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Wednesday, February 10, 2010

Snippets of outlook on Malaysia

Thanks to this recent correction in the markets, this time will be a good buying opportunity again. I still believe markets are going to continue moving upwards and the recent concerns that caused this correction is more hyped-up than a real threat to the economic recovery. Time to buy again as markets might surge after CNY as investors are withdrawing money ahead of the CNY holidays where China markets will be closed for the whole next week and pump in again after CNY.

Anyway, I'll just share a gist of the Malaysian market outlook here, the things we can look out for in 2010.

Catalysts:

New Economic Policies:
This year, we will be seeing a clearer picture of the economic policies to be pursued by the Government over the next few years, to be unveiled in the new economic model by the National Economic Advisory Council (MPEN) in Mar 2010 (Delayed again) and the 10th Malaysia Plan in June 2010 . More favorable economic policies are expected, which is in line with Malaysian Prime Minister’s intention to navigate Malaysia from a middle income to a high income economy. Since Dato Seri Najib Tun Razak’s ascension to the Prime Minister’s office, the Government has laid down more investor-friendly policies, including liberalization of 27 services sector and financial sectors, review of minimum wage for selected industries to attract talents from overseas and improving ties with regional economies like Singapore, India and China via high level visits which could bring in more investments from these regions.

External Trade:
Exports which consist of 107% of total GDP, continue to remain bright in outlook driven by exports of E&E products and commodity related products. E&E products which is 43% of total exports continue to experience growth on the back of strong global demand, especially from Asia Pacific Countries. Global chip sales continue to surge to US$22.6 bil in Nov 09 since bottoming out in Feb 2009 which was near its high of US$22.9bil in Sept 2008. On top of that, manufacturers around the world cut its capacity and investments sharply in 2009 which could create a supply glut sometime in mid 2010. This will raise the prospects of higher selling prices and acceleration in semiconductor equipment investments. On the other hand, commodity exports which consist of 21% of total exports will be driven by global demand growth especially from developing economies and supported by increasing oil supply costs and resulted from declining supply of 'cheap oil'.
Electricity sector (Something to look out for if you doubt the economic recovery) continued to post strong gains in Dec 2009 at 14.1% y-o-y which was the seventh consecutive month of y-o-y increase. This would be one of the strong indicators of economic recovery as most if not all economic activities utilize electricity and it is almost impossible to function without it. I just ran some numbers of GDP and electricity output which showed Malaysia GDP growth has a strong correlation of 80% with electricity consumption.

Retail and Corporate Sector Growth:
Private expenditure, which consists of 54% of GDP, is expected to take the lead in driving Malaysian economy, backed by more pro-business policies, low interest rates and higher corporate earnings. Corporations emerge stronger from the recession enjoy greater efficiency and healthy balance sheets and cash flows.

Newsflow of major projects:
Construction industry expected to thrive this year. Major construction projects like Interstate Water Transfer Scheme (RM8.8 billion), LRT extension (RM7 billion), new LCCT terminal (RM2 billion) and Gemas-Johor Bahru Double Tracking Project (RM5 billion) are expected to roll out over 6-12 months (Please don't delay anymore!!). Construction industry is known to have high multiplier effects on the overall economy via construction output, income generation, employment and imports. It also generates extensive backward and forward linkages with different sectors such as manufacturing industries and service type sectors, of which both constitute a majority portion of total GDP.
Firmer commodity prices: Malaysian economy is very much intertwined with commodities. About 40% of Government’s revenue comes from oil related industries while about 22% of the FBM KLCI constituents consisting of commodity related companies. According to my computation, surprisingly KLCI has an 80% correlation with crude oil price over the past 10 years. Firmer commodity prices lead to improved fiscal position of the Government, enabling higher fiscal spending or lower fiscal deficit of which both are favorable to the economy. Higher corporate earnings among commodity-related companies could also lift up the local bourse.

Appreciation of RM over USD:
In view of the large fiscal deficit of the US resulted from its stimulus measures to curtail one of the worst financial crisis faced by US, US$ is expected to depreciate against RM. This is further backed by Malaysian Government’s efforts to rein in fiscal deficit via cuts in operating (hopefully they can implement that without having too much political pressure to do otherwise) and development expenditure, lowering of fuel subsidies coupled with broadening Government’s revenue base such as review of GST and disposal of government assets, all of which could strengthen the ringgit and enhance Malaysia’s attractiveness as an investment destination. Consequently, Malaysia’s fiscal deficit is expected to decrease to 5.6% of GDP (I'm following Government's guidance) in 2010 from 7.6% in 2009 .

Foreign Fund Flow:
Foreign fund shareholdings in Malaysia declined drastically since March 2008, triggered by the General Election in Mar 2008 which sparked a huge sell down by foreigners. As a result, foreign shareholding in Malaysia plunged to about 21% currently from 27% in Mar 2008. Nonetheless, we are seeing foreign funds slowly returning to the market albeit in a moderate way. Having said that, foreign investors still have reservations about the Malaysian market such as the willpower to execute Government’s planned reforms coupled with political and social security concerns. Nonetheless, with State Elections in Sarawak and the General Election approaching in 2011 and 2012 respectively, it will be crucial for the Government to ensure that its planned reforms be executed to regain the lost votes from the previous General Election. Foreign investors’ interest could revive again, backed by clearer picture of Malaysia’s economic growth plan over the next few years coupled with anticipated execution of Government reform policies and further liberalization of its economy, which could lend support to the uptrend of FBM KLCI. Intersesting to note that FBM KLCI has been resilient in its uptrend over the past year, despite the lack of foreign investors’ support, meaning the market is very much domestic-driven.
Concerns:
Doubts remain over the execution of economic reforms though the Government openly expressed intentions to navigate Malaysia from middle-income to a high-income economy. Investors still have reservations over Government’s willpower to undertake structural reforms as the Government has failed to implement them in the past.

Uncertainty in the political arena arises as Oppositions are making inroads, as seen in the General Election in Mar 2008 which denied BN two-thirds majority in the Parliament. The race in the coming Sarawak State Election and General Election in 2011 and 2012 respectively are expected to be fierce. The recent judgments on high profile cases, scandals and squabbling continue to undermine investor confidence. Further exacerbating the situation including the escalation of inter-race and inter-religious quarrels which led to the desecration and burning of places of worship.

Bye bye, FDI: Domestic and foreign investments in Malaysia are on a declining trend, dropping by about 55% y-o-y in 2009. About 45% of total investments are still being channeled to manufacturing sector which contribute about 30% to the economy while less than 30% find its way to the services sector which contribute about 55% to the economy. This is a hindrance to Malaysia’s intention to direct services sector to lead the economic growth and move up the economic ladder. Infrastructure, political risks, structural cracks and productivity remain key concerns among investors. Malaysia’s net outflow in investments to overseas are increasing significantly, raising concerns over lack of capital investments locally. If Government does not get its act together, we will be losing way behind emerging economies like Thailand, Indonesia and Vietnam.

Valuation:

Where are we now? KLCI still trading at forward PE of 14x, below its 10-year average of 16x. There is still upside in Malaysia equity market in the short term but will not be spectacular, probably about 15% upside. Nonetheless, without FDI support, economy is going to hurt in the long term while foreign funds will continue to ignore Malaysia if we keep on harping on race/religious dominance and undermine the independence of judiciary, police etc.

I think policies and politics are going to be one of the main determinants of the direction of the market this year.

Disclaimer: The above article does not represent an investment advisory service as no subscription or management fees are charged. The contents of the article are provided as general information only and should not be taken as investment advice or as a recommendation to buy or sell any security or financial instrument. Any investment decisions carried out based on information, analysis, or commentary provided above is solely your responsibility. You should consult your investment adviser before making any investment decisions.

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