• We see global growth declining in 2019, driven by the US and China

• Policy tightening in the US is likely to pause, limiting the USD strength and supporting case for ringgit stability

• Corporate earnings for 2019 are still at risk as seen this year, where growth expectation was tracked substantially lower

• We see marginal rise for the KLCI in 2019, mainly as a result from recent sell-off, and wary of contraction in valuation.

Persistent sell-off on economic slowdown and rates

Investors can be forgiven for the confusion presented by a market turmoil especially in EM countries. Performance of EM equities went swiftly from a record high in 1H2018 to a multi-year low currently. Primary to this significant sea change has been the outflow of foreign funds from EM stock markets as currencies were routed in earnest beginning May.

On the other hand, the persistent sell-off in the market has probably gone beyond concerns about a slowdown in global economic growth and what the Federal Reserves will do on interest rates next year. We think the markets are at a crossroad investors will need to assess and balance increasingly frequent news with regards to politics and economic growth.

The 3 key lessons we learned in 2018

Lesson 1: Politics cast a shadow over markets

One of the key reasons for the market malaise this year has been politics, both domestic and externally. The key events that have taken place this year are mostly political, i.e. a surprise outcome of Malaysia’s GE14, while in the US tax cuts and the US-China trade frictions have driven bond rates higher. Emerging currencies as a result have suffered, although they have recovered significantly off their lows this year. Malaysia is an exception as the ringgit has not fallen as much. Certainly, the USD has weakened somewhat in past one month is something of interest – particularly with the completion of the US November’s mid-term elections, as it appears that investors are betting that further dollar-boosting tax cuts are unlikely in the near-term.

There are reasons to be slightly positive – but only just – about emerging market fundamentals in 2019, despite geopolitics and escalation into trade war. Spread tightening in bonds tends to support appetite for assets perceived as risky, like those from emerging markets, until an actual inversion takes place, in our view. And for Malaysia, currency fundamentals are holding much better than Indonesia for example, and has not seen the ringgit falling significantly. Political news – and perhaps risk – for Malaysia would still rise as we head into 2019 as the planned transition of power gathers momentum.Nonetheless, we expect US trade policies to continue to cloud over financial markets in 2019. We believe that political impact both sides of the world tend to have a deeper impact on markets especially when the economy is slowing.

Lesson 2: Cash is king (somewhat)

Monetary tightening and rising short-term yields have prompted massive foreign outflow from equities as cash becomes a viable alternative. This is especially so for USD investors with 2-year US treasury rising to above 2.5% in 2H2018 (currently at 2.7%), compared to 1.8% at end-2017. Two-year U.S. Treasury yields are now more than three times their average over the post-crisis period.

A higher US rates have impacted EM assets much harder than we expected this year as markets suffered sell-offs in 2H in particular. Following the severe melt down in 2018, EM assets now appear to offer better trade-offs for risks in 2019, especially with the Federal Reserve likely to slow rate hikes. Our economics team has pencilled in a 3-time increase in US rates next year. But there is a increasing possibility that the Fed might make do with 2 rate hikes – a more plausible scenario in our view currently – especially that it is now reverting to data dependent stance for future rate hikes.

Lesson 3: Earnings growth matters

Malaysia’s KLCI corporate earnings growth estimate for 2018 slumped to only 0.9% yoy, compared to a growth expectation of 8% when we began the year. In addition, the Hijrah Shariah 30 companies’ earnings are estimated to contract by 3.5%, as exports and the economy moderated. The weak earnings has been devastating on market performance, as well as raising aggregate KLCI valuation to above-trend. The KLCI’s PE multiple rose to above its long-term average of 16.5x for most part of the year.

Our estimates for 2019 still calls for a 5% growth despite a moderation in economic expansion, largely due to expansion in financial sector’s profit which makes up 45% of the KLCI’ total earnings. However, we may be heading for another year of disappointment. History suggests that earnings downgrades have had a significant on Malaysia. In recent quarters, it becomes increasingly difficult to price-in downgrades due to poor earnings visibility. Overall, Malaysia’s corporate earnings growth is well behind EM growth average which is still expected to grow at 9.5% in 2019, led by a rebound in China technology sector.

We believe that a slowing growth and the potential ramification of the US-China trade friction will add uncertainty on Malaysia’s corporate outlook next year. This will result in a more cautious outlook on the level of valuation to be accorded to Malaysia.

Source: BIMB Securities Research - 21 Dec 2018