The bears are not on Bursa yet
ANNOUNCEMENTS on new taxes and a painful Budget 2019 are just the excuses for investors to take their money out of Bursa Malaysia. The fact that Budget 2019 will not have generous handouts is well-known. The writing has been on the wall since May 9 this year when existing government jobs came under scrutiny.
Construction projects saw massive cuts or were being shelved on the back of the country being saddled with a debt of up to RM1 trillion. The era of debt-fuelled economic growth is over.
As for new taxes, the Ministry of Finance had on Sept 14 this year announced that the country would have new taxes and has set up a high-powered committee.
The selldown of stocks on Bursa Malaysia, which is down only 3.7% year-to-date, is long overdue for several reasons.
For starters, Bursa is trading at a price earnings multiple of more than 17 times, while the Hang Seng Index is at less than 10 times. The MSCI Emerging Market Index is at 11.5 times.
The local stock market is able to hold up well largely because it lacks liquidity -meaning the shares of large companies are concentrated in the hands of a few. Bursa’s liquidity is estimated at less than 35%.
Funds such as the Employees Provident Fund and Permodalan Nasional Bhd hold large chunks of shares. In family-owned companies, the individuals keep the shares locked up.
Ideally, the liquidity levels should be about 50% to 60%. High liquidity levels allow for funds to easily buy and sell shares.
Secondly, there is no urgency to put money in Malaysia, as the economy is undergoing a restructuring while the policies for reform are being put in place. For instance, earlier this week, Prime Minister Tun Dr Mahathir Mohamad said the legal reforms would start with the appointment of judges coming under the purview of the Parliament.
Economic growth at between 4% and 5% for this year and next year is fairly reasonable, considering the pressure on emerging markets. However, we are not going to see any mega-projects taking off that could fuel the catalyst for earnings of companies.
Apart from mega-contracts being cut, some sectors, especially those that serve the public, are being pushed to roll out services at lower prices. This impacts corporate profits.
So far, the sectors that have borne the brunt are the telecommunications and construction companies.
Thirdly, there is a re-allocation of funds in global capital flows. The primary reason is due to the rise in yields of US-dollar debt papers on the back of the US Federal Reserve (Fed) hiking up interest rates.
At the moment, the yield on the 10-year US Treasury papers is 3.17%. If the Fed embarks on three interest rate hikes next year as planned, the yield could hit closer to 4%.
Why would the risk-averse investor put money in the over-valued US stock market when yields on risk-free instruments are pretty decent at 4%?
There has been a huge global selldown of bonds on the back of the Fed raising interest rates.
This is because when interest rates go up, bond prices come down. Investors tend to sell their existing debt papers to buy new ones that come into the market with a higher coupon rate.
The selldown in the highly-leveraged bond market has caused a re-allocation of resources.
The US equity market, which has seen a bull run since 2009, is hit by rising yields. The Dow Jones and tech-heavy Nasdaq saw five consecutive days of selldown.
When the US market corrects, it affects sentiment in other parts of the world, especially countries such as Malaysia.
Fourthly, the growth in the global economy is expected to be lower next year due to prolonged trade wars. The US and China’s protectionism measures inhibit global trade and will affect all other countries.
In a nutshell, the higher yields backed by rising interest rates cause an outflow of funds from emerging markets. The lower economic growth forecast exacerbates the situation.
Talk of a capital gains tax or inheritance tax in Malaysia is not really new. In the past few years, it has cropped up every time the budget comes up.
Both these types of taxes are regressive. A tax on capital gains is difficult to administer. More damaging is the potential loss on Bursa Malaysia. Capital destruction would outweigh any capital gains tax.
It would be naive to assume that the current crop of leaders are unaware of the capital destruction effect.
No other country in the region has imposed a tax on money made from the stock market. Why would Malaysia do it?
As for the inheritance tax, it is not something that would bring about immediate money to shore up the government’s coffers. It happens when a person dies and gives their wealth to their heir. It normally impacts only the rich.
However, there are ways to circumvent paying the inheritance tax. One way is to set up a trust. Surely, the accountants know of other ways.
Finance Minister Lim Guan Eng has already outlined several new tax initiatives that the government is looking at when he announced the formation of a new committee to look into tax reforms. He stressed that personal and corporate taxes cannot be raised further.
He said the new committee would look at other areas such as the digital economy.
Hence, why this unfounded anxiety about new taxes?
Malaysia is no different from the rest of the emerging markets. Foreigners are taking money out as they allocate their funds based on the rising yields in the US debt markets and strengthening dollar.
Among emerging markets, we have performed better than most because there is confidence in the new government to reduce corruption, improve governance and try to get a higher multiplier on the economy for money spent.
The legal system is being reformed and slowly other areas of the economic restructuring should be on track.
The funds are putting their money in other places that offer better returns. They will come back to Malaysia and other emerging markets when valuations are attractive and corporate earnings are on the rise.
That is how the smart money works. So, there really is no reason to fret over the selloff. The bear market is not here yet.
Apart from megacontracts being cut, some sectors, especially those that serve the public, are being pushed to roll out services at lower prices. This impacts corporate profits.