contents

 

Economics & Strategy

Still plenty of reasons to be
bearish, but all is not lost

Technical View

Indicators are pointing to a
further weakness of the market
Malaysian Pacific Industries - Low enough?



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ECONOMICS & STRATEGY
(for the week of June 29 - July 3 1998)



Still plenty of reasons to be bearish, but all is not lost

How low can it go? The most recent low the KL Composite Index hit was 435.84 pts on June 16 breaking the previous low of 477.57 pts on Jan 12. Certainly the earnings outlook for corporates has worsened since then due to higher interest rates and foreign exchange losses and estimates of non-performing loans keep being revised upwards. Perhaps a clue in estimating the bottom can be found in the KLCI's dollar adjusted market capitalisation which is one of the indicators global asset managers use. On Jan 12, the KLCI's market capitalisation was RM163.3b or US$35.6b based on prevailing exchange rates of RM4.59/US$. The KLCI on June 16 recorded a market capitalisation of RM142.3b or US$37.1b based on the RM3.99/US$ rate. Assuming RM4.00 to the dollar and market capitalisation of US$36b, a back-of-the-envelope calculation sug-gests that the KLCI should find buying support at between 412 and 420 pts.

Size matters. Or does it? One prominent US strategist has recently commented that stock prices of General Electric, Microsoft, Coca-Cola, Exxon, Merck, Pfizer should warrant more attention than the emerging markets, since the market capitalisation of such companies dwarfs most of the world's emerging stock markets like Malaysia, Singapore, Thailand and Indonesia. We are not sure exactly why, but this divergence does not have the look of permanence. It is possible that emerging markets could outperform these giant corporates by a wide margin within the next two years.

Contrast with early 1998: The Malaysian stock market is still heavily influenced by regional factors which have been negative for more than a year now. Asia's biggest concern now is Japan, the region's great hope for export growth and its weak yen (while in early 1998, it was more an ASEAN problem with Indonesia's currency and political problems taking centrestage). Japan is suffering with GDP contracting by an annualised 5.3% in 1Q98, banks creaking under a burden of bad loans and unemployment rate at a post-war high of 4.1%. On-going problems in Asia mean that net exports can no longer be an engine of growth and Japan will have to rely on domestic spending to boost its economy. But with corporate profits under pressure and non-permanent income tax cuts, the impact of the 16.6 trillion yen stimulus package on consumption will probably be discounted.

No stability yet: Problems in Japan are affecting China and Hong Kong, the region's two other big economies. Talk of a currency devaluation in China increases every time the yen drops a spread. Hong Kong's financial secretary Donald Tsang admitted in a recent Asian Wall Street Journal report that it would not uphold the linked exchange rate mechanism in place since 1983 "at all costs."

Domestic politics - Sorry Anwar, your formula failed, let's try mine: Political unity, one of the frequently touted strengths of this country, is under pressure with the appointment of Tun Daim Zainuddin to a cabinet position last Tuesday. The former Finance Minister has been appointed as Minister of Special Functions and will oversee efforts to get the economy back on track. This is negative, driving a wedge be-tween the top two in the leadership and confirms talk of a widening rift between the PM and his deputy on economic policies. Could this be a sign of an impending power struggle within UMNO?

The latest 2%-point cut on SRR by Bank Negara will unlock RM8b liquidity in the system and immediately reduce interest rates by 21-27 basis points. The financial impact may be quantifiable, by the move will likely be viewed as Dr Mahathir's strong hand of intervention in the affairs of the central bank. Coming so soon after vehement defence of its tight monetary policy, the credibility of the institution (and its governors) has now suffered a mighty blow.

The preoccupation to lower interest rates stems from the need to save local businesses reeling from expensive loan servicing. It also says strongly about Dr Mahathir/Tun Daim's preparedness to try a new formula to resuscitate the economy, and face the adversities. The timing appears well-calculated ahead of June 30. This week, the market is likely to be dictated by how well the ringgit reacts to this easing of liquidity.

Market looks like it has bottomed: A repeat of the liquidity driven bounce in early February looks un-likely with the Japan-China-Hong Kong interplay, which could potentially affect the US and European econo-mies. The Malaysian market looks likely to trade between 450-550 for the rest of 1998, with the bottoms established by foreign value/vulture investors and the highs capped by falling earnings and a growing list of corporate bankruptcies. There are some signs that vulture funds are active - it was recently reported in the Asian Wall Street Journal that New York-based Greenwich Group International is looking to invest in Asian properties. Vulture funds are private partnerships that invest in depressed assets in hope of making a profit when prices rebound. Sentiment towards the region is at a low while US and European stocks continue to chart new highs. Most global fund managers are probably uncomfortable with valuations in both US and Europe where they are overweight. Conversely, almost all the major emerging markets have already fallen -Russia is the latest. The first was Mexico/Latin American collapse in 1995-96 and then Asia in 1997-98. Beyond this week, stocks in the Asean region could be lifted as managers increase their weightings from aggressive underweight to underweight position for diversification and long term outperformance.

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