Navigating a near perfect storm


Why so? With inflation running at a four-decade high in the United States and the eurozone and central banks on an aggressive rate hike path, economic data points are beginning to show the weakening global economy with talk of recession dominating most discussions.

AS global markets ended the first half on a relatively sour note, market strategists and economists are now busy plotting their respective market views for the second half of this year as we head towards a near-perfect storm.

Why so? With inflation running at a four-decade high in the United States and the eurozone and central banks on an aggressive rate hike path, economic data points are beginning to show the weakening global economy with talk of recession dominating most discussions.

Some have placed bets that the US will enter a recession next year while the International Monetary Fund (IMF) believes the United States will just narrowly avoid recession this year and in 2023.

The IMF itself will be releasing the revised gross domestic product (GDP) growth data for the year and 2023 later this month while the World Bank had lowered its 2022 projection to just 2.9% from 4.1% it predicted in late January this year, while growth for 2023 is now estimated at 3% against 3.2% six months ago.

The lowered projection comes on the back of the protracted Russian invasion of Ukraine, the lockdown of several cities in China to contain the new wave of Covid-19 outbreak, supply chain disruptions as well as the strong dollar, which by and large is driven by the US Federal Reserve (Fed) rate hike expectations.

The question on everyone’s mind is whether we are in for a soft landing scenario, as what is being desired by the Fed, or a hard landing as the global economy is now going through some dark clouds midway through the 2022 flight path.

The turbulence we are riding on now can be devastating if we are not able to manoeuvre the near-perfect storm ahead of us.

Focus on supply constraints

While the Fed is dead serious in raising rates to bring down inflationary pressure and pulling away liquidity via its quantitative tightening measure, one wonders if that is the right policy, especially at a time when inflation pressure itself is caused by cost-push factors.

Higher commodity prices, logistical issues as well as economic disruptions caused by war or lockdowns due to covid-19 measures taken by certain governments are supply-driven constraints pushing production costs higher globally.

Sky-high commodity prices have also pushed other raw material prices to the roof, resulting in a higher cost of goods for finished products.

Hence, raising interest rates is not the solution to tackle inflationary pressure as it does not help to bring manufacturers’ costs down.

On the contrary, a higher borrowing cost will disrupt businesses and increase the cost of doing business, which in the end will push finished product prices even higher.

Meanwhile, the consumer, which is seeing his purchasing power shrinking by the day will be hard-pressed to make ends meet when rates increase.

The question is then, how do rising interest rates help to curtail inflation pressure?

Other than the war in Ukraine, which the West seems not to be able to do much to restore order, the rest of the supply constrain issues are well within the grasp of governments to tackle.

In addition, China’s zero-tolerance towards Covid-19, which has impacted the global supply chain earlier, can now put their house in order to ensure there are minimal disruptions from hereon.

China itself should move away from its relentless pursuit of zero-Covid-19 cases and move towards the endemic stage as what the rest of the world is pursuing.

China ought to learn to live with it rather than fight a losing battle with serious economic consequences, not only for itself but for the rest of the world too.

Another supply chain issue is related to the logistical nightmare faced by the global supply chain brought about by a shortage of workers as well as constraints in warehousing capacity and even port congestions.

All this will take time to recover as the logistic industry adds on the capacity to meet the demand, which in some cases will likely be in the form of a permanent shift towards the higher cost, especially labour.

Nevertheless, as in most economic imbalances, supply and demand dynamics will adjust towards equilibrium in time and when that happens, it is hoped the global economy remains on a positive growth trajectory. Easing commodity prices a welcome relief

With the global economy seeing increasing signs that growth momentum is slowing down, demand for commodities too is expected to ease.

In the past month itself, we have seen the benchmark Bloomberg Commodity Index dropping by about 11% from its peak while some other individual commodities have entered the bear market territory.

This is good news for downstream manufacturers as input cost has come off and will help to reduce the cost of production of consumer products.

Even crude palm oil futures has dropped significantly from its closing peak price of RM7,105 per tonne in late April to RM4,912 per tonne as at end of June 2022, down 30.9% for the most active third-month contract.

The sell-off among commodities is likely driven by the market perception that the global economy is now headed towards lower aggregate demand due to the high inflation, especially for discretionary spending.

Hence, for the United States and the eurozone as well as some other developed nations that are seeing aggressive rate hikes, their economies may be headed towards devastation as a hard landing scenario is now more likely than ever as the probability of recession is rising globally. Malaysia is in a sweet spot

The Finance Minister recently highlighted that Malaysia is set to spend some RM77.7bil this year in the form of subsidies not only due to high crude oil prices but also subsidies that are provided for electricity, cooking oil, flour and other subsidies as well as cash handouts.

This is a significant jump of more than RM60bil from the RM17.4bil estimated when tabling Budget 2022 in October last year.

Surely, something got to give to ensure Malaysia maintains its fiscal prudence of hitting the 6% budget deficit target for this year and this can only be achieved either via a higher petroleum-related revenue (likely to increase by RM35bil to RM78.9bil from RM43.9bil projected in Budget 2022), lowering the development expenditure by approximately 19.8% or RM15bil to RM60.6bil from RM75.6bil projected in Budget 2022, as well as reducing other operating expenditure by about RM10bil or 4.5% to RM229bil from RM233.5bil estimated in Budget 2022.

While subsidies may distort real economic issues faced by a nation, especially at a time when global inflationary pressure is at decades high, it is a necessary stop-gap measure to ensure inflation remains under control, which indirectly helps the central bank to keep rates accommodative for economic expansion.

As the minister himself pointed out, without subsidies, Malaysia’s rate of inflation would have been at 11.4% in May and one cannot imagine the dire consequences of high inflation prints on the Malaysian economy, confidence, and sentiment of both consumers and investors.

However, the government must, by all means, remove these crutches when aggregate prices normalise as heavy subsidies do not only constraint the government’s finances but distort real economic issues. Malaysia must move away from fuel subsidies once and for all and allow market prices to dictate actual prices. One way for the government to make this one-time painful adjustment is to have a market price that reflects not only the actual cost but a tax on it.

GE15 on the cards

As politicians on both sides of the divide have their own opinion as to when the 15th General Election (GE15) ought to be held, the pressure will likely mount on the Prime Minister to seek a dissolution of the Parliament upon the expiry of the memorandum of understanding with Pakatan Harapan at the end of this month. Whether the Prime Minister bites the bullet and calls for GE15 is left to be seen as the timing may not be appropriate due to the rising cost of living, which can be rather contentious during an election.

The Prime Minister still has time as the 14th Parliament will only automatically dissolve on July 16, 2023, and GE15 must be held within 60 days from the date of the dissolution.

This suggests that GE can even be held by mid-September 2023, which is more than 14 months from now.

Eyes on the economy and Budget 2023

Malaysia got a boost when Standard & Poor’s raised Malaysia’s long-term rating outlook to stable from negative early this week, and at the same time, the rating agency also pencilled in a GDP growth of 6.1% for the year.

Malaysia is probably one of the rare nations globally to be accorded with strong growth prospects, driven by high commodity prices, reasonably controlled core inflation prints, and accommodative monetary policy.

With Budget 2023 to be tabled in late October, all eyes will again be on the Finance Minister and the government as it is likely that it may turn out to be an election budget, which will please the masses and voters alike.

Nevertheless, the government ought to be pragmatic about the upcoming Budget 2023 as it is another opportunity to put our financial house in order, especially in terms of revenue collection.

While PETRONAS can always be counted upon to provide the government the extra allocation as and when required, it is time to introduce a more comprehensive taxation system that will allow the government to increase its tax collection as a percentage of GDP to a more respectable ratio of 15% from less than 11% estimated for this year based on Budget 2022 estimates. Bursa Malaysia remains a resilient market

As the benchmark FBM KLCI is down some 7.9% in ringgit terms and 13.7% in greenback terms year-to-date at halftime, the market is beginning to show value with forward price-earnings multiple of just 14 times 2022 earnings and undemanding 12.6 times earnings for 2023.

Yes, there are challenges not only for the local bourse but globally as central banks navigate a tough second half, the stock market always tends to be ahead of economic fundamentals and if earnings projections are spot-on for the next one to two quarters, the market will be in a perfect position to ride the upside momentum once inflation pressure eases and global central banks are done with raising rates.

For now, it is good to be nimble and watch out for market opportunities, especially on growth stocks, which have taken a severe beating. Value stocks with good dividends are always a welcome addition to any portfolio during a down market and investors should also keep an eye on the basket of these stocks that are more long-term in nature, boring but provide a steady stream of income.

Pankaj C. Kumar is a long-time investment analyst. The views expressed here are the writer’s own.

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