Strength of US markets rebound seen crucial

The US markets meltdown last week points to one danger ahead – the bursting of the margin debt stock bubble.

Following a partial rebound last Friday from the earlier panic dumping, investors look for direction in US markets early this week.

A weak US markets rebound that fails to hold may herald more pain, as other markets may also be hit in case of weakness.

Heavy use of margin at the end of a long bull run, can exacerbate sell-offs as traders are forced to cut losses to avoid or meet margin calls.

The explosive growth of margin debt, fuelled by cheap money, leads to either a severe market correction or crash.

Margin is most aggressively used before the peak; in this round, retail investors are highly exposed to stocks.

Margin debt, which is huge borrowings used to bet on shares and move them higher, hit a record early this year of US$642.8bil against investors’ portfolios.

Just within 2018, stocks have tanked three times; in the past, only three such ruptures had occurred over six years, according to Bloomberg.

The intense sell-off last week had led many to think of a “new era of volatility” in markets spooked by rising rates, geopolitics and possibly lower earnings.

After fabulous gains, US tech stocks are also crumbling; the Philadelphia Semiconductor Index appears to have peaked even before US markets fell.

“The losses are adding up; after the peak, stockmarkets can destroy more wealth than they create,” said Pong Teng Siew, head of research, Inter-Pacific Securities.

A report that the yuan is not manipulated, if accepted by US Treasury secretary Steven Mnuchin, may partially avert escalation of the US-China trade war.

But market and industry players are careful on yuan weakening, as trade spats between China and the United States have never gone this far in decades.

The yuan, which has fallen 9% against the dollar over the past six months, was set at a reference rate of 6.9120 per dollar last Friday, weaker than an average estimate of 6.9051.

The ringgit is sensitive to yuan movements; there has been an 87% correlation between the ringgit-dollar and the yuan-dollar exchange rates over the past five years.

“A 1% drop in the yuan against the dollar was associated with a 1.3% decline in the ringgit-dollar exchange rate, in the past two years,” said Nor Zahidi Alias, chief economist, Malaysian Rating Corp.

It is a similar case for regional currencies where a 5% weakness in the yuan was associated with a 7% drop in the rupiahs; 3.5% to 4.5% fall in the Thai baht, Philippine peso and Singapore dollar.

However, current yuan movements are unlikely to be large, and not expected to have an outsized impact on regional currencies, said Hor Kwok Wai, chief operating officer, global markets, Hong Leong Bank.

With exports under threat from the trade war and slowing global growth, current account (CA) balances, a broad measure of goods, services and capital flowing into and from countries have come under scrutiny.

Emerging economies with narrowing CA surpluses would be on the watch list.

Malaysia’s CA may be expected to be in surplus this year; the future trend and size of these surpluses will indicate the continued strength of its net lending position to the rest of the world.

From a year high of RM86.15bil in July, and in sharp contrast to a Bloomberg survey for an increase of 8%, Malaysia’s exports declined to RM81.81bil in August.

Although exports stayed above the RM80bil mark, with higher exports of manufactured goods in electrical and electronic products, it is the future sustaining trend that will be important.

For the second quarter, Malaysia’s current account had narrowed sharply to RM3.91bil compared with RM8.77bil in the same period last year.

Looking at emerging economies with CA surpluses in 2017, Thailand (10.57% of GDP) stands out, followed by Slovenia (6.42%), South Korea (5.13%), Bulgaria (4.62%), Azerbaijan (4.13%), Qatar (3.83%), Malaysia (3%), Nigeria (2.76%), Vietnam (2.74%), Hungary (2.69%), Russia (2.23%), Uruguay (1.65%), Guatemala (1.5%), China (1.35%), Czech Republic and Lithuania (0.89% each), and Poland (0.3%).

In the red for 2017 are Brazil (-0.47%), the Philippines (-0.8%), Peru (-1.29%), Chile (-1.5%), India (-1.5%), Mexico (-1.68%), Indonesia (-1.7%); South Africa (-2.46%), Egypt (-3.97%); Argentina (-4.83%) and Turkey (-5.57%).

Turkey’s CA balance has improved slightly with a surplus of US$2.6bil in August, the first since September 2015.

Maintaining CA surpluses will be more challenging in view of, among other things, the International Monetary Fund’s downgrade of its forecast for global growth to 3.7% from 3.9%, for the first time since 2016.