Ben Bernanke’s testimony to Congress on 22nd May 2013, in which he said the Fed could slow the $85ba-month pace of asset purchases “in the next few meetings” if the labour market is strong, unnerved the Treasury market which saw the 10-year rising 85 bps the following month and the S&P500 easing under 4%. Investors may be on the look-out for something similar from Jerome Powell at the monetary policy symposium in Jackson Hole this Friday 27th August. What will it do to Malaysia’s equity market? We believe that if such a similar utterance is made again this week, it will likely make a greater impact to the local bond market than it will to the equity market, if past observation is a reliable guide. In the near term, local market factors may dominate the market’s direction as the recent resolution to the political impasse with the appointment of a new PM has been a welcome respite. We raise our year-end FBMKLCI target from 1,575 to 1,639 points. Overweight Building Materials, Gaming, Rubber Gloves, Technology and Utilities.

Taper before end-2021? The Fed has made good progress in engineering an economic recovery with the desired level of inflation via Fed Funds rate cuts since end 2019 and asset buying programs (QE). It is now expected to consider lifting the accommodation by first tapering bond purchases, possibly before the end of 2021 - there are three meetings left for the rest of this year to do so i.e. 21-22 Sept, 2-3 Nov or 14-15 Dec. As per the previous experience with regards to bond taper, the Fed started tapering at the Dec 2013 FOMC meeting after alluding of the intention in May 2013 and comfortably continued on the tapering path in 2014 as the economy gained traction and firmed without raising the Fed Funds rate until 2016.

Three conditions prompt us to consider a taper to be likely by the year-end: First, the US economy has turned the corner. After three straight quarters of YoY contractions, the economy turned around in 1QCY21 with 0.5% expansion followed by 12.2% in 2QCY21. Private forecasters forecast an average growth of 6.2% YoY over the next three quarters to 1QCY22 (see chart 1). During the 2014 taper, GDP grew just 2.3% that year after a sluggish 1.8% growth in 2013. Second, the Fed has raised its headline inflation expectation to 3.4% for 2021 in June from 2.4% in March versus 1.5% to 1.7% in 2013/14. Third, the current unemployment rate in the US is 5.4%, while in May 2013, it was 7.5%. The only risk we see that would stop the Fed is if the current evolving Covid variants turn out to be much worse heading into the winter months.

The last taper tantrum in 2013 impacted the local bond market more than equity: While the last taper experience in 2013 adversely impacted global bond and equity markets, there was limited impact on the Malaysian equity market then. However, we must qualify this by pointing out that in 2013, especially May that year, the market underwent a minor post-GE13 election rally after BN retained power under ex-PM Najib (albeit at less than two thirds majority). It may well have been the case that investors at that point were more focussed on unique domestic market factors (see chart 2). While the stock market traded mostly sideways for the rest of 2013 after May, the MGS market saw 10-year yield rising 84bps to nearly 4% in the ensuing 6 months. We have already imputed a risk-free rate of 3.60% using 10-year MGMS yield as a proxy (currently 3.20% and started the year at 2.60%)

Expect muted impact on Malaysian equities on taper: This time around, we believe that the taper when announced and implemented, will likely also have a muted impact on our stock market, given the severe lack of foreign interest in the Malaysian equities and trading already as it is, at one standard deviation below 10-year mean. However, the bond market which has seen strong foreign inflows YTD, looks more vulnerable to a steep taperinduced correction. Foreigners only just net sold Malaysia’s debt securities for the second straight month in July (- RM3.6b after June’s -RM0.5b) on amongst others, worsening Covid-19 infections and downgrades in GDP expectations. At 40% of MGS, foreign ownership remains high by historical standards, in contrast to the current foreign ownership of Malaysian equities at just over 20% - an all-time low.

No Fed Funds Rate hikes this year in our view: Drawing on the stages of the last tightening cycle and putting it into today’s context, we believe that the taper will take place through much of next year without the need to raise the Fed Funds rate given moderate expectations on inflation. Since the beginning of the year, the market’s one-year and two-year inflation expectations have risen only moderately by around 40-50bps (see chart 3: Implied forward inflation rate derived from US breakeven treasuries). Raising rates in our view, would more likely to be an end-2022 or 2023 event as alluded to by the latest Fed’s dot plot suggesting two rate hikes in 2023.

Fed Funds Rate hikes tend to dampen the local equity market: There have been three tightening cycles since the 90s – 1994, 2004 and 2016 (see chart 4). As we brace for the next one – but not within the next 12 months in our view - be aware that US rate hikes have caused corrections of 30% from peak to trough in 1994 during the days leading up the first hike on 3rd Feb 1994, 15% by the first hike on 29th Jun 2004 and 8% in 2016 by the first hike on 13 Dec 2016 (see chart 5).

Monetary policy issues aside, local stock market dynamics have changed with a new leadership: A resolution to the recent political uncertainty following the appointment of a new PM is a welcome respite for the market. While it may still be early days, it would be reasonable we believe, to expect the present administration to endeavour to govern for the rest of a full term, bearing in mind that Parliament must dissolve by 16th July 2023. Much needs to be done in that short space to win over the Rakyat. In the more immediate term, the appointment of a new Cabinet will be closely watched as will Budget 2022, where we expect unstinting policy supports for the Rakyat, especially the masses and rural populations (not forgetting too that the Sarawak State election must be held by 2 Apr 2022 if the State Emergency were to end 2 Feb 2022). And in ways akin to the past, policies will be probusiness. Putting them all together, we expect measures by the government to create market-positive conditions. The repercussions of further strain on the Federal government financial position are risks further ahead. But for now, we tactically raise our 12-month forward PE from 14.3x (1 SD below 10-year mean) to 14.9x (0.5 SD below). On FY22 EPS of 110 sen (subject to adjustments pending conclusion of earnings reporting season next week), we raise our year-end target from 1,575 to 1,639 points.

Source: Kenanga Research - 25 Aug 2021