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Understand the causes to treat the symptoms

Tong Kooi Ong and Asia Analytica
Tong Kooi Ong and Asia Analytica6/9/2022 05:39 PM GMT+08  • 8 min read
Understand the causes to treat the symptoms
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When you are seriously injured, it hurts. Pain medications (like steroids) can help reduce this hurt but they do not obviate the need for rehabilitation, or surgical intervention, which requires some suffering, perhaps sacrifices, certainly effort and time. In other words, easy, short-term remedies without addressing the underlying problems have long-term consequences that will ultimately compound the pain.

We have written about the chronic underperformance of Bursa Malaysia numerous times in the past. It is an important subject. A vibrant capital market provides a vital source of funding for investments by domestic companies while the listing of foreign companies on the local bourse can build new ecosystems and create employment opportunities, transfer of knowledge, skills and technology.

We have explained in depth the primary reasons for our languishing stock market, supported by statistics, most recently in our four-part series on the lingering after-effects of Malaysia’s capital controls imposed during the Asian financial crisis (AFC). For a quick recap, Malaysia’s capital controls were unconventional, certainly compared to strategies embraced by our equally embattled neighbours during the crisis.

To be sure, the resulting temporary removal of Malaysia from the MSCI EM index, which is widely tracked by both passive and active global funds, and subsequent decline in the country’s weightage was probably inevitable — taking into account the inclusion of more markets, including China, Taiwan, South Korea and India. But the harsh treatment of foreign portfolio money, including the CLOB (Central Limit Order Book) debacle, must have had at least some lingering negative impact — by raising questions over the integrity of contracts and laws for all future potential investors. In fact, it quite likely also affected confidence for foreign direct investments (FDI). This is underscored by our comparatively weak FDI numbers and portfolio inflows ever since.

Chart 1 tracks the FBM KLCI and actual earnings for its component stocks over time. The price investors are willing to pay is based on their perception of value — for the layperson, this is usually expressed as multiples of earnings or the price-earnings ratio (PER). (This is valid for the market as a whole, but may not hold for individual stocks. See our previous article “A PE ratio of 9 or 229 times says nothing about relative valuations” published on Jan 8, 2018.) In this respect, investor sentiment and stock valuations were clearly lower in the years postAFC. Put another way, the Bursa suffered a de-rating — compression of PE multiples — for well over a decade as a result of, we believe, capital control measures.

See also: We expect long-dated bonds to outperform equities in the near term

Critically, capital controls did not only affect the confidence of foreign investors. There was a noticeable jump in capital outflows from Malaysians, after restrictions on investing money overseas were lifted in December 2002, and the removal of the ringgit-US dollar peg in July 2005. Total investments overseas — in the form of direct investments in equity-debts, portfolio funds and others — more than doubled (approximately 2.2 times) in 2006, from 2002 levels, and more than tripled (3.3 times) by 2007 (see Chart 2).

Malaysians (corporate, institutions and individuals) started sending money out of the country more aggressively, suggestive that fear — of future capital controls — remained long after the actual measures were lifted. Fool me once, shame on you; fool me twice, shame on me. Up till around 2014, Malaysian capital outflows accelerated at a faster clip compared to South Korea, Thailand and Indonesia (see Chart 3).

See also: Abolish AP for cars — the single most effective solution to reduce living costs

These years of cumulative capital outflows have a significant impact on the Malaysian economy. It meant lesser money-savings available for domestic investments (see Chart 4). Lower domestic investments, in turn, have severe long-term consequences — in terms of productive capacity and growth potential, employment and wages,research and development, innovation and productivity gains. All of which then create a negative feedback loop.

We have previously written about how the resulting low productivity gains and too many low-paying jobs translate into our declining global competitiveness, narrowing corporate margins and even lesser profits for reinvestments. Low investments hampered the country’s move up the value chain and the failure to create high-paying jobs resulted in slow per capita income growth, weaker purchasing power and inability of companies to upsell, leading to tepid sales growth. The lack of opportunities perpetuated the brain drain. Rinse and repeat.

The downshift in revenue and earnings is particularly evident in the last 10 years, with the cascading consequences of years of falling investments (see Chart 1 and Table 1). Since earnings are the main driver for stock prices over the longer term, little surprise then that Bursa is underperforming. The causes for Bursa’s chronic underperformance are emblematic of the broader Malaysian economy.

In summary, the steady stream of capital outflows — on top of reduced foreign inflows — that was initially a symptom resulting from capital controls, became one of the main contributing causes to the structural weakness in Malaysia’s economy today. Thailand, Indonesia and South Korea were the three hardest-hit countries during the AFC. All received bailout packages from the International Monetary Fund (IMF) to stabilise their currencies and restructure their economies. All have outperformed Malaysia in the ensuing years — in terms of attracting foreign portfolio inflows and FDI, growth in productivity and GDP per capita.

For more stories about where money flows, click here for Capital Section

Yes, Malaysia’s capital control measures limited the human impact during the AFC, in terms of unemployment, wages and poverty levels. Indeed, the economy and stock market rebounded faster. But it also took away the pressure to restructure and reform what ails. Companies (and their shareholders) that expanded too rapidly, especially in fundamentally unsound investments, and were excessively leveraged should rightly pay the price for their mistakes. And the weakest should have been allowed to fail. Clearly, there is no free lunch. The fact that capital controls are used sparsely in the world should be a warning in itself.

The government constantly insuring the private sector against the repercussions of failure only serves to create future moral hazard. The consequences from capital control measures during the AFC still haunt us today. Unfortunately, it appears that Malaysia has yet to learn this lesson.

To rejuvenate interest in Bursa, there needs to be companies of quality that will excite investors and deliver sustainable earnings growth prospects — that are more attractive than the smorgasbord of options available in so many other stock markets in the world. In other words, the competition for investments is intense. Money will flow to where investors believe they can get the best returns, for the level of risks. Consider Bursa’s offerings. Table 2 is a list of selected IPOs since 2017. These companies have, or had at some point during the last six years, market caps exceeding RM1 billion. Most are old economy stocks.

Let’s be honest — and we bet we are not alone in saying this. Investment is the key driver for future growth. Therefore, the politics and economic policies must be conducive to foster investments for Malaysians and foreigners — if there is to be any chance of arresting and reversing this secular deterioration in the domestic environment.

We cannot emphasise enough the fact that short-term remedies have long-term consequences. Case in point, the export ban on chicken to Singapore. It will not change the fact that prices are going up domestically, which is driven by rising costs, a global phenomenon. Worse, it will likely result in Singapore turning to alternative sources — perhaps permanently, which will be detrimental to Malaysia’s poultry industry in the long run. Surely, there must be better — even if not the easiest — ways to resolve the real, underlying causes for the shortage?

The Global Portfolio closed 3% higher for the week ended June 8. This was better than the MSCI World Net Return Index’s 0.5% gain, thanks mainly to the relative outperformance of our Chinese stocks. The biggest gainer was Alibaba Group Holding, whose shares were up 15% last week. Other notable gainers were CrowdStrike Holdings (+10.8%) and Airbnb (+6%). On the other hand, the biggest losers were Bank of America (-2.1%), iShares 20+ Year Treasury Bond ETF (-1.8%), and Microsoft Corp (-0.7%). Total portfolio returns since inception rose to 35.2%, though still trailing the benchmark’s 42.9% gains.

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.

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