and in Hong Kong are owned by foreigners, and nobody is living in them. It is just an investment strategy to get your money out and this was particularly true when the currencies of the countries were stronger,” he points out.

It is a bubble if it is unsustainable. “I have heard that property prices in Australia, for example, are getting so high that even the Chinese can’t afford them,” says Altman.

There has been considerable debate in the markets on whether central banks should interfere quite so much as they have in the economy. Some have charged that by keeping interest rates artificially low, which resulted in a vast outpouring of fiat credit, central banks have encouraged companies to overborrow and overinvest — a situation which is coming home to roost as we speak.

What is Altman’s take on this? “I do believe that in a crisis, central banks should interfere. I don’t believe they should just because there is some volatility or reduction in growth. I think there is increasing pressure on central banks to stimulate growth and they can rationalise it because the inflation rate is low. And it seems to be globally low, but the problem is there could be deflation and deflation is not good for the markets either.

“If prices go down, that is good for the consumer but not good for the companies. Also, prices may go down, but salaries may go down more.”

So, when will the quantitative easing (QE) come back to haunt the market? “I think it mainly haunts the market when QE is reduced, which is happening, when they start raising interest rates, which they will because of the fact that the government has built up so much debt itself and needs to start repaying it. But primarily, it will happen when companies run out of their own cash flow and need to pay interest. That will only happen when there is an economic recession, and in big numbers,” he says.

Altman points out that it is already happening in industries such as oil and gas because revenues are way down but debt is up. And the other reason for the low commodity prices is the reduction in global demand. “I am talking about China, which is the X-factor now in credit markets.”

China is getting ready for the slower growth. A few days after announcing that its economy grew 6.9% in the third quarter, its slowest quarterly pace since 2009, the People’s Bank of China cut its interest rate for one-year loans by 25 basis points (bps) to 4.35% and lowered its reserve requirements by 50bps to 17.5%. It was the sixth time the central bank has cut rates since November last year.

Basically Altman’s message is clear. “The bubble is building; it probably means higher default rates, maybe above the historical average in one year and it could lead to a financial and then an economic crisis if coincident, with a big drop in productivity or gross domestic product of the country.”

Winter is coming, as they say in Game of Thrones, if it is not already here. It would be good to stock up on food, dress warmly and get ready to wait out the long cold nights.

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