The Risks …
The outlook for regional markets in the final quarter of 2009 is hazy, with uncertainties still loom over the global economy.
The excitement created in the markets by the ample liquidity pumped into global financial systems could evaporate if the stimulus plans fell short of their objectives.
It would be a “wait-and-see” period, while the third quarter 2009 ended on a fairly positive note for most markets on confidence boosted by some of the data coming out of the US , this might not be the case going forward.
It was important to view the markets in the context of some of the economic stimulus packages coming to expiration. Investors have to see if the expiration of the stimulus packages would result in a pullback in the markets.
Investors would tread water and the markets will move sideways until more definitive data comes out from the US .
If investors and consumers retreated in a major way should the US economy, in particular, not fully recover, it would have serious repercussions on global equity markets.
Compared to the first half of the year (2009), there appeared to be a slight slowdown in the uptrend of the local bourse. Part of the reason was that the valuations in the FBM KLCI were now (Oct 2009) rather high. The most common feedback or comment about Malaysia is that the market is not cheap (Oct 2009). In fact, it has been an expensive market and will remain so in the near to medium term.
The market will continue to be supported by the considerable pool of liquidity that is largely trapped in the system. Although most of the capital controls have been lifted, the country’s capital outflow remained slow. Surpluses are mostly trapped in the system, especially since the imposition of capital control in September 1998
Also, the index was more reliant on the financial sector, given that commodity prices had fallen and thus affecting plantation stocks. For the market to pick up steam, there must be rotational play and, for that to happen, commodity prices have to recover.
Another reason why participation in the local market had been lukewarm of late was the government’s plan to cut spending, a move that would dampen the outlook for infrastructure and construction players.
We need a new catalyst, perhaps a recovery in commodity prices, but the conditions that permit that are not here.
All attention would be focused on what Budget 2010 brings, and the extent of the government’s budget deficit, probably there would be increases in sin taxes.
As far as the domestic stock market is concerned, it has been local funds that have kept it up, given the lack of foreign fund participation. There would invariably be a lull in the local market when foreign funds moved their investments to other exchanges that they perceived as doing better, and vice-versa.
The fortunes of the regional stock markets now (Oct 2009) lay with global issues, an important factor was how economies and consumers would respond when the fiscal stimulus measures adopted by countries like the US came to an end.
How will the governments replenish when the cash runs out? You will have to find the money first, and during that period if the consumers or investors pull back, then the markets will suffer. An economic recovery based on government stimulus alone would not last as once the stimulus expired, the economy would slump again.
However, despite the mid- to long-term uncertainties, the equity market remained in a “sweet spot” for now (Oct 2009), driven by abundant liquidity, economic and profit recoveries, easing credit policies and a low inflationary environment.
The US Equities Market …
The stock market's bulls are slowing their charge, and upcoming earnings reports will determine whether they keep going forward or just stop.
Disappointing economic numbers has investors asking whether the market's powerful rally is fading on what would be the start of its eighth month (March – Sept 2009).
This year (2009)'s rally has lifted major stock indexes more than 50 percent from 12-year lows on March 9 2009 and pumped new life into beaten-down investment accounts.
Now (Oct 2009), though, questions about whether the gains are justified are more urgent because stocks are worth far more than they were only months ago (Sept 2009). The market jumped 15 percent in the July-September 2009 period.
The economic reports are stirring concern that investors have been too quick to bet on a recovery.
Employers cut more jobs in September than in August 2009. Other recent reports on everything from factory orders to the mood of consumers have brought reminders of the economy's troubles.
No one expected a seamless recovery but the string of lackluster data has come as investors have little else to go on. Reports on corporate profits, which are the biggest drivers of the stock market, will only start trickling in Oct 2009.
The third-quarter 2009 reports could give investors a better sense of whether companies managed to bring in more revenue to produce earnings growth or whether they again resorted to steep cost-cutting to boost their bottom lines as with the April-June 2009 period.
Investors want to see revenue growth because cost-cutting can only be taken so far.
Some analysts are questioning whether the latest lull in stocks is similar to the 7 percent slide the market endured from mid-June to mid-July before companies reported earnings that topped modest expectations.
Critics said that companies are still relying on cost-cutting, a point underscored by the Labor Department's report that employers cut 263,000 jobs in Sept 2009. That was more than the 201,000 cuts made in August 2009 and well above economists' forecasts.
The cuts, though painful, might still give a short-term boost to the market by allowing companies to post stronger profits. The severe job cuts are up for positive earnings surprises and stronger reports are necessary to encourage firms to stop firing and starting hiring people back.
But the market's rally will start to unravel if job losses continue. Cost cutting can work in the short run to support profits and share prices but in the long run unless goes from cost-cutting to rehiring, then the shortfall of demand will be the undoing of this market.
Still companies will have a harder time impressing investors just by increasing earnings per share.
One aspect of the US economy that is often overlooked is the non financial business sector. Understandably, there has been a great deal of focus on the state of the US consumption, with concerns focusing on high debt levels and an inability to increase spending. The case is almost exactly the opposite when it comes to US non financial corporations, which are emerging from the recession with strong balance sheets, are generally in sound financial shape and are positioned to take advantage of economic growth.
It is believed that the health of these companies will act as an important tailwind for the overall US economy. On the other side of the equation, one concern is the state of the federal budget. The Treasury Dept is likely to soon report US$1.4 trillion deficit for the fiscal year that just ended on Sept 30, 2009. Unfortunately, deficit levels are worsening. The combination of flat to down tax revenues and increased spending levels is likely to keep the deficit above the US$1.5 trillion mark for FY2010.
From a market perspective, market momentum has certainly been helped by the growing perception that the global economy is getting back on track. Many remain concerned that the strong run up in prices means that we are overdue for a correction.
While there are corrective action that could happen at any point and are aware of the long term secular pressures, the market will grind higher due to the flow of cash back into the markets, an equity friendly macroeconomic backdrop and encouraging earnings landscape.
4Q2009 & Beyond …
Before 2009 comes to a close, there could be a surge in volatility in the financial markets as investors become nervous about the global economic picture.
At the moment (Oct 2009), investors are very short term focused, looking at the earnings seasons. But strong earnings may not last.
The momentum in corporate earnings sales and revenues of global companies could start to be disappointing again at the beginning of 2010 due to the effects if a sluggish economic recovery and that could weigh down global stocks. We are not immune to a market correction in the coming months (Oct 2009 & Beyond). The bigger the market rally, the bigger will be the market correction.
In the US, 4Q2009 corporate earnings results could be challenging and 2010’s earnings forecasts are looking a bit too ambitious, because a lot of the economic stimulus measures implemented by the US government earlier 2009 would be wearing off. In addition, there is a little bit more strain on US consumers due to high employment. Upside for US stocks could be more challenging in 4Q2009 and 1Q2009 because the engine for growth may slow down a little. There will be more volatility coming (Oct 2009 & Beyond).
The prospects for emerging market stocks in the months ahead (Oct 2009) still look bright compared with developed market stocks. The emerging market story is now (Oct 2009) more of an earnings story than a valuation story. There is a fair degree of confidence that earnings will be more robust in emerging markets.
Earnings will revised by a larger extent in emerging markets than developed markets. So, valuations for emerging equities cam get cheaper than current levels (Oct 2009) … on earnings upgrades.
Going forward, the valuations of emerging markets and developed markets could narrow and a valuation equilibrium may arise as these markets become integrated from an earnings growth perspective.
People historically expected a discount for emerging markets stocks. But they should not expect a discount in the future because developed markets and emerging markets do not look that dissimilar from a corporate governance prospective.
In terms of attractiveness of commodities, the rebound in commodity prices from their oversold levels is already done. It was driven by the sharp increase in Chinese exports. Since we believed the economic recovery will remain relatively sluggish for the coming 12 months, it is believed that China is not going to import on a large scale.
On top of that, the US dollar which has been under tremendous selling pressure since Sept – Oct 2009, it will rebound in 2010 because the greenback is clearly undervalued. And, a tactical rebound in the US dollar could weigh down prices of commodities, especially gold.
Technical Analysis
The next upper hurdle is resting at 1,260 points, followed by 1,280 points.
Support is expected at 1,231.49 points, 1,220 points, 1,196.46-1,200 points range. If the important lower floor of 1,191, also the 50-day simple moving average line is violated, investors should be prepared for more downward journey on increase liquidation pressure.
Undermining Factors
1. Blowup In US Subprime Loans & Shaky Financial Assets Associated With Them And As A Result Of Re-pricing Or Revaluation Of Risk Contributed To A Squeeze In The US Credit Markets (Stabilizing);
2. Malaysia Political Uncertainty;
3. Fear, Uncertainties, Global Liquidity Crunch & Economic Fallout (Stabilizing);
4. Volatile Foreign Exchange Market;
5. State Of The Global Economy (Rate Of Decline Has Started To Moderate Since March 2009 With Strong Signs Of Recovering);
6. Commodities Prices (Strengthening Especially Gold & Silver);
7. A Global Deflationary Threat -> Hints Of Recovery – Fear Of Inflation
8. Threats Of High Commodities Prices And US Dollar Crisis
Unpredictable Risks/Surprises
1. Terrorist Attack –
2. Oil Supply Disruptions –
3. A Pandemic Disease – Swine Flu
4. Financial Shocks – Unwinding of Yen/Dollar Carry-Trade Funds, China ’s Stock Market Bubble, Global Liquidity Crunch Resulting From Blowup In US Subprime Loans And Shaky Financial Assets Associated With Them & Falling Dollar;
5. Major Social And Geopolitical Upheaval –
Equity Strategy: Easing Malaysia Political Uncertainty, Outcome Of The Credit Crunch And Subprime Loans Crisis Stabilizing, Strengthening Commodities Prices, Stable Global Growth, Moderating Inflation, Easing Monetary Policy & Fiscal Stimulus Measures … Second Leg Global Recovery (Sept 2009 Onwards) !!!
Recession – Recovery – Growth – Boom - Burst
(Transition From One With China As Sole Driver To A More Balanced US/China Model)
a. Global Monetary & Fiscal Policy (The Exit Strategy): Recovering Economy, Weakening US Dollar, High Commodity Prices & Inflation Expectations Building Up
b. The US Equities Market: A Bubble Is In The Forming
c. The Malaysian Equities Outlook: 5 (Optimistic), 6 (Neutral), 5 (Pessimistic)
d. Global Inflation Outlook: Controlled Versus High
e. The US Dollar Carry Trade, The Marriage of The Dollar And Oil Is Growing Estranged & Why Dollar Is Weak Since Aug 2009
f. The Malaysian Equities Market By Nomura, Morgan Stanley & CLSA
g. The US Economy By Treasury Secretary Timothy Geithner, Warren Buffet, The Fed
h. The Good, The Bad & The Ugly Aspects Arising Since Sept 2008 …
i. Market Liberalization - Paring Down Of Government Stakes In GLCs … To Increase Their Stock Liquidity
j. Betting On Next Leg Global Recovery (Sept 2009 Onwards) ... Transition From One With China As Sole Driver To A More Balanced US/China Model
k. What’s NEXT For The Malaysian Economy … The Next Challenge Is To Sustain The Recovery & Investing In Equities On Expectation Of Second Round Recovery
l. What’s NEXT For The Global Equities Market … WHAT MATTERS MORE TO MANY DEVELOPING MARKETS NOW (AUG 2009) IS WHAT CHINA , NOT US, DOES WITH POLICY
m. What’s NEXT For The US & China Equities Market
n. Jims Rogers … Next Commodity Bull Run Had Just Begun, Bets In Airlines, Agricultural Land, Water
o. The Asian Equities Markets … Investors Should Start Accumulating On Weakness During 3Q2009, To Position For Further Upside Later 2009.
p. What’s NEXT (2H2009) For The Malaysian Equities Market …
q. Carry Trades Are Making A Come Back Into Emerging Markets
r. High Commodities Prices & US Dollar Crisis Could Pose Threats To Global Economic Recovery In Coming Months (June 2009 & Beyond).
a. Global Monetary Policy & Fiscal Policy (The Exit Strategy)
i. The Global Monetary Policy …
A weakening US dollar and rising commodity prices led by gold are once again heralding the risk of rising inflation even as the global economy begins to recover.
Having taken a break for most of 2008 because of recession’s dampening impact on demand, inflation is expected to be one of the major challenges for policymakers across the globe in 2010.
They cite three main reasons: a weakening US dollar as it losses its safe haven status amid the global economic recovery; the timing and ability of policymakers in key industrialized countries to pull back the huge amount of liquidity injected into the world’s financial markets by the loose monetary policy implemented during the recession to boost growth; and rising commodity price, spurred by a weaker greenback and rising demand.
A weakening US dollar makes commodities attractive because most of them are traded in the US currency. Investors are taking flight to precious metals, especially gold, to preserve the value of their US dollar assets and also to hedge against inflation.
The general view is that the US dollar will likely to face downward pressure in the months ahead (Oct 2009 & Beyond) as global recovery picks up pace. Additionally, the US currency is being driven down by the huge twin deficits as well as talk of attempts by some Arab countries – together with China , Japan and France – to end US dollar trade in crude oil.
The plan is to move trade in oil from the US dollar to a basket of currencies comprising a unified currency for the Gulf economies, the yen, the euro and the yuan.
As an aside, this shift is unlikely to happen in the short term, given the several of the Gulf states have long been talking about a unified currency but with little to show for it.
A continued weakness in the US dollar will boost commodities. Rising commodity prices, including that of crude oil, will fuel inflationary pressures and may pose a threat at a time when the world economy is just beginning to recover from one of its worst recessions ever.
This is because inflation in an environment of low growth will pose dilemma for monetary policy. Policymakers will have to perform a delicate balancing act between raising rates to dampen inflationary pressures and boosting growth.
It must be noted that while the global economy is recovering better than expected, industrialized countries are still facing high unemployment rates, thus hindering a pick up in consumption spending.
The consensus among economists is interest rates have bottomed out and will likely start rising again as we move into 2010.
What this signals is that liquidity in the financial systems will gradually be tightened, going forward, and that there is a turnaround from deflationary to inflationary fears among investors.
Most Asian central banks are not likely to raise rates significantly even in 2010 because of concerns that higher rates will cause their currencies to appreciate, which will in turn erode the competiveness of their exports at a time when exports are still a key growth driver.
Boosting growth will still be priority, which means that any rate hikes by Bank Negara will likely be small.
The Asia Monetary Policy …
The tide of monetary policy in Asia has turned. The Reserve Bank of Australia's interest rate increase in early Oct 2009 likely kicks off rate hikes across the region in coming months (Oct 2009 & Beyond).
Further withdrawal of monetary policy stimulus measures is inevitable. However, tightening will be gradual, given persistent uncertainty.
Oct 2009 crystallized the fact that the tide of monetary policy in the Asia-Pacific region has turned.
The Reserve Bank of Australia raised the official cash rate by 25 basis points to 3.25%. In doing so, the RBA became only the second central bank in a developed country — after Israel 's — to raise interest rates this year (2009).
This move likely kicks off interest rate increases across the region in coming months (Oct 2009 & Beyond).
Speculation regarding imminent interest rate movements in the Asia-Pacific region has been growing. Central banks in China , India and South Korea are keeping a close watch on rising economic activity and emerging inflation pressures.
As sentiment in global financial markets improves and signs emerge that global growth is resuming, it is inevitable that central banks in the region will raise interest rates from their current emergency levels (Oct 2009).
Gradually lessening the stimulus provided by monetary policy will be important in ensuring the sustainability of economic growth across the region and in keeping a lid on inflation pressures during the recovery.
However, the inevitable withdrawal of monetary policy stimulus measures will necessarily be gradual and measured. While the nascent recovery in domestic demand, industrial production and exports across the region is encouraging, uncertainty regarding the global economic outlook remains pervasive.
Many economies in Europe and the Americas are yet to emerge from recession, while the largest economy in the Asian region—Japan—remains in a delicate state. For that reason, central banks will take their time in raising rates back towards neutral levels and pause well before reaching restrictive monetary policy settings.
ii. The Fiscal Policy …
As the global recession begins to ebb and with the recovery gathering pace, the focus has turned to how the governments will exit the huge fiscal stimulus plans implemented over 2009 to pump prime growth.
The consensus is that timing is of the essence. But herein lies with uncertainty. The concern is that too early an exit will snuff out the nascent signs of recovery, while a late withdrawal could lead to serious problems further down the road, amongst which are high inflation, widening fiscal deficits and bigger government deficits.
On a more positive note, Malaysia has come up with a mid term fiscal consolidation strategy that it involves cuts in both operating and development expenditures to bring the budget deficit down to 4% by 2015.
In Oct 2009, the government has indicated that fiscal spending allocated under the two stimulus plans launched in Nov 2008 and March 2009 will draw to a close by 2010. Thereafter, the growth momentum is expected to be sustained by an improving global economy.
More importantly, over the longer term, growth should be further boosted by economic reforms under the new growth model that will help Malaysia move from a middle income to high income economy.
For now (Oct 2009), the challenge facing our policymakers is the huge deficit, estimated at 7.6% of GDP in 2009; this number could be bigger in 2010 because government revenue will likely take a hit with the slowdown in economic and business activities. This will impact profits and hence tax revenue.
It is only prudent to cut the deficit as soon as possible because we do not want the government’s debt to spin out of control, which can happen if the fiscal deficit remains at above 7% above a period of time. Having said that, the government’s debt, at 41% of GDP toady (Oct 2009) and comprising mainly domestic borrowings, is still manageable. But it is nonetheless higher than 32% of GDP in 1997.
The government has said that it cut its operating expenditure from 2010 as one of the measures to rein in the deficit. One of the ways is ensuring prudence in government spending without comprising efficiency and tightening procurement practices.
How deep will the cut be?
The grapevine has it that the government hopes to announce a cut of some 20% in its operating expenditure in the coming 2010 Budget, which will be tabled in Parliament on Oct 23, 2009.
Indeed, given that a certain degree of fiscal expansion will still be necessary in the next one year (2010), the clearest option for policy makers in the short term is to trim the government’s operating expenditure to reduce the deficit gap.
It is in the operating expenditure that the government will have the most room to manoeuvre. The excesses, unproductive subsidies, wastage and leakages of the past years show the need for a good overhaul of government operations to ensure, among others, greater cost efficiency, improved services and transparency.
An efficient public sector is critical to a country’s development because it plays a key role in facilitating the smooth running of both economic and social activities.
An interesting point to note is that some economists have estimated that efficiency in the public sector could actually add another one or two percentage points some 25% to overall GDP. This is also due to the huge involvement of the government sector in the domestic economy – it currently (Oct 2009) contributes some 25% of overall GDP.
So, how far the government can achieve the 4% budget deficit by 2015 will depend on translating the plans into action.
