More challenges for markets seen in May

WILL the month of May be more challenging than the usual “sell in May and go away”?

Political uncertainty is an issue. In Malaysia, it will be general election in early May while in the US, it will be mid-term elections in six months’ time. Inflation and rising US Government bond yields are major issues causing stockmarket jitters. As bond yields rise, making bond prices cheaper and more attractive, the recent pick-up in short term bond yields is also considered a warning sign.

Higher borrowing costs and the potential flight out of dividend stocks into bonds could spell trouble for equities. Last week’s earnings season and easing Korean tensions could not overcome inflation and rate hike jitters on Wall Street, and that had affected Asian markets.

Could this be just a sentiment issue or a sign of something ominous?

“Rising bond yields indicate the sustainability of the US economy. Current US consumption and retail sales do not indicate high inflationary pressure; it may be a sentiment issue unless oil price soars above US$100 per barrel. Following the general election, Bursa Malaysia may be back to normal after the uncertainty,’’ says Danny Wong, the CEO of Areca Capital.

“In the US, funds have begun to flow out of equities in March and April, unlike in January and February which saw big inflows,’’ according to Pong Teng Siew, the head of research at InterPacific Securities. Retail investors had aggressively bargain-hunted stocks that were sold down in January and February.

Hence, the sharp rebounds. Come March and April, stocks gave up all ground reclaimed in February. “Retail investors are now leaving the market although via smaller net selling,’’ says Pong.

Rising US government bond yields may be a trend ahead. Apart from the Fed rate hike programme, large issuances of longer term bonds to fund the huge US budget deficit (for tax cuts, military and infrastructure spending), supply of which exceeds demand, is causing bond yields to climb sharply.

Rising yields for US government bonds may cause investors to flee from junk bonds, which may impact other markets and companies that issue these junk bonds.

The positive side is perhaps in the process of exiting, there may be some inflows into Asian markets although high yield investors usually stay in fixed income.

“If yields rise enough to draw investors from, for example, junk bonds (which are risky but pay high yields), credit spreads (difference in yields of bonds with different credit quality) will begin to climb.

“While spreads are indeed widening, it is not sufficient yet to cause too much pain to junk bond holders,’’ says Pong. “Now, the spreads are so low, they pay only 50 to 60 basis points above those of US government bonds.’’

Junk bond investors are not seen rushing out yet; it may be an alert sign for the stockmarket which may be considered also in the risky category. A junk bond exit may affect other markets as managers may sell other instruments to raise the cash. If junk bonds swoon, highly indebted companies will likely be forced to pay higher rates and may find themselves unable to raise the funds to keep afloat.

As bond yields rise, the sustainability of the rebound in the US dollar, which hit a fourmonth high last Wednesday, is under watch.

“The US dollar may maintain these higher levels until the end of the third quarter; together with the reduction in Fed liquidity, the US dollar will likely continue to trade positively against other most currencies.

“Due to these global moves, the ringgit, together with other currencies, is likely to weaken against the US dollar,’’ says Hor Kwok Wai, the chief operating officer for global markets at Hong Leong Bank.

Inflation expectations on the back of strong US economic growth as well as the yield gap between the US and Malaysia are factors that influence the direction of the ringgit.

“If the yield gap between the US and Malaysia continues to narrow, rising US bond yields will attract more capital inflows into US dollar assets, and hence, weigh on the ringgit,’’ says Lee Heng Guie, the executive director of Socio Economic Research Center.

In China, big moves in potential easing of debt tightening measures are being weighed, as added pressure comes in the wake of trade tensions.

Slowing March industrial and investment growth in China suggest that momentum may be tapering off; the People’s Bank of China had cut reserve requirement ratios (a percentage of total deposits that banks must keep at all times).

“China will run into the risk of deepening financial stability if the trade war prolongs,’’ says Lee.

“Investment growth will likely be curbed as there will be less incentives and means within China’s private sector to invest elsewhere,’’ says Pong.