A challenging time, but not a crisis

THERE has been mayhem in the Malaysian stock market. The FTSE Bursa Malaysia KL Composite Index (FBM KLCI) is down 8% to 1,716 points on a year-to-date (YTD) basis, making it one of the worst performers in the Asia-Pacific region.

The biggest concern creating the panic selling has been the collapse in oil prices and its implication on Malaysia’s ability to meet its fiscal targets.

As oil prices continue to take a beating, Malaysia’s economic outlook increasingly appears to be bleak, with the World Bank now cutting Malaysia’s growth forecast to 4.7% from an earlier estimate of 4.9%.

However, Minister in the Prime Minister’s Department Datuk Seri Abdul Wahid Omar is sticking to his growth target of 5% to 6% for 2015.

Since hitting its peak of 1,892.65 points in the third quarter of 2014, the local bourse has gone into a tailspin in the fourth quarter, magnified by the selling activities of foreign funds that appear to be never ending.

To date, some RM5bil has flowed out of the country, versus the RM3bil which entered Malaysia at the beginning of the year.

This, in turn, has weakened the ringgit to 3.49 against the US dollar, one of its weakest levels in five years.

With a warning by Petroliam Nasional Bhd (Petronas) that capital expenditure could be cut by 15% to 20% next year, this caused a massive selldown in oil stocks, with one analyst after another downgrading price targets. Most oil and gas (O&G) stocks are down by some 40% to 60% on a YTD basis.

For 2015, the Government had initially projected an oil-related revenue of RM62.4bil (2014: RM68.8bil), but Petronas recently warned that if the crude oil price averaged at the top-end of the US$70 to US$75 per barrel range, its dividends to the Government next year would fall to RM43bil.

The herd mentality kicked in and many research houses have turned bearish by cutting their year-end targets and proclaiming gloom.

So, is this a repeat of the 1998 crisis? And has the FBM KLCI seen its bottom?

In crisis mode?

UOB KayHian Research head Vincent Khoo says this is not a repeat of 1998.

“It’s a challenging time, but definitely not a crisis. It’s not systemic. The Government is actively trying to manage its debt situation,” says Khoo.

He adds that there could be some depreciation in the ringgit and some moderate rise in non-performing loans, but nothing severe.

“From the perspective of the FBM KLCI, we may see another 5% downside, but I would think that most of the bad news has been inputed into the market. We also see decent inflows coming in every month, hence buffering some of the portfolio outflows,” he says.

UOB KayHian in its recent strategy report highlighted that it expects capital inflows to go into the pension funds, insurance companies and retirement funds next year.

As an indication of rising domestic liquidity, UOB KayHian says that the net asset value of domestic unit trust funds has been growing and now makes up some 20% of Bursa Malaysia’s market capitalisation.

Danny Wong, fund manager at Areca Capital Sdn Bhd, feels that there is opportunity, especially when there have been irrational moves and with the market over-reacting.

In the last two weeks, Wong has been picking up stocks, including some in the O&G sector. Over the short term, he does agree that the FBM KLCI’s movement will take its lead from oil prices.

“We see value, not broadly, but selectively. Many of the O&G stocks have been bashed down. Many of our companies are service support companies. They aren’t doing exploration or risky service contracts. For companies which have locked in contracts, you know they will deliver on earnings.

“Then, the concern is whether they will be able to replenish their books. Well, I don’t think the oil price will remain at this level over the long term, but even if it does, you have earnings and dividends to fall back on,” explains Wong.

Khoo has projected an FBM KLCI trading range of 1,700 to 1,850 points, with the lower end of the range likely to dominate the first half of next year’s trading. At 1,700, the FBM KLCI will be trading at 13.5 times 2015 earnings.

With the current depressed situation, Khoo says the local bourse will be trading at below historical average PEs of 15 times, while stock valuations will be sub-optimal.

“Despite some portfolio outflows, we believe there is still sufficient liquidity in the market for some trading ideas. In fact, we have a tactically overweight call on the O&G sector, as it has been terribly oversold,” says Khoo.

The fiscal deficit issue

On the fiscal deficit situation for 2015, Khoo says that if left unchecked and assuming an average oil price of US$65, along with some savings from the fuel subsidy and the goods and services tax, Malaysia’s fiscal deficit would widen to 4%.

“I believe this is something the Government would definitely not want and would be taking steps to counter,” says Khoo.

Already, Deputy International Trade and Industry Minister Datuk Hamim Samuri has said the Government would be unveiling measures to further bolster the recent fall in the value of the ringgit.

Wong feels the fiscal deficit issue isn’t as severe as the market feels it to be.

“The concern now is that oil prices stay at this current low level for more than six months. Then, this may affect our sovereign debt rating. Firstly, I don’t think this is the case. But even if that happens, yes, our oil revenue will drop, but this will be mitigated by the fuel subsidy savings. We will also see the Government cutting back on some expenditure next year. The overall effect will not be that bad. It will still be manageable,” he says.

RHB Research feels the impact on Malaysia’s finances will be neutral if oil prices average US$80 per barrel.

However, if crude oil averages at around US$75 in 2015, Malaysia could see a revenue gap of RM3.25bil, which can still be bridged.

For instance, Malaysia has announced the implementation of a managed float fuel price scheme starting Dec 1, where retail petrol and diesel prices will be market determined on a “managed float”.

This gap could still be bridged by a combination of scenarios: first by convincing Petronas not to cut dividends so severely, second by cutting the increase in development expenditure by RM3bil, which is half of the increase of RM6bil budgeted for 2015, and third, Malaysia could still utilise the contingency expenditure of RM2bil set aside in Budget 2015.

Under this scenario, RHB Research says that the Government could still achieve its fiscal deficit target of 3% of gross domestic product (GDP) or close to it.

However, if oil prices were to fall to around US$60 per barrel, then it will cause the fiscal deficit to widen by about 1.1% of GDP and will likely derail the Government’s objective of achieving its 3% target.

The market moves ahead of the economy

Bear in mind that while the economy may suffer, the stock market is a different animal. The economy may still be floundering, but the market can already be rallying. The market always reacts first and much earlier.

During the US subprime crisis of 2008, the Dow Jones began its sharp downward spiral from the 11,000-point level in September 2008. It hit its all-time bottom of 6,547.05 on March 9, 2009.

Almost immediately, the market started its upward ascend. By March 2010, the market had achieved its pre-crisis levels and was back at the 11,000-point level.

Hence, when the US economy only truly regained some semblance of normalcy three years later, the Dow Jones recovered in a year.

Here in Malaysia, the FBM KLCI has effectively been on a downward spiral since July, which coincides with oil prices beginning their descend.

All in all, it has been close to six months of the index dropping, no doubt interspersed with some up days.

While it is very likely that the movement of the FBM KLCI will correlate with oil price movements, the more pertinent question for investors is whether all the bad news has been priced into the market.

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