SINGAPORE (Dec 3): November was another choppy month for Wall Street and global stock markets. Despite robust corporate earnings in the US, expectations are that earnings have peaked as interest rates start to rise and the US-China spat affects trade. A decade of pump-priming amid low interest rates and easy credit has reflated asset prices and led to growing indebtedness, and this has to be unwound.
A key driver behind the market rout was fears that interest rates were likely to rise more than expected. The US Federal Reserve raised interest rates by 25 basis points to 2.00% to 2.25% in September. It foresees another rate hike in December and three more next year.
However, as stock markets face increased volatility, there are also expectations that the pace of rate hikes may be tempered. Case in point: Wall Street rallied sharply on Nov 28 after US Federal Reserve chairman Jerome Powell said interest rates were “just below” neutral.
The worries over US interest rates come amid fears of peaking economic growth, with added inflationary pressure from the ongoing US-China trade war, which is likely to result in higher input costs and consumer prices. The US slapped a 10% tariff on about US$200 billion ($274 billion) of Chinese goods in September, with the tariffs expected to increase to 25% in January 2019.
A counter-balancing factor to inflation is lower commodity prices, especially crude oil prices, which have recently slumped. If commodity prices stay low, inflationary pressures can be kept in check.
What will higher interest rates bring to the corporate sector? A decade of low interest rates and easy money has seen total corporate debt in the US surging 86% from US$4.9 trillion in 2007 to nearly US$9.1 trillion in mid-2018, according to the Securities Industry and Financial Markets Association. Nonetheless, the general consensus is that these concerns are unlikely to manifest themselves in the near term, as bond default rates remain low and the US economy is on a strong footing. Fitch Ratings forecasts bond defaults for 2019 at the lowest since 2013 and US corporates are in good shape.
The 2017 tax breaks saw US companies’ nominal tax rates reduced from 35% to 21% and many have used the additional cash to reduce debt. According to Moody’s, the top 100 US corporate non-financial companies have spent US$72 billion of new cash flows to repay debt, while US$81 billion went to shareholder returns through buybacks and dividends.
As a result, new debt issuances have also fallen as debt refinancing and expansion needs eased. Fitch estimates that new investment-grade issuance dropped 15% y-o-y to US$531 billion for the first three quarters of 2018 while high-yield issuance declined 32% to US$138 billion.
How about Malaysia’s corporate sector?
Much has been written on the high indebtedness of Malaysian households, but surprisingly little about the state of the corporate sector.
One measurement for total private sector indebtedness is “domestic credit to private sector”, which refers to financial resources provided to households and businesses by financial corporations in the form of loans, purchases of non-equity securities, trade credits and other accounts receivable.
In Chart 1, we have compared domestic credit to private sector for Malaysia and the US, measured as a percentage of GDP over the last 20 years, from 1997 to 2016. As can be seen from the chart, in 1997, during the onset of the Asian financial crisis, Malaysia had a ratio that was higher than the US, at 158.4% of GDP, versus 146.1% for the US. By 2016, though, Malaysia’s ratio had fallen to 123.9%, while the US’ had risen to 192.2%.
From its high of more than 150% in 1997-1998, Malaysia’s ratio fell to as low as 96.7% in 2008 as borrowers, especially corporates, reduced gearing after the Asian financial crisis. Meanwhile, in the US, the ratio had been steadily climbing, reaching a peak of 206.3% in 2007, just before the sub-prime crisis, and ending at 192.2% in 2016.
More interestingly in the case of Malaysia, household debt has been the main driving force behind private-sector debt, rather than corporate lending. Chart 2 shows the ratio of Malaysia’s household debt to GDP, which surged from 48.4% in 1997 to 88.4% in 2016.
By deducting the figures of Chart 2 from Chart 1, we would arrive at the implied corporate debt as a percentage of GDP for Malaysia, and the figures, as outlined in Chart 3, are very interesting. Implied corporate debt as a percentage of GDP has fallen from 110% in 1997 and levels of above 100% in 1997-1999, to just 35.5% in 2016.
Malaysian companies have also resorted to the capital and debt markets to borrow, but by and large, they are relatively lowly geared and on strong footing — unlike during the Asian financial crisis two decades ago. Hence, there is much more room to withstand rising interest rates and external shocks.
Our Global Portfolio benefited last week from the rally on Wall Street as concerns over a faster-than-expected acceleration in interest rate hikes started to ease. Our portfolio rose 2% for the week, led by Amazon.com and DIP Corp, which rose 8.8% and 8.9%, respectively, for the week. Our Global Portfolio’s returns stand at -8.9% since inception, lower than the benchmark index, MSCI World Index, which is down 1.8% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
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