• We observe credit spread historically a reliable predictor of both ringgit and KLCI

• Credit spread – and a sustained crude oil price – suggests worst for Malaysia equities may be behind us

• Lira contagion possibly contained as seen in previous Greece crisis

• We revised our year-end KLCI target to 1,850

Contagion wall of worry

The fear of the Turkish lira contagion has triggered substantial selling in emerging assets, including equities and currencies this year. The lira in the past 6 months has fallen by nearly 40% and has brought down with it the MSCI AC Asia (ex-Japan) by 12% and MSCI Emerging Market by 15%. At the same time, the USD (as measured by the Dollar Index) has risen by 8% (refer chart 1), which demonstrates clearly a pattern of flight to safety. The conflict and tariff impositions by both US and China appear to be imploding, but the clash between both countries are currently priced in, in our opinion.

Drawing parallel to previous crisis

We see similarities in asset performance currently shaping out and the Greece debt crisis (and China stock market collapse) in 2015-2016. During this period the USD rose as funds flowed into the currency, rising to about 1.05 to the Euro at its peak. The USD is currently a significant beneficiary, as too are US bonds, resulting in weak performances in other asset classes such gold and non-US equities. Indeed, the credit spread between Malaysian bonds and US treasuries doubled during the Greece crisis – soaring from a relatively low level of just over 1% to more than 2% within a period of 3 months. However, Malaysia’s spread has stayed relatively stable despite the current turmoil in several emerging currencies.

Source: BIMB Securities Research - 27 Aug 2018