This article first appeared in Capital, The Edge Malaysia Weekly on September 16, 2024 - September 22, 2024

IF history serves as a precursor for investors on what to expect for equity markets should the much-anticipated cutting of interest rates by the US Federal Reserve be initiated this Wednesday (Sept 18), fund managers are predicting the following — short-term volatility and opportunities for accumulation as beaten-down stock prices present better returns on investment.

Fund managers tell The Edge that they are expecting intense market volatility to persist in the short term, particularly as the US presidential election takes place on Nov 5. Investors will be watching for the policy direction of the new president, with deepening geopolitical tensions and the ongoing US-China trade war expected to further fuel uncertainty.

“While these external risks contribute to short-term instability, the longer-term outlook tends to improve after rate cuts historically, providing a more favourable environment for markets once policies stabilise and economic conditions become clearer,” fund management company Areca Capital’s CEO Danny Wong tells The Edge.

After the US’ release of a mixed jobs report for August on Sept 7 showing a smaller-than-expected rise, with unemployment inching from 4.2% to 4.3% in July, interest rate futures contracts briefly priced in a 50-basis-point rate cut this year but the possibility has narrowed to about 25bp.

A report from the US Labor Department last Wednesday shows that the post-pandemic spike in the country’s inflation eased for the fifth consecutive month to 2.5% in August, down from 2.9% in July, clearing the way for the Federal Reserve to cut interest rates held in the 5.25%-5.50% range since July 2023.

Year to date (YTD), the FBM KLCI is up by 12.73%, closing at 1,639.8 points last Wednesday after falling from a peak of 1,678.8 points on Aug 30 in a series of market corrections since July. On the same day, the FTSE Bursa Malaysia Top 100 Index stood at a YTD increase of 13.2% at 11,873.2 points after falling from 12,246.68 points on July 18. 

A similar trend was seen on the Nasdaq Composite Index, which is 15.3% up YTD at 17,025.9 points after falling from 18,647.45 points in mid July, as well as the S&P 500 Index, now up 15.21% after falling from a YTD high of  5,667.2 points during the same period.

“Global equities along with Bursa Malaysia are in a seasonally volatile period, based on historical patterns. Despite the FBM KLCI hitting a five-year high (of 1,678.8 points) at the end of August, the broader market or medium-to-small cap indices also hit the all-time highs a month earlier and have since undergone profit-taking activities. If the market is pricing in more rate cuts, I would not rule out more volatility on Bursa Malaysia in the near term,” says Principal Asset Management Malaysia chief investment officer of equities Lee Chun Hong.

He also explains that based on Principal’s internal projections, the earnings growth for Corporate Malaysia remains healthy going into 2025. However, he predicts that should the US enter a recession instead of a soft landing, the Malaysian economy will be hit temporarily.

“A 25bp cut could boost stocks, but the markets are likely to remain cautious due to volatility and potential profit-taking. The reality is that a larger cut may signal deeper economic concerns, leading to negative market reactions. However, historically, rate cuts have benefited emerging markets like Malaysia. If a US soft landing plays out, gradual rate reductions could stabilise the Malaysian market,” says Wong.

The fund managers contend that ultimately, domestic factors will have a more profound influence on the FBM KLCI than the US Fed rate cut.

“We believe that Malaysia should be resilient and is still on a growth trajectory. Economic growth is accelerating incoming foreign direct investments (FDI), development of local hard and soft infrastructure and capacity building for China Plus One demand,” says TA Investment Management Bhd chief investment officer Choo Swee Kee.

The fund managers recall that rate cut cycles typically occurred during periods of economic distress, often leading to market corrections and increased volatility. Notable examples include the dot-com bubble bust in 2001, during which the US Federal Reserve slashed interest rates from 6.5% to 1.75%, the housing market crash in 2008 (5.25% to 0%-0.25%) and the Covid-19 pandemic in March 2020 (1.5% to 1.75% to 0%-0.25%) (see chart).

A technical chartist points out that stocks have tended to trade flat to negative in the first few months after a rate cutting cycle begins but moves higher over the following 12 months. And that drawdowns during these 12 months also tend to be more severe.

While global rate cuts have followed recessions or crises in the past, the fund managers emphasise that such is not the case this time.

“Initial market reactions to these rate cuts were often negative, as they highlighted deeper economic concerns. However, as markets stabilised following the rate cut cycles, stocks generally performed well in the low-interest-rate environment, supported by cheaper borrowing costs and improved liquidity,” assures Wong.

“In the 21st century, during events such as the global financial crisis (GFC) and the Covid-19 pandemic, US rate cut cycles were dramatic, reflecting the necessity of protecting the economy from significant downturns. However, this time we are not confronted with black swan events, but rather a balancing act to maintain the US economy in a Goldilocks state — neither too hot nor too cold,” says Principal Southeast Asia CIO of fixed income Jesse Liew, noting that the Federal Reserve has yet to declare victory over inflation.

That said, Liew warns that aggressive rate cuts could risk undermining the progress made in combating inflation, which initially led to the Fed Funds rate being raised to a high of between 5.25% and 5.5%. He believes that with many Americans still grappling with elevated post-Covid prices, it would be essential that the Fed adopts a measured approach to fulfil its dual mandate of stable prices and maximum employment.

“Generally, equity markets [tend to] react positively provided the rate cuts are not due to a recession. Especially emerging markets, as the currencies will appreciate against the USD and central bankers in these regions will have room to cut rates to bolster economic growth,” assures Principal’s Lee.

Moving forward, the fund managers are anticipating key fiscal and monetary policy updates in the fourth quarter, namely Putrajaya’s Budget 2025 announcement in October, to act as a catalyst for the local bourse as clarity on fiscal policies and incentives attract FDI.

“Infrastructure spending will play a crucial role. Malaysia’s strategic location and resources make it an FDI hub, especially as companies diversify from China,” says Areca’s Wong.

To Principal’s Lee, less pressure on the ringgit will bode well for both the equities and fixed income markets. Bursa Malaysia has been an outperformer so far in 2024 due to a few factors. A stable government with policy reforms agenda provided the excitement. Secondly, stronger economic growth will be translated into earnings growth and further lift investors’ confidence. In other words, these few factors need to remain in place to buoy Bursa in the second half of 2024 and the beginning of 2025.

To this end, the fund managers urge investors to keep their portfolios diversified by focusing on companies with strong fundamentals, solid balance sheets and high earnings prospects.

“Regularly reassess your strategy and risk tolerance, especially in turbulent times. Keep some cash on hand for flexibility to buy promising beaten-down stocks for mid- to long-term growth. Stay selective and patient, ignoring short-term market noise if you have a long-term perspective,” says Wong. 

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.