By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
Malaysian equities were dead money since May 2108 when the Pakatan Harapan coalition won the general election. Dr. Mahathir Mohammed, the 94-year-old Prime Minister, launched an anti-corruption crackdown and arrested former PM Najib Razaak, implicated in the looting of the $5 billion 1MDB sovereign wealth fund. Dr. Mahathir also imposed an austerity budget, froze public spending and renegotiated opaque Belt and Road infrastructure projects with China. Business/consumer sentiment and foreign fund inflow slumped as the US-China trade dispute escalated. However, I now believe Malaysian equities are at ideal accumulation levels and can deliver 15 – 20% returns for US dollar investors in the next twelve months. Why?
One, Dr. Mahathir has abandoned his austerity program, freed local state-owned companies to renegotiate Chinese joint ventures extracted from his pliant predecessor and ended the public spending freeze. Two, $2 billion had exited the Bursa Malaysia KLCI index since May 2018. After all, the Mahathir anti-corruption crackdown, fiscal austerity and the plunge in the ringgit to 4.15 coincided with four Fed rate hikes, an oil/LNG price plunge, King Dollar, US-China trade rifts and an exodus of offshore funds from emerging markets. The world is now totally different. The Powell Fed wants to cut rates. King Dollar is on the ropes. The Volatility Index has fallen to 13 as the S&P 500 soared 18% since New Year 2019. Offshore funds want to accumulate EM equities, debt and FX. Voila, June marked the first month since January that foreign funds were net buyers in Kuala Lumpur and selling pressure has eased.
Malaysian ringgit bonds are one of the bargains in Southeast Asia with the 10-year government bond yield at a 3.65%. I expect Bank Negara to remain on hold, the ringgit rise to 4 against the US dollar and Malaysian 10-year debt yields to fall to 3.40% by year-end 2019. This is bullish for Malaysia’s KLCI index for the next six months. Global institutional investors are finally reallocating funds to MSCI emerging markets in the post-Osaka, post dovish Fed macro milieu.
Malaysia has a 2.1% index weight in the MSCI emerging markets index, the ninth biggest in the world, lower than Thailand but higher than Indonesia and the Philippines. This means passive tracker money alone is a tailwind for the Bursa Malaysia KLCI index in 2H 2019 and I can credibly envisage the index rising from 1690 now to 1850 – 1900 by year-end 2020.
Malaysian equities were voted the “least loved stock market in Asia” in 2019 – obviously, the survey did not include Pakistan! Yet this no longer true. The KLCI recovered all its cumulative 6% loss in June and even climbed above its 200-day moving average downtrend last week on rising volume. The trend is your friend until the trend comes to an end. This bearish trend has, I believe, now come to an end.
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Malaysia’s tight labour market, rising wages, seminal role in global IT/semiconductor supply chains and diverse economic base makes it more of a consumption/defensive market than say, Indonesia or even the Philippines. Bank Negara estimates 4.3% to 4.8% GDP growth. Yet the World Bank and Finance Minister Eng are more optimistic in their growth forecasts. We could even see 5% GDP growth next year as the stalled infrastructure projects get going in 2H 2019 and the current FDI surge continues. This is one reason I loaded up on the iShares Malaysia (EWM) equities index fund at 30 last week as a prelude to stock picking on the Bursa.
Malaysia is not cheap at 15.6 times forward earnings and EPS growth for the index will be mediocre at 5 – 6%. The global economic slump does not bode well for oil prices, as Malaysia is Southeast Asia’s only energy exporter. However, a stimulative budget and higher public spending will goose corporate EPS growth. There are definitely signs of mergers in telecoms (watch Axiata!) and banking (watch Maybank!). If the Federal Reserve slashes its policy rate thrice, as the Chicago futures markets predict, while Bank Negara remains on hold till early 2020, the battered ringgit could finally get a bid and boost my EWM tracker’s upside.
Malaysia Banking Berhad (Maybank) is a $150 billion asset colossus that controls 25% of the deposit and loan/financing market in Malaysia. It is Malaysia’s largest commercial bank, the fourth largest in Southeast Asia and the third-largest Islamic bank in the world. I believe the bank is an ideal proxy for a revival in the Malaysian economy with its retail branch banking network and franchises in leasing, insurance, merchant banking, capital markets and venture capital. EPS growth is mediocre, the bank trades at a 6.35% dividend yield, 12 times earnings and a 1.2 price/book value.
If my investment theses play out, I expect a 15% total return in the bank at a target of 10 ringgit. There are multiple catalysts for a modest valuation rerating of Maybank. The restructuring designed to improve ROE is the obvious catalyst. Foreign fund inflows provide a trading boost to the shares. The bank has been prudent in credit risk management and has growth optionality in Singapore and Indonesia. It is a proxy for Malaysia’s public spending and corporate finance revival.