Market Review & Outlook as at 30 June 2018 Overview US It was an event-filled month, with drama at the G7 Summit, a historic landmark meeting between North Korea and the US as well as a slew of G3 central bank meetings. As expected, the US Federal Reserve raised the Federal Funds Rate by 25bps to 1.75%-2.00%, the second increase this year. The long-standing language that policy rates would remain below its expected long-term rate was dropped from the policy statement, which is construed as potentially hawkish. The dot plot now indicates two more rate hikes this year. The jobs report showed 223,000 jobs were created in May, above economists forecast of 190,000. Unemployment rate fell to 3.8% while average hourly earnings rose by 2.7% YoY. Political turmoil in Italy and Spain and escalating global trade war tensions between the US and China also raised volatility in global financial markets. EU The European Central Bank (ECB) reportedly would end its monthly asset purchases in December but would not raise interest rates "at least through the summer of 2019. Earlier expectations were for the ECB to taper QE by September and hike rates in July 2019. Currently, the ECB is purchasing 30bn of assets monthly but this will be reduced to 15bn monthly after September and end completely by the end of the year. The ECB also cut the Eurozone's growth forecast for this year to 2.1% from 2.4%. MY Malaysia s forex reserves decreased by USD1.7bn to USD107.9bn as at 14 June 2016, on the back of continued outflows from the equity and fixed income markets. The reserves are sufficient to finance 7.5 months of retained imports and 1.0x the short term external debt. The CPI rose 1.8% YoY in May vs 1.4% in the previous month, in line with consensus expectations and driven by higher transport (+3.8% YoY) and food prices (+2.2% YoY). As part of their expenditure rationalization efforts, the Pakatan Harapan government has decided to postpone, restructure or outright cancel several large scale projects initiated by the previous Barisan Nasional administration. Two of the largest projects to be affected are the High Speed Railway (HSR) and East Coast Railway Line (ECRL). The Prime Minister Tun Dr. Mahathir bin Mohamad stated that the HSR will be postponed whilst Finance Minister Lim Guan Eng said that the ECRL project will only be implemented with a significant cost reduction. Datuk Nor Shamsiah Mohd Yunus, has been appointed as BNM Governor from 1 July 2018 to 30 Jun 2023, taking over from Tan Sri Muhammad Ibrahim who resigned on 15 June 2018. Her appointment ensures continuity in the direction and conduct of monetary policy going forward. [1]
Equities GLOBAL EQUITIES Market volatility was high in the month of June as investors were fearful that the escalating trade tensions between the US and China would hurt economic growth. Dow Jones Industrial Average Index fell by 0.59% in June while Euro Stoxx 50 Price declined by 0.32%. ASIA PACIFIC EQUITIES North Asia Market also suffered sell offs in June, amid worries over trade tensions. Hong Kong s Hang Seng Index fell 4.97% in June and Shanghai Composite Index lost 8.0%. The sell-off in Hong Kong and China markets was triggered by the soft economic data releases from China including the industrial output and retail sales and was further exacerbated by escalating tariff tensions. The People s Bank of China cut the reserve requirement ratio for commercial banks by 50 basis points, which investors perceived negatively as it raised fears that economic growth is facing headwinds domestically and from abroad. Similarly, South Korea s KOSPI was down 4.0% and Taiwan s benchmark lost 0.35%. Uncertainty regarding trade tension between the two world s largest economies will continue to be an overhang to the equity market. As such, we are adopting a defensive strategy on market for now. Nevertheless, over the longer term, we remain positive as favourable global and corporate fundamentals as well as reasonable valuations should support the market. ASEAN EQUITIES The month of June saw ASEAN markets fall 7% MoM vs -5% MoM for APAC ex-japan. Singapore (-5%) and Thailand (-8%) performed the worst, finally succumbing to the emerging markets sell-off despite their more resilient currencies. The rest of ASEAN continued their decline as well, with the Philippines notching a 15% drop YTD, followed by Indonesia at 11%. Forward P/E multiples have dropped to 10- year averages for the two markets whilst Singapore s STI is almost at -1SD below its 10-year mean. Thailand and Vietnam remain the most buoyant, relative to their 10-year historical averages. There is greater scope to find value now but stock prices have generally not yet reached truly low-risk levels. MALAYSIAN EQUITIES The Malaysian market remained volatile in line with the regional peers, driven by major external concerns such as the downside risks to growth outlook due to escalating trade tensions and interest rate hikes. The KLCI declined by 2.8% MoM with foreigners net selling MYR4.9b worth of equities in June 2018 (May: MYR5.6b), the largest monthly outflow since mid-2013 bringing YTD outflow to MYR6.8b. Finance was the worst performing sector in the month, due to its high foreign ownership. Plantation also underperformed when the EU parliament, under its preliminary decision for Renewable Energy Directive, agreed to omit palm biofuel from being considered as renewables by 2030. This would put an estimated 3.5 mt of palm oil (6% of global consumption) at risk. Telekom Malaysia shares fell after the announcement made by the Communications and Multimedia Minister, Gobind Singh Deo, that broadband price will be reduced by 25% come year end. [2]
Strategy In the short term, we believe that markets will remain volatile as investors are worried about trade tensions that could potentially escalate to a full scale trade war. Hence, we have positioned our portfolio in a neutral stance for now. However we remain positive in the longer term, as 1) global markets growth remain intact; 2) the newly elected local government is putting in every effort to revitalize the country; and 3) Malaysia being one of the few countries with current account surplus and the market being low beta in this region, would remain the foreign investors choice. We continue to prefer sectors such as finance, oil & gas, consumer staples, exporters, technology and high dividend yielding stocks such as REITs. [3]
Fixed Income ASIAN BOND MARKETS In the Asian Dollar space, we saw negative returns across countries amid the impact of an escalating trade war between China and the US, fear of contagion to emerging markets and USD strength resumption. The high yield space was more adversely affected relative to investment grade, where high yield bonds lost 2.26% against investment grade bonds at -0.74%. In the local currency space, performance was mixed with the biggest loser being Indonesia. The USD rebound triggered sell-off in the Indonesian bond market led by local institutions. To stem the currency weakness, Bank of Indonesia hiked its 7-day reverse repo rate again by 50.0 bps to 5.25% in a scheduled policy meeting. This brings total increase of 100 bps in less than 60 days. The hike, however, did little to reverse pressure on the IDR. MALAYSIAN BOND MARKET We expect BNM to maintain the OPR at 3.25% for the rest of the year. The domestic economy continued to expand at a healthy rate of 5.4% YoY in 1Q2018 but there are downside risks to growth from hereon with the potential escalation of a global trade war. Inflation continues to be benign and the removal of the GST will help suppress inflationary pressure. Global bond yields will be driven by two increasingly divergent factors, the hawkish monetary policy in the US and increasing concerns over the long term growth outlook of the global economy. These developments have resulted in a significant flattening of the UST yield curve. As at end June 2018, the 2Y vs 10Y spread has stood at 32bps which is the lowest in over a decade. The weakening of MYR against the USD may also weigh on the market due to fears of more foreign outflows. Nevertheless, unless there are more surprises from both domestic and external events, we expect the bond market to be well supported by local institutions and pension funds as current yields remain attractive to long term investors. Government Securities The month of May 2016 saw foreigners reduce their holdings of Malaysian government debt securities from MYR205.4b to MYR192.5b. The fall in foreign holdings was driven by the global sell down in emerging markets and may have been further exacerbated by domestic developments following GE14. In the primary market, there were two government bond auctions as follows: MYR2.5b 20-year new issuance of MGS 6/38 which drew a BTC ratio of 1.94x at average yield of 4.893%. MYR3.5b 15-year reopening of GII 6/33 which garnered a BTC ratio of 2.783x at average yield of 4.778%. Despite the significant reversal in foreign holdings, local MGS yields were anchored by strong local investor support and the fall in UST yields from their highs in May 2018. Trading volume for government securities fell sharply from MYR62.0b in May 2018 to MYR38.0b. [4]
Increasing concern over the likelihood of global trade war has started weigh on growth expectations, which should provide support for global bond yields. The decline in the UST 10Y yield from its recent high of 3.11% to 2.86% has resulted in the UST 10Y vs MGS 10Y spread widening to 135 bps, which is line with historical average spread. There will be sizeable local govvie maturities between August and October 2018 which could cause volatility if foreign investors choose to not roll over their holdings although mitigated by the holding structure as current foreign holdings are mostly real money investors and passive benchmark funds. Corporate Bonds Corporate bonds and sukuks traded largely unchanged over the month as investors became more comfortable with the govvies volatility. Trading volume increased to MYR 5.6b from MYR 4.7b in the previous month with interest mostly concentrated in the GG and AA segments. Despite the Pakatan Harapan government announcing that it will take no immediate action on toll road charges, liquidity for toll road bonds continues to be tight as market participants adopt a wait-and-see attitude. There is a dearth of new bond issuances and yield-hunting local investors continue to support the secondary given the lack of primary market options. The government s commitment to reduce government debt has led to either outright cancellation (MRT 3), indefinite postponement (HSR) or renegotiation (ECRL) of major infrastructure projects. Given that these projects were to be largely financed by government guaranteed bonds, we expect the GG bond issuance pipeline to shrink, a positive development for GG bonds from a technical supply-demand dynamic. Corporate issuances include PASB (MYR2.1b), AmBank (MYR700m) and both Hong Leong Bank and Hong Leong Financial Group (MYR500m each). There were no major rating actions during the month. Strategy Portfolio Duration We are structurally neutral as BNM has not signaled further OPR move in the near future. Any move on the policy rate would depend on the pace of domestic economic growth and inflation. Security Selection We focus on valuation play to take advantage of the volatile market to enhance portfolio return, which currently favors corporate bonds over government bonds in view of the wide corporate credit spreads. We will participate in high quality lower rated corporate bonds in the primary market which offer better yield pick-up relative to the secondary market as and when price discovery takes place for the new issuances. [5]
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