For all intents and purposes, the US home mortgage market has been nationalized without anybody noticing. Last September, reportedly over 95% of all new loans for single-family homes in the US were made with federal assistance, either through Fannie Mac and the implied guarantee or Freddie Mac or through the FHA. If government support goes away, and it will go away, where will that leave the home market? Lenders are still lending but reverting to 75% to 80% loan to value. But that doesn’t help a homeowner whose property is worth less than the mortgage.
Then, commercial world has to follow suit. Because it is a normal progression. Obviously, when single-family homes decline in value, multifamily apartments decline in value too. And when consumers hit the wall with spending and debt, that is going to have an impact on retailers that pay for commercial space.
Lenders also saw that underwriting guidelines for commercial real estate loans, especially in the securitization markets, were erroneous. They realized that some of the properties had been financed too aggressively and today it is clear that commercial properties are not performing and that values have gone down, although I have got to tell you, the denial is still widespread, particularly in the United States and on the part of lenders sitting on and servicing all these real estate portfolios.
The current volume of defaults is already alarming. And the volume of commercial real estate defaults is growing every month. That can only keep going for so long, and then you hit a breaking point that I believe it will come sometime in 2010.
Key risk is that we might be heading to a Japanese-style solution. In 1989 and 1990, Japan didn’t want their banking system to implode so they made it easier for their banks to it on bad assets without owning up to the losses. And what’s the result? Well, it leaves the status quo in place. The real problem with this is twofold. One is that it prolongs the problem – if a bank is allowed to sit on bad assets for three to five years, it is not going to sell them. Well, the money tied up in the loans the bank is sitting on is idle and it is not being used for anything productive.
The banks have a lot of incentive to delay the realization of the problem because if they liquidate the asset and the loss is realized, then they have to reserve the loss against the capital immediately. If they keep extending the loan under the rules present today, then they can delay a write-down and hope for better days. I think the US government will contrive something to help commercial real estate so that it doesn’t hurt the banks that lent on commercial real estate. I will resemble what they did with housing. But it won’t really be solution. In fact, it will make the problems much more intense.
Wednesday, January 27, 2010
The Rude Awakening
Since November 2009, Hong Kong equities fell 10% and it underscores the increasing threat to valuations as China curbs growth and the US proposes limits on the banking industry. The heyday of the Bush-Obama bailout frenzy is coming to an end. Its chief architects – Treasury Secretary Geithner and Fed Chairman Bernanke – are politically dead or dying, its loyal opposition – Obama adviser Paul Volcker and FDIC Chairman Bair – is gaining rapidly in influence.
We all know along that TARP was a classic financial blunder and ultimate moral hazard. It rewarded guilty bankers while shafting innocent taxpayers now stuck with the bill. The Fed’s zero interest rate policy is a ticking time bomb. It subsidizes and stimulates high stakes gambling on Wall Street while it robs prudent savers of nearly every penny they hoped to earn in interest.
Public opinion regarding the president’s handling of the federal deficit has nosedived. Back in March, 52% of voters approved and 47% disapproved. Now, the numbers have reversed dramatically to the opposite side – only 36% in favour and 62% against.
Paul Volcker who previously shunned and ignored by most of the Obama team has re-emerged from the shadows and regained the limelight. He is looking over the president’s shoulders. He is pressing the administration to get tough with Wall Street. And ultimately, he could push Obama to change course on key aspects of the bailouts.
Whether he will retain that standing – in the heat of battle or in the wake of a renewed banking crisis – remains to be seen. But for now, his reappearance on the front lines is a metaphor for the sweeping mood change among voters and a possible policy shift at the White House.
We all know along that TARP was a classic financial blunder and ultimate moral hazard. It rewarded guilty bankers while shafting innocent taxpayers now stuck with the bill. The Fed’s zero interest rate policy is a ticking time bomb. It subsidizes and stimulates high stakes gambling on Wall Street while it robs prudent savers of nearly every penny they hoped to earn in interest.
Public opinion regarding the president’s handling of the federal deficit has nosedived. Back in March, 52% of voters approved and 47% disapproved. Now, the numbers have reversed dramatically to the opposite side – only 36% in favour and 62% against.
Paul Volcker who previously shunned and ignored by most of the Obama team has re-emerged from the shadows and regained the limelight. He is looking over the president’s shoulders. He is pressing the administration to get tough with Wall Street. And ultimately, he could push Obama to change course on key aspects of the bailouts.
Whether he will retain that standing – in the heat of battle or in the wake of a renewed banking crisis – remains to be seen. But for now, his reappearance on the front lines is a metaphor for the sweeping mood change among voters and a possible policy shift at the White House.
Sunday, January 24, 2010
The End Game
This year is a waiting game, but makes no mistake, we are coming close to the end game in almost drunken fashion. Over the next several months, we are going to start explore various aspects of the end game. Can this time be different?
In highly leveraged economies, particularly those in which continual rollover of short term debt is sustained only by confidence in relatively illiquid underlying assets, it seldom survives forever, particularly if leverage continues to grow unchecked.
The longer we try to put off the pain, the worse the total pain will be. The US is facing a long and difficult road as it attempts to correct the over-indebtedness and wasteful expenditures of the past two decades. At $3.70 of debt for every dollar of GDP, US debt is excessive. According to a book ‘This Time is Different – Eight Centuries of Financial Folly’ by Reinhart and Rogoff, the main standard in explaining more than 250 crises studies in whether debt is excessive relative to national income, even though idiosyncrasies apply in each case. They reiterate that this old rule continues to apply and this time is not different.
It has been more than a year since the Fed began a massive expansion of Fed Reserve Bank credit from $1 trillion to $2.2 trillion, flooding the banking system with reserves. According to the late Nobel prize winning economist Milton Friedman, an increase in M2 of such increase in reserves to M2 of such magnitude would have been highly inflationary. However, M2 did not explore instead in the past twelve months, this aggregate has risen only 3% and this is less than ½ of the average growth rate over the last fifty years. Essentially, debt overwhelms monetary policy.
Despite the concurrent developments of little money growth and declining loan growth, the fear nevertheless remains that an inflation surprise might be just around the corner. Today it is obvious that the US economy has plentiful excess resources, so any increase in demand will result in little price change. This will be the case until our unemployment rate of over 17% drops by a considerable amount and we begin to use factories well above current 68% utilization rate.
Deficit spending only provides a transitory boost to the economy. It initially raises GDp as it did in the second half of 2009 but then the effect dissipates and later is reversed as financial resources available to the private sector are reduced. At the height of Japan’s banking crisis in the 1990s, repaving the streets in Tokyo became a routine exercise. As a result, Japan’s gross government debt-to-GDP ratio is now nearly 200% and a drag on what once was a vibrant economy.
In highly leveraged economies, particularly those in which continual rollover of short term debt is sustained only by confidence in relatively illiquid underlying assets, it seldom survives forever, particularly if leverage continues to grow unchecked.
The longer we try to put off the pain, the worse the total pain will be. The US is facing a long and difficult road as it attempts to correct the over-indebtedness and wasteful expenditures of the past two decades. At $3.70 of debt for every dollar of GDP, US debt is excessive. According to a book ‘This Time is Different – Eight Centuries of Financial Folly’ by Reinhart and Rogoff, the main standard in explaining more than 250 crises studies in whether debt is excessive relative to national income, even though idiosyncrasies apply in each case. They reiterate that this old rule continues to apply and this time is not different.
It has been more than a year since the Fed began a massive expansion of Fed Reserve Bank credit from $1 trillion to $2.2 trillion, flooding the banking system with reserves. According to the late Nobel prize winning economist Milton Friedman, an increase in M2 of such increase in reserves to M2 of such magnitude would have been highly inflationary. However, M2 did not explore instead in the past twelve months, this aggregate has risen only 3% and this is less than ½ of the average growth rate over the last fifty years. Essentially, debt overwhelms monetary policy.
Despite the concurrent developments of little money growth and declining loan growth, the fear nevertheless remains that an inflation surprise might be just around the corner. Today it is obvious that the US economy has plentiful excess resources, so any increase in demand will result in little price change. This will be the case until our unemployment rate of over 17% drops by a considerable amount and we begin to use factories well above current 68% utilization rate.
Deficit spending only provides a transitory boost to the economy. It initially raises GDp as it did in the second half of 2009 but then the effect dissipates and later is reversed as financial resources available to the private sector are reduced. At the height of Japan’s banking crisis in the 1990s, repaving the streets in Tokyo became a routine exercise. As a result, Japan’s gross government debt-to-GDP ratio is now nearly 200% and a drag on what once was a vibrant economy.
Thursday, January 21, 2010
China’s Predicament
Liu Mingkang, head of the China Banking Regulatory Commission (CBRC) said in an interview recently that several Chinese banks had been asked to restrain their lending after proving to have inadequate capital reserves. While the regulators will strive to control credit flows, the broader Chinese imperative to maintain growth at any cost contradicts the ability to preserve loan quality and allocate capital efficiently.
Under the guidance of the central government, bank lending – the dominant form of financing in China – has skyrocketed in the past year to spur growth, fend off the effects of slower global trade and thereby maintain social order. Amid the loan boom, Chinese authorities have at times sought to restrain banks, fearing a massive build up of bad loans.
In February, April, July and October 2009, Beijing restrained the banks, only to see lending spike again in March, June and September 2009 – and now again in January 2010. Essentially, Beijing is caught in a cycle of speeding up and slowing down credit expansion. With each deceleration, China’s loan-dependent businesses, mostly state-owned and state-controlled, cry out in pain, resulting in another acceleration to make sure they do not grind to a halt.
2010 is expected to be another year of high lending with Beijing projecting 7.5 trillion yuan in new loans – a smaller sum than the 9.6 trillion yuan lent in 2009, but indicative of a glut of credit consumption.
In order to achieve even a mild reduction in lending in 2010, the Chinese authorities know they will have to take some serious actions to restrict the banks. The demand for banks to increase their capital bases beginning in late 2009 and the raising of reserve ratio requirements on January 12, 2010 forced banks to set more cash aside that would otherwise be lent out. The January 20, 2010 demand that certain commercial banks stop lending for the rest of the month is another such move.
The problem for China is that the entire economy depends on extremely loose lending policies and when credit slows, companies in the critical manufacturing and trade sectors get squeezed. A great many Chinese companies rely on external consumers for their profits but while exports showed growth for the first time in December, they face the usually slow months of January and February, only when spring comes around will it really be clear whether global demand has recovered significantly to support China’s exporters.
Thus, exports are no refuge yet and since Beijing has no intention of knocking the legs out of growth, it will continue shoving credit into the system.
Under the guidance of the central government, bank lending – the dominant form of financing in China – has skyrocketed in the past year to spur growth, fend off the effects of slower global trade and thereby maintain social order. Amid the loan boom, Chinese authorities have at times sought to restrain banks, fearing a massive build up of bad loans.
In February, April, July and October 2009, Beijing restrained the banks, only to see lending spike again in March, June and September 2009 – and now again in January 2010. Essentially, Beijing is caught in a cycle of speeding up and slowing down credit expansion. With each deceleration, China’s loan-dependent businesses, mostly state-owned and state-controlled, cry out in pain, resulting in another acceleration to make sure they do not grind to a halt.
2010 is expected to be another year of high lending with Beijing projecting 7.5 trillion yuan in new loans – a smaller sum than the 9.6 trillion yuan lent in 2009, but indicative of a glut of credit consumption.
In order to achieve even a mild reduction in lending in 2010, the Chinese authorities know they will have to take some serious actions to restrict the banks. The demand for banks to increase their capital bases beginning in late 2009 and the raising of reserve ratio requirements on January 12, 2010 forced banks to set more cash aside that would otherwise be lent out. The January 20, 2010 demand that certain commercial banks stop lending for the rest of the month is another such move.
The problem for China is that the entire economy depends on extremely loose lending policies and when credit slows, companies in the critical manufacturing and trade sectors get squeezed. A great many Chinese companies rely on external consumers for their profits but while exports showed growth for the first time in December, they face the usually slow months of January and February, only when spring comes around will it really be clear whether global demand has recovered significantly to support China’s exporters.
Thus, exports are no refuge yet and since Beijing has no intention of knocking the legs out of growth, it will continue shoving credit into the system.
Monday, January 18, 2010
Systemic Fragility
Hedging, speculating and Ponzi financing are some key concepts that we are hearing a lot in this modern time and according to Minsky, these are the foundation to systemic fragility.
A unit is hedged if expected cash-flow from operations substantially exceeds its debt servicing commitments. It is engaged in speculative finance if it has to depend on periodically refinancing debts. A Ponzi unit has to constantly borrow more in order to meet its debt servicing commitments.
A prolonged period of stability would induce some units to migrate from hedge to speculative and others from speculative to Ponzi finance and this makes the system as a whole increasingly fragile. In a highly fragile economy, no identifiable exogenous shock is needed to unleash a crisis. Some trivial, random event would be sufficient to be the trigger.
What makes this analysis relevant in today’s content is that it describes a process of general leveraging as part of a business downturn. It is quite clear that it is a fallacy of composition to suppose that general leveraging can take place without a decline in asset prices and excess supply of goods and services in general. When leverage is increasing all around, with all parties buying on credit, all also find themselves making a profit. This reinforces the process.
The large investment banks had leverage ratios in the high 20s or low 30s. Hedge funds and some European banks may have been even more highly levered. When the sector as a whole attempts to de-leverage by reducing liabilities, a variety of de-stabilizing processes are set in motions.
A unit is hedged if expected cash-flow from operations substantially exceeds its debt servicing commitments. It is engaged in speculative finance if it has to depend on periodically refinancing debts. A Ponzi unit has to constantly borrow more in order to meet its debt servicing commitments.
A prolonged period of stability would induce some units to migrate from hedge to speculative and others from speculative to Ponzi finance and this makes the system as a whole increasingly fragile. In a highly fragile economy, no identifiable exogenous shock is needed to unleash a crisis. Some trivial, random event would be sufficient to be the trigger.
What makes this analysis relevant in today’s content is that it describes a process of general leveraging as part of a business downturn. It is quite clear that it is a fallacy of composition to suppose that general leveraging can take place without a decline in asset prices and excess supply of goods and services in general. When leverage is increasing all around, with all parties buying on credit, all also find themselves making a profit. This reinforces the process.
The large investment banks had leverage ratios in the high 20s or low 30s. Hedge funds and some European banks may have been even more highly levered. When the sector as a whole attempts to de-leverage by reducing liabilities, a variety of de-stabilizing processes are set in motions.
Pair Trades
Pair trading is a popular currency trading strategy. It gives us the opportunity to capture a dislocation between two currencies by taking a long position in one currency and a short position in another currency simultaneously in equal dollar amounts. In identifying a good pair trade, one would have to look for two currencies that share the same characteristics that have a strong historical statistical correlation in order to minimize the losses.
I found two pairs of currencies for one to work on beginning of this year.
First, intra-Europe regional – the paths of the Euro and the British Pound, which have diverged in recent months due to the under-performance of the UK economy relative to that of the Eurozone. My argument is that the Euro could be vulnerable to a sharper decline and the culprit will be the sovereign debt problems in the region. Greece has been downgraded by all three rating agencies on concerns of the ability to service its sovereign debt. Now Portugal, Spain, Italy and Ireland are all under the microscope for similar reasons. I think we will see both currencies Euro vs USD and British Pound vs USD to move lower but the euro will likely fall faster as the issues with Greece and other weak spots in the Eurozone continue to unfold. I am looking for the Euro to weaken against the pound, bringing the spread back together.
Secondly, intra-Asia currencies play between Japanese and Korean Won against the USD. Japanese Yen has been the best performing currency in the past two and half years while other Asian currencies were crushed during the height of uncertainty. That in turn caused a divergence between the Japanese Yen and other Asian currencies, especially the Korean Won.
This was driven by the forced unwinding of the yen carry trade. In other words, the huge interest rate gap between the Japan and the rest of the world drove investors to borrow massive amounts of yen for virtually free, exchanging it for higher yielding currencies around the world. But the sour economic conditions in Japan and attempts to fight record deflation with more stimulus is beginning to weigh on the yen. Meanwhile, South Korea’s economy has fared far better on a relative basis and this makes a convergence between these two currencies likely and offers the potential for a profitable pair trade.
I found two pairs of currencies for one to work on beginning of this year.
First, intra-Europe regional – the paths of the Euro and the British Pound, which have diverged in recent months due to the under-performance of the UK economy relative to that of the Eurozone. My argument is that the Euro could be vulnerable to a sharper decline and the culprit will be the sovereign debt problems in the region. Greece has been downgraded by all three rating agencies on concerns of the ability to service its sovereign debt. Now Portugal, Spain, Italy and Ireland are all under the microscope for similar reasons. I think we will see both currencies Euro vs USD and British Pound vs USD to move lower but the euro will likely fall faster as the issues with Greece and other weak spots in the Eurozone continue to unfold. I am looking for the Euro to weaken against the pound, bringing the spread back together.
Secondly, intra-Asia currencies play between Japanese and Korean Won against the USD. Japanese Yen has been the best performing currency in the past two and half years while other Asian currencies were crushed during the height of uncertainty. That in turn caused a divergence between the Japanese Yen and other Asian currencies, especially the Korean Won.
This was driven by the forced unwinding of the yen carry trade. In other words, the huge interest rate gap between the Japan and the rest of the world drove investors to borrow massive amounts of yen for virtually free, exchanging it for higher yielding currencies around the world. But the sour economic conditions in Japan and attempts to fight record deflation with more stimulus is beginning to weigh on the yen. Meanwhile, South Korea’s economy has fared far better on a relative basis and this makes a convergence between these two currencies likely and offers the potential for a profitable pair trade.
Bank Failures in 2010
More bank failures are expected this year – inevitably involving the greatest bank losses in history and already costing the FDIC ten times more than the great S&L and banking crisis of the 1980s did. In her testimony before the Financial Crisis Inquiry Commission, FDIC Chairman Blair attacked the Fed under Greenspan for causing the housing bubble and subsequent debt crisis with its highly stimulative, low interest rate policy of the 2000s.
And to make things worse, the Fed under Bernanke is now pursuing an even more stimulative, lower interest rate policy than it did under Greenspan, threatening to create even larger bubbles and more devastating busts. It is potentially to see 200 banks to fail this year, easily surpassing last year’s 140 bank failures.
In just the last two years, between bank bailouts and easy money, Washington has done more to encourage the growth of the shadow banking system than in all previous years combined and in the absence of another Wall Street meltdown, the chance of sweeping reforms is virtually nil.
In addition to the 140 banks and S&Ls that failed in 2009, 31 credit unions went under, bringing the total tally to 171. The average bank failing today is six times larger than it was then, producing far greater losses. Each bank failure is costing the FDIC about ten times more than it did in the 1980s crisis, according to the Meridian Group of Seattle.
Until last week, the consensus opinion on Wall Street was that the troubles at the big banks were over that to close this chapter in history, the only task remaining was a mop up operation at smaller regional and community banks around the country. That theory was shattered when JP Morgan Chase revealed it was forced to add $1.5 billion to its consumer loan loss reserves. When it took over Washington Mutual last year, the biggest failed S&L of all time, it inherited a cesspool of mortgages that are now going bad at an accelerating pace. Other big consumer banks like Citigroup and Bank of America are likely to face similar woes.
I also note than the trading profits of big investment banks are a bubble. Without the Fed’s largesse, without the low cost financing and without the big risk appetite it generates, most of the big bank trading profits would have been impossible. More to the point, just as soon as the Fed finally executes an exit plan, the bulk of these profits are likely to turn to losses.
And to make things worse, the Fed under Bernanke is now pursuing an even more stimulative, lower interest rate policy than it did under Greenspan, threatening to create even larger bubbles and more devastating busts. It is potentially to see 200 banks to fail this year, easily surpassing last year’s 140 bank failures.
In just the last two years, between bank bailouts and easy money, Washington has done more to encourage the growth of the shadow banking system than in all previous years combined and in the absence of another Wall Street meltdown, the chance of sweeping reforms is virtually nil.
In addition to the 140 banks and S&Ls that failed in 2009, 31 credit unions went under, bringing the total tally to 171. The average bank failing today is six times larger than it was then, producing far greater losses. Each bank failure is costing the FDIC about ten times more than it did in the 1980s crisis, according to the Meridian Group of Seattle.
Until last week, the consensus opinion on Wall Street was that the troubles at the big banks were over that to close this chapter in history, the only task remaining was a mop up operation at smaller regional and community banks around the country. That theory was shattered when JP Morgan Chase revealed it was forced to add $1.5 billion to its consumer loan loss reserves. When it took over Washington Mutual last year, the biggest failed S&L of all time, it inherited a cesspool of mortgages that are now going bad at an accelerating pace. Other big consumer banks like Citigroup and Bank of America are likely to face similar woes.
I also note than the trading profits of big investment banks are a bubble. Without the Fed’s largesse, without the low cost financing and without the big risk appetite it generates, most of the big bank trading profits would have been impossible. More to the point, just as soon as the Fed finally executes an exit plan, the bulk of these profits are likely to turn to losses.
Sunday, January 17, 2010
Money Talks
We continued to be bombarded with more statistics that are showing the economy is improving. You can see that we have put the deepest depths of the recession behind us and a good portion of this is because of government spending and a shift in monetary policy. The Fed is going out of their way to stress that nothing is going to change and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
First, we need to understand little about Chairman Bernanke’s background. At the heart of his entire philosophy, he is a strong proponent for massive money printing and he literally wrote a book on this subject – the book that is now essentially the Fed’s operating manual on precisely how to print enough money to overwhelm almost any economic collapse.
Bernanke believes that the Fed prematurely hiked rates in 1937, prolonging the Great Depression into 1938 and beyond. He is convinced that single, momentous blunder of history is what doomed the world to a nasty ‘double-dip’. One thing for sure, he will consistently bend over backwards to avoid raising rates and he will continue to do everything in his power to pump more and more liquidity into the economy.
Neither the Obama administration nor Congress is showing any fiscal discipline. And definitely they are not acting with some counter-balancing actions. It all goes back to the 1937-38 analog and I have no doubt that Treasury Secretary Tim Geithner is singing from the same hymnal. The philosophical approach that is dominating Washington policy holds the belief that as soon as the government curtails its support for housing and mortgages, the market will tank again.
The spread between short-term and long term interest rates will widen and I could safely assume that long-term bond prices to go much lower. Last year was the single worst year for long-term Treasury bonds in decades and if you got hammered in 2009, don’t let 2010 result in more of the same. Consider dumping the long-term government debt and rest assured that the belief that non-Treasury bonds are impervious to price declines resulting from higher rates are not true after all.
In 2009, downgrades and debt auction failures in countries like the UK, Greece, Ireland and Spain were a stark reminder that unless advanced economies begin to put their fiscal houses in order, investors and rating agencies will likely turn from friends to foes.
First, we need to understand little about Chairman Bernanke’s background. At the heart of his entire philosophy, he is a strong proponent for massive money printing and he literally wrote a book on this subject – the book that is now essentially the Fed’s operating manual on precisely how to print enough money to overwhelm almost any economic collapse.
Bernanke believes that the Fed prematurely hiked rates in 1937, prolonging the Great Depression into 1938 and beyond. He is convinced that single, momentous blunder of history is what doomed the world to a nasty ‘double-dip’. One thing for sure, he will consistently bend over backwards to avoid raising rates and he will continue to do everything in his power to pump more and more liquidity into the economy.
Neither the Obama administration nor Congress is showing any fiscal discipline. And definitely they are not acting with some counter-balancing actions. It all goes back to the 1937-38 analog and I have no doubt that Treasury Secretary Tim Geithner is singing from the same hymnal. The philosophical approach that is dominating Washington policy holds the belief that as soon as the government curtails its support for housing and mortgages, the market will tank again.
The spread between short-term and long term interest rates will widen and I could safely assume that long-term bond prices to go much lower. Last year was the single worst year for long-term Treasury bonds in decades and if you got hammered in 2009, don’t let 2010 result in more of the same. Consider dumping the long-term government debt and rest assured that the belief that non-Treasury bonds are impervious to price declines resulting from higher rates are not true after all.
In 2009, downgrades and debt auction failures in countries like the UK, Greece, Ireland and Spain were a stark reminder that unless advanced economies begin to put their fiscal houses in order, investors and rating agencies will likely turn from friends to foes.
Tuesday, January 5, 2010
Foreign Ownership in Malaysian Equities
The Malaysian share market stays above 1,200 from a trough of 836 in mid-March 2009. Yet foreign investors had barely made their presence felt during the run-up. This has been often cited as one of the key reasons why our local market had been lagging its regional peers.
Foreign participation as a percentage of total trading value on the Malaysian stock exchange has dropped from 42% in 2008 to 25% in 2009 indicating inactive foreign participation. Foreign brokers’ market share is declining. Of the six licensed foreign brokers in Malaysia, only three appeared inside the top 15 brokers’ ranking with a combined market share of 11% of total trading value for 2009 versus a 22% market share in 2008. Foreign ownership stands at 21% of overall market capitalization as of September 2009 – the lowest in five years.
There are two key reasons why foreign investors are underweighting Malaysia as an investment destination in recent years. Even though the domestic market price-to-earnings (P/E) earnings is excessively demanding by historical standards, viewed together with slower earnings growth prospects and less appealing relative its peers in the region.
The relatively small size of Malaysian bourse as measured by market capitalization and its low turnover velocity of 39% versus other regional exchanges caused out market to be marginalized as international fund managers could afford to give Malaysia a miss with minimal risk of broad portfolio under-performance.
Hence, it is no surprise that Malaysia is very much been seen as a defensive low-beta market.
Foreign participation as a percentage of total trading value on the Malaysian stock exchange has dropped from 42% in 2008 to 25% in 2009 indicating inactive foreign participation. Foreign brokers’ market share is declining. Of the six licensed foreign brokers in Malaysia, only three appeared inside the top 15 brokers’ ranking with a combined market share of 11% of total trading value for 2009 versus a 22% market share in 2008. Foreign ownership stands at 21% of overall market capitalization as of September 2009 – the lowest in five years.
There are two key reasons why foreign investors are underweighting Malaysia as an investment destination in recent years. Even though the domestic market price-to-earnings (P/E) earnings is excessively demanding by historical standards, viewed together with slower earnings growth prospects and less appealing relative its peers in the region.
The relatively small size of Malaysian bourse as measured by market capitalization and its low turnover velocity of 39% versus other regional exchanges caused out market to be marginalized as international fund managers could afford to give Malaysia a miss with minimal risk of broad portfolio under-performance.
Hence, it is no surprise that Malaysia is very much been seen as a defensive low-beta market.
2010 Malaysian Equities Outlook
The latest quarterly corporate earnings reporting is showing continued to surprise on the upside over the last two quarters with companies reporting better margins and better product mix. Based on the current earnings projection, the KLCI is trading at 15.5x 2010 earnings and 2.1x price-to-book ratio. This represents 0.5x PER premium to the average PER over the last seven years from 2002 to 2008.
Hence, valuations are no means cheap, though not stretched. It is trading comparable to the Singapore and Hong Kong markets but it is still very much under owned market by foreign investors. Given high liquidity, low interest rates and a weaker US dollar environment, the possibility of overshooting on the upside for an extended period remains. To sustain this momentum, the government will have to continue to keep stimulus spending or not to prematurely tightening monetary policy, otherwise the economic and earnings recovery could turn out to be weaker-than-expected.
The downside of this scenario is the risk of build up in asst bubble. Commodity prices, equities and property prices have gone up significantly and we have seen some countries like Hong Kong, Singapore and South Korea to some extent have stepped up their efforts to prevent substantial inflows of hot money that could cause a huge swing in currencies and asset prices.
Volatility in our market is likely to increase and investors need to be prepared for portfolio rebalancing given the expectations of policy tightening and countries implementing ‘exit’ strategies in the course of this year. Market could take a craggy path from 2Q2010 on a host of external concerns, including upturn in the global interest rate cycle, easing fiscal stimulus especially in the US and rising threat of commodity inflation.
In terms of thematic plays, commodity space remains the favorite one on higher demand and prices. Plantation and oil & gas sectors will be again on investors’ radar screen. Feeding from commodity inflation, the next beneficiary from this will be property sector as asset prices on the uptrend.
Banking sector will remain another key play, but not because of economic recovery, but possibly to be driven by the wave of merger and acquisition among small and mid cap banking counters. Loan growth will be kept at around 7-9% this year and the key selling point of banking play will be improvement in asset quality as measured by drop in NPL and potential for more active capital management as several banks that have raised capital to prepare for a severe economic downturn may end up with excess capital. In 2009, the government had laid the groundwork for change – apart from further liberalization of the financial services sector, the FIC rules were also regulated and in June 2010, the government is expected to roll out the 10th Malaysia Plan and that could well be the make or break for the Malaysian market as a whole.
Hence, valuations are no means cheap, though not stretched. It is trading comparable to the Singapore and Hong Kong markets but it is still very much under owned market by foreign investors. Given high liquidity, low interest rates and a weaker US dollar environment, the possibility of overshooting on the upside for an extended period remains. To sustain this momentum, the government will have to continue to keep stimulus spending or not to prematurely tightening monetary policy, otherwise the economic and earnings recovery could turn out to be weaker-than-expected.
The downside of this scenario is the risk of build up in asst bubble. Commodity prices, equities and property prices have gone up significantly and we have seen some countries like Hong Kong, Singapore and South Korea to some extent have stepped up their efforts to prevent substantial inflows of hot money that could cause a huge swing in currencies and asset prices.
Volatility in our market is likely to increase and investors need to be prepared for portfolio rebalancing given the expectations of policy tightening and countries implementing ‘exit’ strategies in the course of this year. Market could take a craggy path from 2Q2010 on a host of external concerns, including upturn in the global interest rate cycle, easing fiscal stimulus especially in the US and rising threat of commodity inflation.
In terms of thematic plays, commodity space remains the favorite one on higher demand and prices. Plantation and oil & gas sectors will be again on investors’ radar screen. Feeding from commodity inflation, the next beneficiary from this will be property sector as asset prices on the uptrend.
Banking sector will remain another key play, but not because of economic recovery, but possibly to be driven by the wave of merger and acquisition among small and mid cap banking counters. Loan growth will be kept at around 7-9% this year and the key selling point of banking play will be improvement in asset quality as measured by drop in NPL and potential for more active capital management as several banks that have raised capital to prepare for a severe economic downturn may end up with excess capital. In 2009, the government had laid the groundwork for change – apart from further liberalization of the financial services sector, the FIC rules were also regulated and in June 2010, the government is expected to roll out the 10th Malaysia Plan and that could well be the make or break for the Malaysian market as a whole.
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