A good read on Malaysia mid-income trap by Dali

Malaysia's Middle Income Trap (or is it "Trapped")

Bolton bets on Chinese domestic consumption

By Robert Cookson in Hong Kong

Published: July 15 2010

Anthony Bolton, the fabled British stockpicker, is staking his reputation on a £460m ($702m) bet that the Chinese economy is shifting away from exports and towards domestic consumption.In an interview with the Financial Times,

Mr Bolton, whose China Special Situations fund of that value was launched in April amid a blaze of publicity, revealed that his portfolio was heavily weighted towards stocks in the consumer sector. “The golden era for exports is coming to a conclusion and now it’s going to be very much more about the domestic economy, the domestic consumer – that’s going to drive the market,” said Mr Bolton, president of investments at Fidelity International.Mr Bolton, who has a formidable track record at picking winning stocks, said he had taken on relatively little exposure to commodity producers or exporters.

Until late last year, Mr Bolton planned to retire to the Caribbean, but decided to set up the Hong Kong fund because of his belief in the prospects of China’s economy. Mr Bolton’s bullish stance pits him against big-name investors such as Hugh Hendry, head of Eclectica Asset Management, and Marc Faber, author of The Gloom Boom & Doom Report, who are betting that the Chinese economy will crash.

Mr Bolton’s portfolio selection will be closely analysed by other investors seeking to emulate his previous success. During his 28 years running Fidelity International’s Special Situations fund in London, he delivered an annualised return of 19.5 per cent.

The China Special Situations fund is heavily weighted towards sectors that are plays on the domestic economy, including financials, retailers, service businesses, and pharmaceuticals.About one fifth of Mr Bolton’s fund is allocated to stocks in the consumer discretionary sector. By contrast, the consumer discretionary sector makes up just a twentieth of the MSCI China index against which his fund is benchmarked.

His biggest sector holding is in financial stocks, which account for a third of the fund – a lower proportion than in the benchmark. Mr Bolton said he was confident that last year’s lending binge by Chinese banks would not lead to a dangerous rise in bad debts.In a bid to take advantage of under-researched stocks, Mr Bolton has invested more than half of the fund in medium-sized companies and small caps.

Buying stocks overlooked by most investors was a strategy that served Mr Bolton well in the west. But sceptics question whether Mr Bolton will be able to pull off the same trick in China, given that he does not speak Mandarin and only moved to Hong Kong three months ago.In another indication of investor hesitance, his fund failed to reach its target of £650m ($1bn).Only 12 per cent of Mr Bolton’s holdings are listed on stock exchanges on the Chinese mainland.

Most are China stocks listed in Hong Kong, the US and elsewhere, as well as other stocks listed in Hong Kong such as HSBC.The China Special Situations fund raised £460m before starting trading on the London Stock Exchange in April, becoming the largest UK investment trust to be launched in 16 years.The four biggest individual holdings in the fund are China Mobile, Industrial and Commercial Bank Of China, China Merchants Bank, and Tencent, the Chinese internet business.

For related posts, click the following links:

Random thoughts on current issues

Jottings on China yuan's reform

Fund focus: OSK-UOB Asia Consumer Fund

Subsidy rationalisation has started: Overall good for Malaysia's economy

The news: Prices of sugar, petrol, LPG, diesel to go up Friday

If Malaysia continues with subsidies, Malaysia is actually subsidizing the whole region such as Thailand, Indonesia and Singapore as our subsidized goods are smuggled out of the country. This literally makes Malaysia a Santa Claus giving gifts to its neighbours. As subsidies are removed gradually and the economy becomes more market driven, we could more efficiently allocate our resources towards more productive areas, help industries to become more efficient and move up the value chain, consolidate our fiscal position and make our economy less dependent on oil. Overall, it's a good direction for the Malaysian economy.

Some thoughts on 10th Malaysia Plan

• Construction projects: More aggressive rollout and implementation? Newsflow has been quite slow in 1H2010, maybe due to govt's intention to announce all these projects one shot in 10MP or they really need to control the government coffers. Possible contracts include LRT extension, MRT (recently announced), possible revival of the high speed rail from KL to Singapore, Pahang Selangor Water Transfer project, SCORE (Sarawak). Possible beneficiaries: IJM, Gamuda, Sunway, Mudajaya, IJM, Loh & Loh, CMSB, WCT, Naim, HSL.

• Fiscal Consolidation: GST and subsidy removal - Government should bite the bullet and implement these measures to strengthen the fiscal position of the government as the tax base is too narrowed on oil revenue while subsidies are spoiling the industries and cap industries from moving up the value chain. Basically, with the current subsidies on oil, flour, sugar etc, we're actually the Santa Claus of the whole region, subsidizing Singapore, Thailand, Indonesia as people smuggle our cheap goods out of the country.

• Listing of GLCs - Petronas two subsidiaries (potentially Petronas Carigali and Malaysia LNG) and MOF's subsidiaries (Percetakan Nasional Bhd, Ninebio, Inno Biologics Composites Technology Research Malaysia). More participation of the public in the GLCs which could instill greater transparency, efficiency of the businesses.

• More divestments of GLC shares? More GLCs following Pos Malaysia's shares divestment by Khazanah? Companies held by Malaysia investment arm include Axiata, Telekom, Proton, MAS, UEM, MAHB, Tenaga, PLUS, Time Engineering etc.

• Liberalization of economic policies: Hopefully more licenses could be granted to foreign parties to allow more foreign participation in the banking industry and capital markets.

• More private-sector led economic growth: The private sector needs to take the lead in growing the economy with the support of the government. In 9MP, RM230 billion development expenditure was all funded by the government. Nonetheless, in 10MP, Government will only fund RM180 billion with RM15 billion being the funds for PFI (Private Finance Initiatives) to allow greater participation of the private sector in development projects. Najib will be focusing on SMEs by granting greater incentives for SMEs which are innovative and are moving up the value chain or at the high value-added industries. This is in line with the government's intention to move Malaysia into a higher level economy.

• Concerns: All can be great with words only but implementation is still the key. The government should not fear the political backlash and should implement policies which could hurt in the short term but are actually beneficial in the long term e.g. GST, subsidies removal. These measures should be implemented as early as possible but at gradual pace to allow the industries and people to adjust to the new economic reality of high commodity price environment, deteriorating fiscal position and the middle income trap.

Economic numbers: The week ahead

US:

• Retail Sales - Modest growth expected
• Consumer Confidence Index - Weak labour market could continue to weigh it down
• Initial Jobless Claims
• External Trade

EU:

• Germany Factory Orders - Underlying trend on the upside, but might grow at slower pace after a big jump in the previous month
• Germany IPI - To be higher on rising orders
• UK IPI - To be higher on rising orders

China:

• External Trade - Optimistic, driven by higher export prices. But sustainability of EU and US economic recovery will determine the direction of its export growth going forward.
• IPI - Might slow owing to falling PMI
• CPI - Higher at est. 3.2% driven by higher grain prices
• Retail Sales - To be higher driven by higher retail sales price. But might erode household income.

Malaysia:

• IPI - Continue to be strong following strong export numbers
• 10th Malaysia Plan (10 June 2010)

Malaysia Ringgit still have upside, but likely be limited

The ringgit had a spectacular performance this year. It was the best performer among regional peers by strengthening 6.6% year-to-date against the USD. The second best performer was India Rupee which strengthened by 4.5% against USD, followed by Korea Won and Indonesian Rupiah which rose by 4.2% and 4.1% respectively against USD.

There were several factors which contributed to the stellar performance of the ringgit. Amongst them include Malaysia’s better than expected economic recovery, the central bank’s monetary tightening policies, the New Economic Model (NEM), speculation on revaluation of China’s yuan coupled with speculative funds inflow into Malaysia’s financial system.

Ringgit supported by firm economic fundamentals

The ringgit was supported by Malaysia’s stronger economic fundamentals, as evidenced by the recent economic statistical releases. Malaysia’s economy showed a significant turnaround in 4Q 2009. Its 4Q 2009 GDP beat analysts’ estimates considerably by posting a 4.5% year-on-year growth, backed by improving external and domestic demand. Macroeconomic numbers are improving as well, with exports and manufacturing sales seeing double-digit growth. In addition, MIER’s (Malaysia’s Institute of Economic Research) CSI (Consumer Sentiments Index) and BCI (Business Conditions Index) continued to trend upwards by rising for the third and fourth consecutive quarter respectively in 1Q 2010, indicating brighter days ahead for private expenditure, which will be driving the economy this year.

In conjunction with the optimistic economic recovery, the central bank started tightening its monetary policy by hiking OPR (Overnight Policy Rate) by 25 basis points on 4^th Mar 2010 to 2.25%. This was later followed by the unveiling of the NEM (New Economic Model) on 30^th Mar 2010 which proposed economic reforms aimed at alleviating Malaysia into a high income economy. Both have somewhat influenced the recent surge in the ringgit.

China’s yuan appreciation could further strengthen the ringgit

Speculation of China’s yuan revaluation further added to the strength of Asian currencies, including the ringgit. Pressure on China’s yuan revaluation is mounting as global imbalances resurface again, caused by faster economic growth in the Asian region as compared to the developed nations amidst a recovering world economy. As a result, the US and European countries are blaming Asian countries, especially China, for suppressing the strength of their currencies to give their exports an unfair cost advantage. In the recent Nuclear Summit held in Washington, US President Barack Obama once again urged China to let the yuan rise at a faster pace.

A higher yuan could actually spell good times for the Asian currencies. Historical data has shown that Asian currencies actually benefitted from yuan appreciation, mainly due to China’s rising position as a major trading partner among the Asian countries. To recap, Chinese government allowed its yuan to appreciate against USD in July 2005. The yuan had since appreciated by 1.6% over the next twelve months, giving rise to the appreciation of Asian currencies. Consequently, the Singapore dollar, Indonesian rupiah and Malaysian ringgit appreciated by 5.1%, 7.0% and 2.7% respectively during the same period.

Further appreciation in the ringgit on cards, but upside will be limited

The uptrend of the ringgit is likely to remain intact over the next six months as the ringgit appears undervalued. Based on The Economist’s Big Mac Index published on 17 March, it suggested that the ringgit is the second most undervalued currency under its coverage as the ringgit is still 40.8% below its fair value benchmark against the USD. In addition, the ringgit seems undervalued based on analysts' REER (Real Effective Exchange Rate) for the ringgit. As such, there is a high likelihood for the ringgit to appreciate further.

In addition, the ringgit will be supported by the widening interest rate differential between Malaysia and the US as Bank Negara is expected to hike OPR possibly by another 50 basis points by the end of 2010 while US Fed is likely to retain interest rates at low levels for an extended period of time. This could lead to higher capital inflows, thus supporting the ringgit.

Nonetheless, the ringgit’s upside might be somewhat limited. Malaysia being an export-oriented economy could be hurt by a surging ringgit. This is in addition to the resultant capital inflows which could lead to imbalances in pricing of certain asset classes. In view of this, the central bank might intervene to limit gains in the ringgit to ensure Malaysia’s exports remain competitive and prevent any asset bubbles from occurring. Consequently, any gains in the ringgit should be modest, which is in line with consensus view that the ringgit will hover at around 3.15 to 3.24 level against USD in the next six months. One way to monitor the intervention by the central bank is to look at the international reserves which should increase if the central bank wants to absorb the upward pressure on the ringgit.

Mixed effects on equities from higher ringgit. Economy to benefit?

Overall, a higher ringgit has mixed effects on Malaysian equities. On one hand, a higher ringgit environment will benefit sectors like automotive and food producers which have lower costs of imports while utilities companies such as Tenaga Nasional could benefit owing to its sizeable foreign debt coupled with lower coal costs. On the other hand, exporters such as glove manufacturers, E&E (Electrical & electronic) manufacturers and plantation companies might be adversely affected by the higher ringgit. Having said that, glove manufacturers at the moment seem to be able to pass the higher costs to the customers owing to the rising demand for gloves. As for plantation companies, they could have a natural hedge against forex risks as imports of fertilizers from overseas will be cheaper which could offset the higher palm oil export prices.

Notwithstanding its effects on the equities, a higher domestic currency could actually help Malaysia to move its economy to a higher growth path focused on knowledge and value-adding in addition to attracting foreign talents and retaining local ones. In view of this, a higher ringgit seems to fit in well with NEM’s objective to move Malaysia into a high-income economy. However, this is still dependent on the government's ability to see through their intended economic reforms.

EU Debt Crisis: Overhyped!! Not too concerned

The recent debt debacle in Greece has partly triggered the recent correction which saw markets worldwide declining by as much as 10%, besides other causes such as the increased regulations proposed on US banks and China's tightening measures. The worst performing markets are EU & Taiwan currently. DJ Stoxx 600 declined 11% from its high in mid Jan 2010 followed by TWSE decline of 10%. KLCI, as expected, was rather sheltered from the onslaught by dropping a mere 3.7%. In addition, EUR has dropped against major currencies such as USD and Yen by 5.9% and 9.5% YTD.

Is the Greek crisis a major cause for concern at the moment for the equity markets? I believe the market has hyped up this issue too much and the correction seen now is overdone and should be temporary. Here, we'll just take a closer look at the debt concerns in EU.

Greek crisis:

Greece debt levels came to the limelight owing to its high debt levels revealed after the government revised its fiscal deficit for 2008, raising questions on the transparency and accuracy of its accounts. By 2010, its fiscal deficit and debt/GDP levels will reach 12.7% and 113% respectively, much higher compared to the EU's SGP (Stability and Growth Pact) standards which requires EU members to adhere to its fiscal deficit and debt/GDP limits of 3% and 60% respectively. Its debt/GDP level is also the highest in Eurozone and 2nd highest in terms of fiscal deficit after Ireland (Eurozone's fiscal deficit and debt/GDP at 6.9% and 84% respectively in 2010). In addition, its economy is expected to remain in the negative in 2010 before turning a small positive in 2011, raising concerns over the sustainability of its economy and its ability to repay its debts. About EUR 17 billion worth of Greek bonds will be maturing mostly in 1H 2010 and whether Greece will be able to pay the loans is in question.

Small impact apparently: Nonetheless, note that Greek economy is just a very small portion of the EU, accounting for just 2.7% of Eurozone's GDP. On top of this, Eurozone's overall debt levels are relatively lower as compared to US (Fiscal Deficit: 11.6%; Debt/GDP: 93.6%) and Japan (Fiscal Deficit: 7.1%; Debt/GDP: 227% - Massive!!).

Possible Outcomes:

1. Greece exit from Eurozone:

This will be a precursor to the destruction of the single EU currency which they have taken years of painstaking efforts to unite. It would be more costly for Greece to exit from EU as it will have to fend for itself without the EU umbrella. Its currency will be devalued, alleviating its foreign debt even higher while at the same time borrowings will be extremely costly for Greece.

2. Own fiscal consolidation efforts:

Rather hopeless apparently. Its plans for budget cuts were met with strong opposition with strikes across most sectors and public unrest on the streets. Corruption is too deeply entrenched in the system and there is too much political baggage to head off any fiscal consolidation efforts.

3. Help from EU:

This will be the most likely outcome. EU member representatives have pledged to step in to provide financial aid to Greece should the need arises, likely in the form of guarantee for Greek bonds and extending low-cost lifeline to banks with Greek exposure especially Greek banks. Nonetheless, European commission (EC) authorities will have to assume a supervisory role over Greek's economy by imposition of conditions on Greece to regularize its economy. Greek's financial autonomy has to be diluted.

Furthermore, Greece could be the 'Lehman Brothers' of Europe where Greek's debt risks will cascade through the financial systems of other EU members. Greek government bonds are widely held by Greek banks which are used as collateral for loans from ECB and German banks are known to have substantial holdings in Greek bonds and bank debts. Should Greek economy collapses, the domino effect could be severe throughout EU. EU cannot afford to have this kind of crisis to occur.

4. Help from IMF:

Greece is still under the Eurozone. Any crisis that happen within the Eurozone, EC is obligated to solve it and not having authorities outside of EU to assist. IMF's financial aid package could be costlier at the same time.

Other highly indebted countries:

Spain, Ireland and Portugal are countries which are put in the spotlight as well over its ballooning debts. However, the conditions of these countries are not as severe as Greece. Spain and Ireland, though having a high fiscal deficit of 10.1% and 14.7% respectively, are stronger in their fiscal position as their debt/GDP for 2010 will just be at 66.3% and 83% respectively, therefore allowing more fiscal flexibility to boost up their economy.

On the other hand, Portugal's economy is much smaller which contributes about 1.8% to Eurozone's GDP. Its bonds maturing in 2010 are expected to amount EUR 5.9 billion while fiscal deficit and debt/GDP will be 8% and 85% respectively. In other words, its small economy is easier to be handled.

Recent bond issuances have been successful nonetheless:

13th Jan 2010: Spain 10-Year bonds worth EUR 5 billion at interest rate 0.63% above German Bunds' only

26th Jan 2010: Greek 5-Year bonds worth EUR 8 billion at interest rate of 6.2%

16th Feb 2010: Spain 15-Year bonds worth EUR 5 billion at interest rate of 4.7%

Sometime in end Feb 2010: Greek planning a 10-Year bond issuance worth EUR 3-5 billion at unknown interest rate

(The success of the planned Greek bond issuance anytime now will determine whether Greece will need any financial aid. The dilemma faced by Greece is that the bond issuance might need a high premium on interest rate to justify the risks of investors buying Greek bonds and Greece won't be able to service the debt. But Greece will need the money to refinance its maturing debts at the same time. Have to see how this will unfold)

Conclusion:

EU will come to the rescue if Greek economy fails. Might not even need assistance in the short term if bond issuances are proved successful. Nonetheless, Greece will need to regularize its economy by imposing austere budgets to ensure its economic sustainability. However, the country is plagued by public backlash, massive corruption and structural weakness, rendering its efforts to steer the economy out of recession toothless.

There have been talks of severe contagion effects of sovereign defaults on EU economies and the moral hazards arising from financial aid given to Greece. However, I think these two risks will be low. Firstly, EC cannot afford this crisis to blow out of control and therefore will help its troubled members. Secondly, if financial aids are given out, EC will be imposing strict controls on Greece and the country's financial autonomy has to go. If the members wish to exercise their autonomy, they will have to put their house in order. Moral hazards will happen only if members are not disciplined for creating such chaos.

Overall, valuations of EU are cheap, trading at PE of 12x and 10x for 2010 and 2011 respectively. Corporate earnings growth will be 25% and 20% for 2010 and 2011 respectively. Investors will steer their attention back to earnings which will be key driver of markets once the debt concerns subside. Investors might consider buying into European equity funds to take advantage of the current correction.

Disclaimer: The above article does not represent an investment advisory service as no subscription or management fees are charged. The contents of the article are provided as general information only and should not be taken as investment advice or as a recommendation to buy or sell any security or financial instrument. Any investment decisions carried out based on information, analysis, or commentary provided above is solely your responsibility. You should consult your investment adviser before making any investment decisions.

Snippets of outlook on Malaysia

Thanks to this recent correction in the markets, this time will be a good buying opportunity again. I still believe markets are going to continue moving upwards and the recent concerns that caused this correction is more hyped-up than a real threat to the economic recovery. Time to buy again as markets might surge after CNY as investors are withdrawing money ahead of the CNY holidays where China markets will be closed for the whole next week and pump in again after CNY.

Anyway, I'll just share a gist of the Malaysian market outlook here, the things we can look out for in 2010.

Catalysts:

New Economic Policies:
This year, we will be seeing a clearer picture of the economic policies to be pursued by the Government over the next few years, to be unveiled in the new economic model by the National Economic Advisory Council (MPEN) in Mar 2010 (Delayed again) and the 10th Malaysia Plan in June 2010 . More favorable economic policies are expected, which is in line with Malaysian Prime Minister’s intention to navigate Malaysia from a middle income to a high income economy. Since Dato Seri Najib Tun Razak’s ascension to the Prime Minister’s office, the Government has laid down more investor-friendly policies, including liberalization of 27 services sector and financial sectors, review of minimum wage for selected industries to attract talents from overseas and improving ties with regional economies like Singapore, India and China via high level visits which could bring in more investments from these regions.

External Trade:
Exports which consist of 107% of total GDP, continue to remain bright in outlook driven by exports of E&E products and commodity related products. E&E products which is 43% of total exports continue to experience growth on the back of strong global demand, especially from Asia Pacific Countries. Global chip sales continue to surge to US$22.6 bil in Nov 09 since bottoming out in Feb 2009 which was near its high of US$22.9bil in Sept 2008. On top of that, manufacturers around the world cut its capacity and investments sharply in 2009 which could create a supply glut sometime in mid 2010. This will raise the prospects of higher selling prices and acceleration in semiconductor equipment investments. On the other hand, commodity exports which consist of 21% of total exports will be driven by global demand growth especially from developing economies and supported by increasing oil supply costs and resulted from declining supply of 'cheap oil'.
Electricity sector (Something to look out for if you doubt the economic recovery) continued to post strong gains in Dec 2009 at 14.1% y-o-y which was the seventh consecutive month of y-o-y increase. This would be one of the strong indicators of economic recovery as most if not all economic activities utilize electricity and it is almost impossible to function without it. I just ran some numbers of GDP and electricity output which showed Malaysia GDP growth has a strong correlation of 80% with electricity consumption.

Retail and Corporate Sector Growth:
Private expenditure, which consists of 54% of GDP, is expected to take the lead in driving Malaysian economy, backed by more pro-business policies, low interest rates and higher corporate earnings. Corporations emerge stronger from the recession enjoy greater efficiency and healthy balance sheets and cash flows.

Newsflow of major projects:
Construction industry expected to thrive this year. Major construction projects like Interstate Water Transfer Scheme (RM8.8 billion), LRT extension (RM7 billion), new LCCT terminal (RM2 billion) and Gemas-Johor Bahru Double Tracking Project (RM5 billion) are expected to roll out over 6-12 months (Please don't delay anymore!!). Construction industry is known to have high multiplier effects on the overall economy via construction output, income generation, employment and imports. It also generates extensive backward and forward linkages with different sectors such as manufacturing industries and service type sectors, of which both constitute a majority portion of total GDP.
Firmer commodity prices: Malaysian economy is very much intertwined with commodities. About 40% of Government’s revenue comes from oil related industries while about 22% of the FBM KLCI constituents consisting of commodity related companies. According to my computation, surprisingly KLCI has an 80% correlation with crude oil price over the past 10 years. Firmer commodity prices lead to improved fiscal position of the Government, enabling higher fiscal spending or lower fiscal deficit of which both are favorable to the economy. Higher corporate earnings among commodity-related companies could also lift up the local bourse.

Appreciation of RM over USD:
In view of the large fiscal deficit of the US resulted from its stimulus measures to curtail one of the worst financial crisis faced by US, US$ is expected to depreciate against RM. This is further backed by Malaysian Government’s efforts to rein in fiscal deficit via cuts in operating (hopefully they can implement that without having too much political pressure to do otherwise) and development expenditure, lowering of fuel subsidies coupled with broadening Government’s revenue base such as review of GST and disposal of government assets, all of which could strengthen the ringgit and enhance Malaysia’s attractiveness as an investment destination. Consequently, Malaysia’s fiscal deficit is expected to decrease to 5.6% of GDP (I'm following Government's guidance) in 2010 from 7.6% in 2009 .

Foreign Fund Flow:
Foreign fund shareholdings in Malaysia declined drastically since March 2008, triggered by the General Election in Mar 2008 which sparked a huge sell down by foreigners. As a result, foreign shareholding in Malaysia plunged to about 21% currently from 27% in Mar 2008. Nonetheless, we are seeing foreign funds slowly returning to the market albeit in a moderate way. Having said that, foreign investors still have reservations about the Malaysian market such as the willpower to execute Government’s planned reforms coupled with political and social security concerns. Nonetheless, with State Elections in Sarawak and the General Election approaching in 2011 and 2012 respectively, it will be crucial for the Government to ensure that its planned reforms be executed to regain the lost votes from the previous General Election. Foreign investors’ interest could revive again, backed by clearer picture of Malaysia’s economic growth plan over the next few years coupled with anticipated execution of Government reform policies and further liberalization of its economy, which could lend support to the uptrend of FBM KLCI. Intersesting to note that FBM KLCI has been resilient in its uptrend over the past year, despite the lack of foreign investors’ support, meaning the market is very much domestic-driven.
Concerns:
Doubts remain over the execution of economic reforms though the Government openly expressed intentions to navigate Malaysia from middle-income to a high-income economy. Investors still have reservations over Government’s willpower to undertake structural reforms as the Government has failed to implement them in the past.

Uncertainty in the political arena arises as Oppositions are making inroads, as seen in the General Election in Mar 2008 which denied BN two-thirds majority in the Parliament. The race in the coming Sarawak State Election and General Election in 2011 and 2012 respectively are expected to be fierce. The recent judgments on high profile cases, scandals and squabbling continue to undermine investor confidence. Further exacerbating the situation including the escalation of inter-race and inter-religious quarrels which led to the desecration and burning of places of worship.

Bye bye, FDI: Domestic and foreign investments in Malaysia are on a declining trend, dropping by about 55% y-o-y in 2009. About 45% of total investments are still being channeled to manufacturing sector which contribute about 30% to the economy while less than 30% find its way to the services sector which contribute about 55% to the economy. This is a hindrance to Malaysia’s intention to direct services sector to lead the economic growth and move up the economic ladder. Infrastructure, political risks, structural cracks and productivity remain key concerns among investors. Malaysia’s net outflow in investments to overseas are increasing significantly, raising concerns over lack of capital investments locally. If Government does not get its act together, we will be losing way behind emerging economies like Thailand, Indonesia and Vietnam.

Valuation:

Where are we now? KLCI still trading at forward PE of 14x, below its 10-year average of 16x. There is still upside in Malaysia equity market in the short term but will not be spectacular, probably about 15% upside. Nonetheless, without FDI support, economy is going to hurt in the long term while foreign funds will continue to ignore Malaysia if we keep on harping on race/religious dominance and undermine the independence of judiciary, police etc.

I think policies and politics are going to be one of the main determinants of the direction of the market this year.

Disclaimer: The above article does not represent an investment advisory service as no subscription or management fees are charged. The contents of the article are provided as general information only and should not be taken as investment advice or as a recommendation to buy or sell any security or financial instrument. Any investment decisions carried out based on information, analysis, or commentary provided above is solely your responsibility. You should consult your investment adviser before making any investment decisions.

Something on exit strategy

As we hear from recent news on countries such as G20 planning exit strategies for their respective stimulus packages costing trillions of US$ which helped their economies navigate out of the woods, this actually raise concerns among investors over the adverse implications that might befall the capital markets again. This shouldn't be a surprise as countries in the past have executed wrong policies which plunged their economies into recession again like what happened in Japan during 1990s and US in 1937-38. There are also some investors who are concerned that the impending exit strategies might include immediate interest rate hikes.

My opinion is that the tightening policies will be in a gradual and sequential manner and the governments cannot afford to repeat the mistakes made in the past. To recap, US actually doubled the reserve requirement in 1936-37, raised interest rates, cut fiscal spending and began collecting security taxes all at about the same time, resulting in much of the stimulus disappeared in a hurry. This plunged the economy into recession again in Sept 1937. In a similar situation, Bank of Japan hiked up interest rates in 1989 from 2.5% to 6% within a year, resulting in a recession that never quite pick up right until now.

Exit Strategy:

Just recently in an article by Ben Bernanke in Wall Street Journal, he mentioned 5 measures for US exit strategy as follow:

1. To raise the interests paid on banks reserves balances at the Fed

2. To arrange large scale reverse repurchase agreements

3. Treasury sells bills and deposits the proceeds with the Fed Reserves

4. To offer term deposits to banks to lock up banks reserves held at the Fed

5. To sell a portion of its long term securities to the open market if necessary

All these measures have an aim: To absorb the massive liquidity injected into the market and to control the excess reserves brought by quantitative easing programme. Despite the liquidity injection by the Fed to normalize the credit market, the banks are not so keen to lend out to the market but tend to put back into the Fed account, resulting in a sudden spike in excess reserves from an insignificant amount in Sept 2008 to US$1trillion in Nov!! If the market recovers again, the gigantic excess reserves could have a money multiplier effect which would cause disastrous consequence. On that note, it is imperative for US government to withdraw these stimulus measures and normalize the financial market again.

Interest Rate Hike:

What about interest rate hikes in US? I think this will still be a distance away for US as the economy remains fragile, unemployment rate remains high, CPI still negative while domestic demand remains weak. Only very few countries can afford interest rate hikes such as Australia and Israel. Australia raised interest rate by 3 times within the last two months to 3.75% from 3%. Until and unless these numbers start improving in US, interest rate hike will not happen. Some estimated that they'll only raise it in 3Q2010 or 4Q2010.

From the graph above, unemployment rate and interest rate movement are inversely proportional to each other while interest rate movement is lagging behind CPI and utilization rate. With unemployment rate expected to remain high even for the rest of 2010 coupled with deflationary environment and low domestic demand, interest rate hike might not happen in the near term or until after financial markets could function normally again without the excess liquidity in the market brought by the stimulus measures.

Impact to equity market?

Some argue that interest rate hikes will adversely impact the equity market. The reason being it will restrict money supply and liquidity in the market will be limited, thus putting downward pressure on the equity market. However, the last 2 interest rate hike cycles in US were showing quite the contrary.

The interest rate hike seems to be following the trend of the equity index. This might be because interest rate hikes usually occur during the late recovery and expansionary stage where corporate earnings start growing again (the main determinant of equity prices in the long run).

Hmmm, so, will there be another second dip? It will depend on how wise the governments are in altering the fiscal and monetary policies in tandem with the economic conditions. For me, there's a low likelihood of it occurring again and governments cannot afford to repeat mistakes made in the past again. Exit strategies for the stimulus packages are expected to be gradual as well and will not be immediate. Slow recovery ahead...

US economy returns to growth in 3Q after deep slump

WASHINGTON: The U.S. economy grew in the third quarter for the first time in more than a year as government stimulus helped lift consumer spending and home building, fueling an unexpectedly strong advance, according to Reuters on Thursday, Oct 29.

Signaling the end of the worst recession in 70 years, the Commerce Department on Thursday said the economy expanded at an annual rate of 3.5 percent in the July-September period, snapping four down quarters with its fastest growth pace since the third quarter of 2007.

The report buoyed global stock markets, which were also cheered by improving third-quarter corporate earnings, including higher-than-expected profits from consumer product giants Procter & Gamble Co and Colgate-Palmolive Co.

It raised hopes for further improvement in corporate profits and sent stocks on Wall Street rallying after four days of losses. The Dow Jones industrial average and the Standard & Poor's 500 Index notched their biggest percentage gains since July 23.

Prices for U.S. government debt and the U.S. dollar fell as traders exited safe havens. "The economy has emerged with gusto from the deepest recession since World War Two," said Harm Bandholz, economist at UniCredit Markets and Investment Banking in New York. "The short-term prospects for the economy remain good."

Economists polled last week had expected a 3.3 percent GDP gain, but many had cut those estimates in the past couple days. As it turned out, growth was fairly broad-based with solid gains in consumer spending, exports and home CONSTRUCTION [].

But it was also driven by emergency government programs like the popular "cash for clunkers" incentive for new auto purchases and an US$8,000 tax credit for first-time home buyers. The auto discount program ended in August and the home tax credit is due to expire next month, although Congress is working on a plan to extend it.

Stripping out auto output, the economy would have expanded at only a 1.9 percent rate in the third quarter. In the absence of government support, there are fears the brisk growth pace will not extend into coming quarters, with rampant unemployment also inflicting damage.

"The economy is entirely dependent on federal deficit spending at the moment. But the stimulus will not fade right away ... that means we can rely on solid growth continuing through the first quarter of next year," said Chris Low, chief economist at FTN Financial in New York.

"Once the government steps aside, growth is likely to fall back to a 1 to 2 percent rate of growth." The United States is entering recovery following in the footsteps of major economies like China and the euro zone.

Source: Reuters

Budget 2010 & others: My simple take

Highlights:

Construction:

Government spending about RM9bil on infrastructure projects, of which RM4.7bil on road and bridge projects, RM2.6bil on water supply and sewerage services, RM899mil for rail facilities, RM820mil for ports and sea services coupled with RM276mil for airport projects (Upgrading of Penang or Sibu airports?). In addition, another RM2.3bil will be allocated for construction and upgrading of infrastructure in rural areas, of which RM857mil will be used to construct 510km of rural roads and 316km of village roads such as Kapit, Lawas and Kimunjan in Sarawak and Kinabatangan, Kota Belud and Keningau in Sabah.

Beneficiaries:

Road and bridge projects - WCT, Gamuda, Mudajaya, IJM, Muhibbah Engineering etc.

Water supply & sewerage - Hock Seng Lee, Loh & Loh, Salcon, WCT

Ports & sea services - Gamuda, Muhibbah Engineering, Putrajaya Perdana

Airport projects - WCT, Fajarbaru, Gamuda

Sarawak & Sabah: Hock Seng Lee, Naim Holdings, Cahya Mata Sarawak, UBG, WCT

Property:

A tax of 5% on gains from disposal of property while the existing tax exemption is maintained only for gifts between parents and child, husband and wife, grandparent & grandchild. This exemption will also be given on disposal of residential property once in a lifetime. This will take effect from 1 Jan 2010. Nonetheless, the Government is launching a scheme to allow EPF contributors to utilize current & future savings in Accounts 2 for purchase of one property at a time. However, the calculation of future savings remains vague.

A counterproductive move to the property sector which is a discouragement to property investors from local and abroad. Whether the 5% tax is applied to gains from all kinds of disposal remains vague. What happen if I bought a house like 20 years ago which cost me RM50K and now am selling it at RM200K? Then I have to pay as much as RM7.5K in taxes which is a lot. There are even some reports that said that this 5% tax on gains only applies to disposal of properties within 5 years and beyond while gains from disposal within 2, 3 & 4 years might actually be taxed as high as 30%, 20% & 15% respectively (Not sure about this though). Could be a dampener to property stocks prices next week. Nevertheless, the new EPF scheme to allow usage of Account 2 to purchase residential properties will provide some respite, hopefully.

Telcos:

Tax relief on broadband subscription fee up to RM500 a year from 2010 to 2012 is proposed. Government will also expedite implementation of High Speed Broadband at a total costs of RM11.3bil, of which RM2.4bil is from the Government while the rest of RM8.9bil will be from Telekom Malaysia. Broadband services with 10Mbps will be available in KL & Selangor by end-March 2010.

Tax relief is positive for telcos like Digi, Axiata, Maxis (to be listed soon) and Green Packet (Packet One is the subsidiary which offers Wimax). TM might attract interest on HSBB.

Finance industry:

Liberalize common sharing arrangements between stockbrokers and remisiers in 2 stages to encourage retail participation. The 1st stage is to allow sharing at min rate of 40% for remisiers and fully liberalized by Jan 2011. Allow 100% foreign equity participation in corporate finance and financial planning companies as compared to current requirement of 30% local stake.

The liberalization will allow greater competition among stockbrokers in rewarding remisiers who perform well and at the same time encourage remisiers to garner more interest in the stock market from the investors. The allowance of 100% foreign equity participation in corporate finance is a welcome relief which will encourage greater competitiveness among the local corporate finance providers and more corporate exercises will be seen in the market, good for the capital market.

The statement of 'From Low Income to High Income Economy'

A slogan that has been preached for 10 years but doesn't seem to go anywhere.

Here are some Government proposals and aims:

1. Double income per capita within 10 years:

Very ambitious. This means 7.2% growth p.a. Adding 2% p.a. population growth, 9.2% growth p.a. in income per capita for the next 10 years!! We are aiming to beat China izzit?? How are we going to do that?? No answers.

2. Increasing private investment by enhancing domestic investment and encourage local companies abroad to remit their profits and reinvest into the country:

How to encourage? Dunno. Companies are not charity organizations. There is no obligation or responsibility at all for local companies abroad to remit their profits & reinvest into Malaysia. If they could find greener pastures overseas, why come back here? Government must take action first. Don't expect companies or talents to automatically come back to contribute to Malaysia. Just by talking to companies' management here, they find it so difficult to employ good people to work with. Lazy, incompetent and the worst thing is that they can't even speak a proper sentence in English. Our very little attraction of bringing in foreign investment which is our proficiency in English has even been destroyed by our very own system here. "Demolish PPSMI", we often hear. Recent Government's flip flop decision to revert back to BM in teaching Maths and Science is not helping either.

3. Providing business friendly environment:

First thing that comes to my mind, broadband. Our broadband penetration is just 25%, broadband service ranking is No.48 out of 66 countries. Broadband fees are exorbitant, a lease line 6Mbps from TM costs RM250K per year, which is way beyond many SMEs' budget. If we don't have the IT infrastructure to enable businesses to run, how to attract investors? Well, at least HSBB by TM is rolling out in 1Q2010, a good move in the right direction. Hopefully the timeline will be done as announced. Coupled with other reasons like escalating crime rates, corruption, weakening workforce, we are actually seeing a decreasing trend in net FDI as shown below.

4. Strengthening higher education by allowing IPTA greater autonomy and relaxing rules on income generation:

Nothing to say. A look at our universities' ranking will show how pathetic our education system and human capital are. As long as universities are not fully liberalized, not free to think, not free to discuss politics or join political parties, have to kowtow to the Government in appointment of management & funds or anything, not based on merits, not given fair chance of education among all races, then kiss goodbye to whatever intentions to strengthen higher education. Poor universities => incompetent graduates => absorbed into civil service => ballooning civil service => high operating expenditure => lower GDP growth => stagnant salaries => strain on working population. We have a massive 1.2 mil civil servants against 10 mil working population. More money is poured out to sustain Government operation rather than being spent on development. Growth in operating expenditure is increasing at a greater magnitude than development expenditure for the past few years.

Nonetheless, the budget is starting a new direction for the management of its expenditure. The Government intends to cut operating expenditure from RM154.2bil to RM138.3bil to reduce inefficiencies in Government operations while development expenditure remains almost the same. Ok. Fair enough. Hopefully, the Government could continue the trend in cutting operating expenditure and increasing development expenditure at the same time.

A lot of measures laid out in the Budget do not have a clear direction on how it can transform Malaysia into a high-income economy. Human capital development is of utmost importance. I'm sure many had discussed at length on our problems of human resources. Before we develop all the 1st class infrastructure, we have to develop human capital first. But we are doing it the other way round. Thus all these projects on Putrajaya & Cyberjaya, Proton City, MSC, Iskandar Corridor etc have a greater chance of failing. We simply don't have the capability or mental capacity to handle all these projects. (By the way, what's happening to Iskandar? CEOs keep on resigning from their posts one. Too much politics involved kah? Too corrupted? Too much bureaucracy?)

The Government also intends to implement measures to attract talents to Malaysia. I guess the main motivator will be the salaries here. Since Malaysian salaries are so low, it will be an uphill task to attract Malaysian and foreign talents to come to Malaysia. The continuous influx of foreign labor (3.5 million out of 27.5 million population = 12.7%!!!) will continue to impede the economy from moving higher in the value chain and putting a cap on Malaysian salaries. Malaysian companies won't be willing to move up when cheap foreign labor is so readily available.

Anyway, Malaysia has always been famous for talk and less action. Word without action is dead. Hopefully, Najib could prove otherwise. Give him the benefit of doubt as he pleaded.

For the Budget 2010 speech, click here. (Very long la. 49 pages. Eyes swollen already)

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