This article first appeared in Wealth, The Edge Malaysia Weekly on April 25, 2022 - May 1, 2022
Longer-duration government bonds and corporate bonds in the infrastructure and automotive sectors are two bright spots investors would want to look at. However, equities are expected to outperform fixed income as the global economy continues to recover, says RHB Banking Group chief economist Dr Sailesh Kumar Jha.
According to Jha, longer-duration government bonds represent investment opportunities as yields spiked at the end of March while prices fell. For instance, the yield for the 10-year Malaysian government securities (MGS) rose to about 4% on March 28 from about 3.7% a week ago.
“The [10-year] MGS yield had been moving in line with the 10-year US Treasury yield earlier. But it disconnected from the US Treasury and went up big, surprisingly. Investors could find value in extended-duration government bonds,” he says.
Jha notes the spike in the yield of the 10-year MGS coincided with the Ministry of Finance’s announcement that it would review fuel subsidies due to the surge in global oil prices. Brent crude oil spiked to about US$123 per barrel on March 8 from about US$69 four months ago. It fell to US$108 per barrel on April 6.
“The markets were worried as the government was projecting fuel at US$67 per barrel, based on our estimation. It went up to about US$100 per barrel, which is quite a big difference of more than US$30. Markets are worried that it will impact the government’s fiscal position,” he says.
During that period, Malaysian five-year credit default swaps (CDS), a type of derivative contract traded by international investors as insurance against the country’s default risk, also went up sharply in mid-March.
However, Jha says investors could have overreacted as the Malaysian economy is expected to grow at 5.5% in 2022, based on the firm’s forecast, which will allow the government to collect taxes to meet its fiscal deficit target. There is also the one-off prosperity tax that will fill up the government’s coffers.
“From our perspective, there is no material risk for the government to meet its 6% fiscal deficit target this year unless the country’s economy collapses way below the 5.5% projection. Concerns about Malaysia’s fiscal position, affected by the fuel subsidy, are too much. Yields have moved up too aggressively,” he says.
Investors could also find value in corporate bonds issued by infrastructure companies with overseas exposure and those in the automotive sector. The former will benefit from the ongoing global economic growth while the latter benefits from the recovery in consumer spending.
“We are more positive on infrastructure companies with large foreign exposure. The numbers of companies with domestic projects might disappoint as the rolling out of these projects locally has been modest in recent years. There are also severe challenges in the industry due to labour shortages and the delay in implementing mega projects such as the ECRL (East Coast Rail Link),” says Jha.
From an asset class perspective, Jha favours equities over bonds, based on the expectation that global growth will remain intact and oil prices will not spike to US$150 to US$200 per barrel, as expected by some market players.
He says concerns over the Russia-Ukraine conflict are now in the rear-view mirror and will continue to subside. While bear markets were observed when the war began in February, a global economic crisis seems unlikely.
A veteran of the financial markets for more than two decades who has gone through several crises, Jha has not observed any major flights to safety in the market and liquidity has remained intact since the Russia-Ukraine conflict started, an important sign that an economic crisis is not yet brewing.
“I remember sitting on the trading floor with Barclay Capital in 2007 [before the global financial crisis happened], observing congestion in the dollar, euro and yen market [as there was a flight to safe havens]. We mentioned it to our colleagues in the developed markets. Something was wrong. But recently, we did not see that in those markets,” he says.
“There is no shortage in liquidity. It is what drives markets at the end of the day. If liquidity is there, you have a fair chance that nothing serious will happen.”
As the Russia-Ukraine conflict is now in the rear-view mirror, Jha expects oil prices to hover at US$100 to US$120 per barrel and will remain somewhat stable moving forward. The elevated oil prices are partly due to underinvestment in the oil market due to the environment, social and governance (ESG) trend.
Oil prices are not expected to spike to US$150 to US$200 levels as the US government is guiding that it will push for more shale oil production. “The US government policy is geared towards bringing shale oil back. It is huge. It is a problem of when we will get that oil in the market.”
Based on such a projection, Jha favours US, Indian and Southeast Asian equities. US equities, especially those in the technology sector, are expected to do well, as the global economic growth story remains intact. “In the US, we have been suggesting that investors look at growth companies, even though value companies have outperformed growth year to date. Companies on the Nasdaq are expected to do well.”
Indian and Southeast Asian markets, including Malaysia, are also appealing, given that their overall prices have fallen to attractive levels. “Asset allocation-wise, we see adjustments in US, Indian and Southeast Asian equities. Prices are quite low. They are likely to go north on the back of global growth.”
On the local front, Jha favours the semiconductor sector as global growth continues, especially those linked to the US market.
Jha and his team are of the view that the ringgit will strengthen to RM4.15 against the US dollar by the end of the year.
One of the reasons the greenback has strengthened against the ringgit recently is due to a turn in the market’s view at the end of last year that the US Federal Reserve will hike interest rates more aggressively. “That impacted capital flows [from emerging markets to developed markets] and the weakening of the ringgit against the dollar,” he says.
However, Jha says views and information on a strengthening US dollar have already been priced in across various asset classes. The upside of the US currency is, therefore, capped.
Meanwhile, market players seem to be too worried about Malaysia’s fiscal position, reflected in the rise in the five-year MGS. A turn in investor sentiment could see the ringgit strengthen against the US dollar.
Jha reminds investors to keep an eye on the tax reforms that the Malaysian government has started talking about this year. The Goods and Services Tax could be reintroduced.
He adds that international credit rating agencies have been keeping an eye on the Malaysian government’s fiscal position. Fitch Ratings says the government’s debt, including its guarantees, could reach 78.1% of GDP in 2021, from 65.2% in 2019. Its debt burden is significantly higher than the median “BBB” rating category.
“The tax reform needs to come into the picture quickly. The government needs to start talking about it, which is not positive news to the market,” says Jha.
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