This article first appeared in Capital, The Edge Malaysia Weekly on April 25, 2022 - May 1, 2022

UNCERTAINTIES in the geopolitical landscape as a change in the interest rate regime looms have contributed to volatility in financial markets globally, leading to jitters among investors. Fund managers believe that investors are currently sandwiched between two extremes.

Risk factors such as higher interest rates and inflation as well as potential political risks are seen as dampening investor sentiment, while current stock valuations remain undemanding as the nation continues its transition towards endemicity.

“We see high volatility behind us and ahead of us. It will take some time for the market to stabilise, which will only happen when all the current risk factors become more predictable,” TA Investment Management chief investment officer Choo Swee Kee tells The Edge.

“It is this very transition that is causing the market volatility as investors no longer have a clear direction forward,” says Areca Capital Sdn Bhd CEO Danny Wong.

He adds that market uncertainties have compelled many investors to sell off their stocks regardless of their fundamentals.

“This is typical of short-term investors who are very much sentiment-driven, and affected by the deluge of daily news,” Wong remarks.

Over the past week, the benchmark FBM KLCI continued on a losing streak that began on April 11, before rebounding last Wednesday and closing the following day at 1,598.32 points.

Year to date, the FBM KLCI has risen 2.22%, and traded within a range of 1,503.34 on Jan 25 and 1,620.44 on March 1.

Meanwhile, US stocks have seen some volatility with the S&P 500 losing 6.44% year to date (as at April 21). The Dow Jones Industrial Average was down 3.24% over the same period.

Wong believes the recent downward trend in the local index is not a reflection of the market in its entirety as prices in the last two to three months have been supported by high commodity prices.

As for how long the volatility will last, it is hard to tell given the many factors at play, but private investor and former investment banker Ian Yoong forecasts that the situation will persist until the first half of 2023.

“Whether the conflict in Ukraine escalates is unpredictable. We’re hoping for everything to return to normal (pre-Covid-19) … [when] the Russia-Ukraine war comes to an end, it will take nine to 12 months for the global economy to recover. The economic and physical damage to infrastructure will require time to repair and for rebuilding to be carried out. A Marshall Plan for the 21st century will be necessary for Ukraine and perhaps other countries if the war spills over,” he says.

Yoong believes that listed companies that will thrive are businesses with “pricing power and [high demand] for their products and services. Customers will pay for the products or services even if those companies increase their prices”.

Overall, Yoong thinks that the best strategy is to stay invested in equities. “Cash and near-cash assets will only deplete in value over time. It is best to invest in well-managed listed companies in resilient sectors rather than fixed income securities or fixed deposits, as cash is a poor investment in an environment of high inflation. Bear in mind that inflation [in the US] stood at a 40-year high recently. Cash is not king in this environment.”

For now, he believes that it is wise to focus on the commodity, plantation and oil and gas (O&G) sectors.

“O&G services companies with sound balance sheets, which are mainly dependent on Petroliam Nasional Bhd (Petronas) and other upstream companies in Malaysia, are promising. These companies have been in the doldrums since 2016. Petronas will most likely increase its capital expenditure for 2023 on oil price expectations sustaining above US$80 for the next two years. The O&G industry has been at the low end of the capital cycle for the past three years,” Yoong notes.

He adds that national oil company Petronas plans to allocate an average of RM20 billion in capex in upstream activities over the next five years.

“Capex was much lower over the past few years at about RM12 billion per annum on average. In addition, there will be speculative interest in listed companies involved in bids for digital banking licences in 3Q2022,” Yoong forecasts.

Meanwhile, Choo stresses that one should look beyond risk factors and into the economic fundamentals and future potential of an investment.

“The market is cyclical and there are peaks and troughs. If the market is at the peak, then such volatility could cause the market to correct. However, in the case of the FBM KLCI, we are almost at the trough and we believe it has limited downside. Hence, it is a good opportunity to stock pick for recovery or for future growth potential,” he explains.

“Since forecasting is difficult in the current volatile market, we believe that the best strategy is to ignore all noise and focus on companies’ core fundamentals, which will reflect their values in the longer term. Short-term volatility will be immaterial if you have a long-term view.”

Choo likes real estate investment trusts and certain utility stocks for their defensive qualities. “Generally, in times of high uncertainty, defensive and recovery sectors will do well. For post-Covid-19 pandemic plays, we think tourism-related sectors like airlines, airports and luxury retailers are good for the recovery play.”

Similarly, Wong encourages investors to hold fast to a mid- to long-term investment horizon. “As the market reopens and interest rates normalise, such as the expected US Federal Reserve rate hike of 25bps to 50bps to 75bps, note that this is a step towards normalisation,” he says, “Counters in the banking and consumer sectors will benefit, while cash-rich companies will benefit from higher interest rates.”

Wong also notes that the pickup in global economic activities including travel has been encouraging which, in turn, bodes well for trade. Malaysian exporters, for instance, will benefit from this, he says.

“For a steady dividend yield, banking stocks will be key. For growth, long-term technology stocks are good but note that good technology counters have been down; therefore, be selective,” Wong cautions.

“Were I sitting on a pile of cash, I would hold on to 30% of it while investing the remaining 70% via the barbell strategy by selecting stocks that are beneficiaries of the economic reopening, such as consumer stocks as well as technology stocks for the longer term,” he adds.

Wong continues to favour financial stocks. “After a difficult 2021, there were high provisions which were not fully utilised. That, coupled with rising interest rates and loan growth, will contribute to banks’ earnings. Therefore, I believe financial and banking stocks will benefit in the next one to two years.

Meanwhile, Wong notes that the recent high in gold prices indicate a diversion of investor interest to gold for its stability amid uncertainties in the equities market (see chart).

According to Wong, the possibility of a US recession is too soon to tell at this juncture. “If the [external factors] such as the hike in interest rates or inflation were the sole issue, investors would know how to respond. But various [global events] are taking place simultaneously amid a global and unprecedented healthcare crisis. This makes for an inverted yield curve, which signals a potential US recession and gives rise to concerns of stagflation.

“If the yield curve continues to invert for another 10 to 12 months from now, historically, that suggests that a recession will [only] follow six months to a year after that point,” Wong explains.

An inverted yield curve is rare and reflects bond investors’ expectations of a decline in longer-term interest rates, which is typically associated with recessions.

“China being one of the [last] few countries with a zero-tolerance policy on Covid-19 and an extra protective stance is worrying. The country’s continual imposition of stricter lockdowns impacts global trade. Busy ports have ground to a halt. This will have ripple effects on supply chains. Therefore, avoid stocks with factories or activities in China for now as a temporary measure to manage risks,” says Wong, noting that China’s zero-Covid-19 policy contrasts sharply with Western nations’ transition to endemicity. This, he explains, is telling of the normalisation of trading activities around the world.

“Any direct impact [from China] on the Malaysian market is minimal, excluding companies with factories there. But, of course, there will continue to be a divergence of trade as supplies are sourced from alternative parties and countries for now,” says Wong.

On this, Yoong believes China will likely adjust its Covid-19 policy given its impact on the economy. “A zero Covid-19 policy that exceeds a year will cause severe economic damage and hardship to its people. The leadership will balance loosening restrictions with battling the pandemic to ensure the wheels of industry continue to turn.”

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's App Store and Android's Google Play.