Navigating 2021 - Market Outlook Forum

Webinar presented by CFA Society Malaysia.

Executive Summary

COVID-19 is and has been one of the biggest determinants of financial markets over the past year. Recognizing the need to address this issue, CFA Society Malaysia organized a panel forum on Market Outlook for Global and Local Markets for 2021.

Regional and Malaysian Economic Outlook 2021

On the Global outlook, while there will be a macroeconomic recovery in 2021, investors should prepare for a very bumpy ride and a key change in the year besides the roll out of the vaccine is the installation of Joe Biden as the US President. “US-China relations will remain a pressing issue although uncertainties in global trade policy direction should be lower” said Khai Jhek. This will be positive for ASEAN, a key beneficiary of the ongoing global supply chain realignment. Vietnam, Malaysia and the Philippines are seen as the biggest beneficiaries from the E&E or semiconductor focused dispute between US and China. Another positive development for the ASEAN region in 2021 would be the ratification process of the Regional Comprehensive Economic Partnership (RCEP). The main benefit for Malaysia will come from smoother trade facilitation given that Malaysia already has existing agreements with ASEAN countries who are all signatories of the agreement.

Going into 2021, the key determinant for Malaysia’s economic prospects will be the degree of success of the COVID-19 pandemic response. According to Khai Jhek, “The path to recovery will be uneven given that the recent targeted tightening of the MCO is stricter than CMCO or RMCO implemented previously and the states that are placed under the strictest MCO regime are mostly the key economic hubs such as Selangor and Johor. Together the states under MCO constitute about 66% of overall GDP.” However, this is tempered by the fact that there is a much wider range of sectors allowed to operate compared to the MCO 1.0 back in March-April 2020 which should help offset the expected economic output loss over the next few months.

Upside risk to Khai Jhek’s outlook would be a faster than expected rollout of the COVID-19 vaccine while downside risk would come from an inability to control the spread of the virus. An unchecked virus will result in stricter lockdowns which would in turn affect both domestic and global supply chains.

Equity Markets in 2021

Keat Seng believes 2021 will be a good year for equity markets. Chief amongst it is the expectation of a V-shaped economic recovery. If the GFC experience was anything to go by, investors can expect the continuation of loose monetary and fiscal policies and outperformance of the Asian markets. Earnings visibility is good as a result of the return of business confidence and pent up demand. Finally the easing of trade tensions should also be a positive catalyst for the markets.

Keat Seng further notes that there are two key lessons that can be drawn from the post GFC period. The accommodative policies that were introduced in 2008/2009 took a long number of years to unwind as Taper Tantrum did not happen until four years later in 2013 and an additional 2 years before the Fed started hiking rates. China led the global recovery then and it looks like they will also lead global recovery today.

Keat Seng further lays out reasons why he believes there will be more fund flows into Asia and emerging markets as he sees a return of risk appetite, which will divert money away from safe haven assets into riskier asset classes like emerging market equities and cyclicals.

Second is the chase for yield and higher return in EM/Asia given the massive scale of quantitative easing. The sharp recovery in world trade also disproportionately benefits this side of the world. Finally the weakening of the US dollar should lead to portfolio money flowing into the aforementioned asset classes.

In summary, Keat Seng said, the signs point to a clear preference for stocks over bonds; commodities and cyclicals over defensives; EM equities, bonds and currencies over its DM counterparts and Small caps over Large Caps.

Keat Seng walked the audience through his thoughts on the challenges faced by the Malaysian index, the market and the economy. He highlighted the very apparent disconnect between the benchmark index’s returns and the growth of the real economy as the KLCI has delivered a negative price return versus 2.7 GDP growth per annum over the last 5 years, and under-performing real GDP growth over the last 10 and 15 years.

He then talked about Malaysian market’s key challenge as it has become almost irrelevant to international investors. Malaysia only commands a 2%+ weight in the regional index today, a huge decline from its weight of 20%+ in the 90s.

Questions were then raised about the sustainability of equity market growth. Keat Seng believes the 2 main drivers of growth of the Malaysian equity market are rapid growth in largely captive GLIC and private sector investment funds as well as unique pooled savings/investment schemes that channel funds into the domestic capital market instead of being intermediated through the banking system as is the norm in most countries. Key risks to this model of equity market growth arise from the possibility of GLICs diverting funds to higher yielding international markets and the willingness of investors to continue to invest, or borrow to invest in these funds. Concerns were also raised over the cost of distortion to the banking system and capital market.

Keat Seng ended his presentation by raising some thought provoking points. "The KLCI does not represent the economy. On the face of it, KLCI‘s market capitalization which accounts for 59% of Malaysia’s total capitalization is quite fair. However, 55% of KLCI’s market capitalization are GLCs, 54% comprises banks, plantations, power and oil & gas which are sectors that can be considered ex-growth or under threat from disruption". Technology and other high growth sectors have no representation on the index. On the positive side, more than half of the 30 component stocks have 10% or more exposure to international operations or exports, which is a big plus given that Malaysia’s economy is too small for businesses to sustain a secular long term growth trend. It is no coincidence that most of Malaysia’s multi-baggers in recent years are either exporters or have businesses with regional or international operations.

Fixed Income Markets in 2021

“One of the biggest themes in 2020 was that the amount of negative yielding assets amounted up to $1 trillion dollars especially in Europe and on an unhedged basis, these negative yielding assets delivered double digit returns driven by a flight to safety as investors panicked due to the economic fallout of the pandemic.” Yue Xiang said. As fixed income has finite returns over a period of time, a strong return in 2020 may translate into more normalised return in the years ahead thus, Yue Xiang believes that we are at close to or at the bottom of the rate cycle.

The recently concluded Georgia Runoffs and the Democratic sweep of the House and Senate is expected to make passage of the stimulus bill a lot easier. Yue Xiang added that the multi trillion dollar stimulus package will translate into a bigger deficit which will ultimately translate into a higher treasury supply. Coupled with expectations of a successful vaccine rollout, treasury yields have already steepened on the long end. Yue Xiang’s base case is that this will be a year of two halves with yields steepening in the second half as growth returns stronger. In Asia, the outlook is brighter than other Emerging markets due to stronger fundamentals and historically speaking, Asia has always had one of the lowest default rates. On security selection, Yue Xiang is positive on the corporate bond market as he expects credit spreads to tighten due to its defensive nature as compared to the more volatile MGS.

Yue Xiang addressed 2 key issues namely the downgrade of Malaysia’s sovereign debt rating and higher supply of government bonds in 2021. The reasons cited behind the downgrade was the ballooning fiscal deficit and the raising of the debt ceiling. Yue Xiang said “GDP growth is unlikely to catch up to debt so the debt ceiling might go to 61 or 62 (from 60) and peak at around 63 in 2023”. Government bond supply is also expected to be higher this year as a result of additional stimulus to aid in the economic recovery.