Morgan Stanley Global Research Upgrades Malaysia

The influential Morgan Stanley Research has upgraded Malaysia and Egypt last week in the much followed Asia Strategy Report. Below are excerpts from the report:

Key changes in our country quant model this month are:

Upgrading: Malaysia and Egypt from equal-weight to overweight;
Downgrading: Peru and Chile from equal-weight to underweight.

Overweight countries are: China, Brazil, Taiwan, India, Israel, Poland, Malaysia and Egypt;
Underweight countries are:

Strong points for Malaysia in our model include a #1 currency ranking and #4 business cycle ranking. Relative P/Book has fallen to 1.0x due to recent under performance. Malaysia also gains in our model ranking this month, moving from #8 to #6. Strong points for Malaysia in our model include a #1 currency ranking (a combination of fundamental upside and a stock market consisting mainly of domestic demand, Malaysia ringgit earning stocks).

Malaysia ringgit is making steady progress against the US dollar.We also rank Malaysia’s business cycle score in the top quartile of EM countries in the model. Exports seem set to
trend up strongly from here, and Malaysia is one of the EM countries most geared to a recovery in global trade and commodity prices.

Due to recent under performance, the P/BR relative of MSCI Malaysia to the EM benchmark (now 1.0x) has fallen significantly. Malaysia is one of the least technically overbought markets in the asset class, ranking #5 on this metric. Moreover, the median GEM fund is running a significant underweight of 132 bps versus the benchmark, substantially higher than the average for the last five years.

Malaysia Country Forecast By EIU

There are research units, even highly respected ones, that actually makes "big picture" business environment forecast on Malaysia and other emerging markets. I guess its to help foreign companies to better plan their long term investment plans. Some of the forecasts are quite "in your face" and matter of fact, not so sure if you ask me. My comments in colour.


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Malaysia: Business environment at a glance

FROM THE ECONOMIST INTELLIGENCE UNIT Policy towards private enterprise and competition 2010-11: The government gradually reverses the decades-old policy of discrimination in favour of bumiputera (ethnic Malays and other indigenous peoples). Protection of intellectual property rights continues to improve. (Yes, there have been some deliberate action towards that. For Najib to make the biggest impact prior to the next election, I think giving bumiputera status to all Malaysians born on and after 1957 would be the simplest and most effective reversal of said policy, without actually having to remove the policy, which might be politically insurmountable). 2012-14: Scope for the government to protect domestic industries and bumiputera groups dwindles as South-east Asian economic integration proceeds. (I totally agree and Malaysia better remove the subsidies and indirect duties that protect these domestic industries in order for them to better compete, or be decimated). Policy towards foreign investment 2010-11: Competition with China guides investment incentives; Malaysia emphasises its advantages in labour skills (such as English-language proficiency), natural resources and infrastructure. 2012-14: Malaysia expands incentives in order to establish itself as a regional services centre. Foreign trade and exchange controls 2010-11: The ringgit appreciates against the US dollar, but the exchange-rate regime of a managed float against a trade-weighted basket of currencies is maintained. 2012-14: Further bilateral trade agreements and progress towards regional economic integration prompt Bank Negara Malaysia (the central bank) to allow offshore trading of the ringgit. (Bank Negara is treading very cautiously on this, and they have their reasons. International convertability and free flow of the ringgit should be promoted, albeit gradually). Taxes 2010-11: The government continues to subsidise fuel and food. It also makes minor changes to personal tax rates, as part of a package of measures aimed at supporting domestic demand. 2012-14: Macroeconomic fundamentals improve, allowing the government to introduce a goods and services tax. Financing 2010-11: Keeping financial markets liquid remains a priority for the government. 2012-14: Competition for corporate finance intensifies as the economy recovers fully from the global economic downturn. Malaysia continues to play a leading role in the development of Islamic banking and finance. The labour market 2010-11: Despite government efforts to trim the size of the foreign workforce, illegal immigration remains a problem. 2012-14: A shortage of highly skilled labour impedes progress at the upper end of the value chain. Positive discrimination in favour of bumiputera continues to harm labour market efficiency. Infrastructure 2010-11: The government implements projects aimed at supporting activity in the construction sector. Public transport improves as a result of increased government investment. 2012-14: Major infrastructure projects are delayed, owing to a lack of private-sector involvement. Energy policy focuses on improving distribution rather than increasing generating capacity.

The Economist Intelligence Unit

p/s photos: Janine Zhang

Finally, A Sensible Cost Of Living Study - An Important Posting

(click on image to enlarge)

There have been many cost of living studies which somehow does not get it quite right. In many cases, it is skewed towards the expatriate lifestyle. The flamboyant CLSA has come up with a highly interesting piece on Asian living standards, with comparisons as well to US, UK and Australia. The basket of 27 items were well selected as reflective of a middle class lifestyle maintenance. It also looked into the currency effects, which will give a true purchasing power parity comparison.

The items selected:
1) Nokia 3600
2) Mobile phone monthly bill
3) Monthly broadband bill
4) Apple iPod
5) Acer laptop Aspire
6) Levis jeans
7) Louis Vuitton handbag
8) TV- 37" Sharp Aquos
9) Sony Playstation PSP
10) DVD (err...)
11)Movie ticket price
12) Coca-cola
13) Canned beer
14) Champagne
15) Marlboro Lights
16) Chicken
17) Rice
18) Eggs
19) English Newspaper
20) Economist magazine
21) KFC meal
22) Lowest price for new car
23) Toyota Camry 2.4
24) Petrol
25) Taxi flag down rate
26) Private doctor consultation
27) Private school fees per month

Taking the US living cost as the 1.00 benchmark, then one can assess the relative disparity. The table showed that India is at 0.59. Relatively speaking, one can buy the same items 41% cheaper in India and so on. Followed by Indonesia at 0.60, China at 0.69 and then Malaysia at 0.72... surprisingly on par with Taiwan at 0.72. It is more expensive in Thailand, coming in at 0.79. HK is there but at a surprisingly mild 0.93. It is more expensive/costly to be living in Australia, UK, Singapore and Japan, coming in at 1.14, 1.14, 1.15 and 1.57 respectively.

The fun part is here, dissecting the report and data. Interesting facts, if buying an iPod, best to go to the US, HK or Indonesia where is is less than $150. In the Philippines and Thailand, its double that. Same for the laptop, the Acer Aspire 10 inch screen cost$330 while its $400-500 in Asia, and a stupid $785 in the UK. The Sharp Aquos TV sells for $500 in the US, Malaysia, Singapore and Thailand but is double that in China, Japan, Korea and Taiwan. Its even more than double in Australia and the Philippines.

The usual 20 Marlboro Lights cost $1-$2 in most of Asia, but is $8 in Singapore and most other Western countries. Guess what, as governments try to alleviate the health care cost side, the $1-$2 will gravitate towards $5 within 5 years.

The figures on its own are meaningless in PPP UNLESS you divide it by the annual median income. One would not mind so much living in Singapore compared to Malaysia (the PPP being 1.14 vs 0.72 if one's pay reflects that disparity - e.g. if you earn $30,000 in Malaysia a year, you should be equally well of earning $47,500 in Singapore. (1.14 /0.72 x 30,000).

Basket Shortfall: The basket of items missed out on a few critical items. If you are going to reflect on PPP vs median income, a proper Cost of Living study must include rental/mortgage costing as that should easily be the #1 cost item in most households. Another is, owning a car is one thing, maintaining, running, parking, tolls are another - people in HK and Singapore can tell that those are major considerations. The other would be the tax considerations. It is not clear but one should take the net disposable median income for a more meaningful analysis.

A better measure: I am surprised CLSA did not do this. One should just take the cost of purchase for the basket of items and divide them by the annual median income for each country. That would yield a better value add measure. It is no point if you are living in India with the lowest cost factor at 0.59 if your income is way lower than everybody. So, I have taken the median annual income and divided by the cost of living for each country. The higher the figure the better as that is basically how many multiples of the annual expense of the basket of items:
1) US 4.9x
2) Australia 2.9x
3) Japan 2.5x
4) UK 2.2x
5) Korea 2.0x
6)Taiwan 1.5x
7) Singapore 1.47x
8) HK 1.3x
9) India 0.9x
10) Malaysia 0.8x
11) China 0.3x
12) Indonesia 0.2
13) Thailand 0.15x
14) Philippines 0.11

From the table above, despite being more expensive, one is still much better off living and working in Singapore, the UK, the US and Australia, and even Japan. Of course some caveats, the annual median income is skewed if your population is predominantly labour intensive or have a large proportion of rural folks. Hence if you are living and working in executive positions in countries such as Indonesia, Malaysia, India or China, your income should be a lot higher than your country's median income, thus making them quite liveable and actually higher in the rankings.

The Malaysia Problem: The PPP can act as a basic argument on overvaluation and under valuation of the local currencies vis-a-vis the USD. For instance, the Sing dollar is technically 14% overvalued while the ringgit and renminbi are 28% undervalued. But of course there are other more pertinent factors as to why some currencies will stay undervalued substantially vs the USD for the longest time: one is reliance on cheap currency for export competitiveness; two, cheap currency to make it an attractive destination for foreign direct long term investment; three, a high subsidy mentality towards essential goods and services; four, how "open" is the central bank in allowing the free flow of the currency in circulation; five, global acceptance and unencumbered circulation of currency; six, political risk ... etc.

It can be said that countries such as Taiwan, China, Malaysia are all registering strong surpluses and have a more than adequate foreign reserves. Why then are the governments there not allowing their currencies to appreciate - my thesis is that these currencies are NOT ALLOWED to appreciate by their own governments and central banks, rather than the global markets stopping these currencies from rising - they are more concerned with making sure their industries stay competitive, preserve jobs. Singapore can allow their currency to appreciate because they are not tied to exports, they have made services as their major economy cornerstone and thus brought in expertise and high value added industries to their economy. You need to continually move up the industry value chain. Granted, Singapore is also a financial center, something Malaysia cannot easily aspire to become, but we must be aware of these gaps and at least narrow the gaps. You cannot and should not use the cheap currency as the driving force of your economy as that will put things on the backfoot and forever end up with industries that are either sunsetting, labour intensive or low value add. That will forever lock us in low pay, low value add, low income environment.

The problem will be cyclical as well when your currency is cheap and your industries are low value add and labour intensive as that will bring forth the need to maintain relatively low wages but also a lot of subsidy on essential goods in order to maintain the equilibrium. Why do you think Malaysia has over 2m legal foreign workers and probably another 2m illegal ones - its to keep the wages low. It may not be a deliberate policy but one that is brought on by our low cost environment. In the end, our subsidy on essential goods and services will come to a highly significant amount that we no longer can tolerate.

Have a masterplan to dismantle the subsidy, have a schedule. Eventually that will mean that only companies and industries that are globally competitive (without subsidies) can survive, with the exception of a few critical sectors. For example, why are petrol, gas and electricity the same for companies and the public? Why are we subsidising the companies as well? If there are certain industries that cannot compete once we remove the indirect subsidies, then we will be better off. We do not need steel plants or cement plants if we can buy them cheaper elsewhere.

We can still play this game as we are a resource rich country, but we all know that those resources are being depleted rapidly. Petronas provides a huge chunk of our country's spending budget. Imagine if Petronas can only give half of what they have been giving for the past few years - we cannot even pay for the civil service.

Why FBM KLCI Can Touch 1,260 In This Rally

Foreign funds have largely neglected Malaysia for the past 6 months, even though equity markets in general have performed well. Asian equities have outperformed mature markets in 2009 thanks to foreign institutional investment inflows, hopes of economic revival in H2 2009, and fiscal stimulus and liquidity measures that are finding their way into equities. These factors might be making some Asian markets expensive.

Markets have gained 48% YTD as of July 27 (82% since October 2008) with China (50%), India (65%) and Indonesia (62%) as the best performers, and Vietnam (22%) and Malaysia (35%) as the worst. Hence, looking at the broader picture, Malaysian equities have been a huge laggard and under performer. The first chart basically shows how much funds from foreign investors have dried up for Malaysian equities.

That has been reflected in the level of foreign ownership of listed Malaysian shares. Despite the consensus that the global economy may well be on its way to recovery, foreign funds ownership levels has not gotten anywhere back to the pre-crisis level of say April 2008 (25.7%).

I have managed to come across a great chart by the highly respected Bank Credit Analyst, which basically explains which markets would "see the most action" in this current rally. Anyone could plot a valuation chart based on the country's prevailing interest rates and match that with the country stocks' forward or trailing PER. That would be quite one dimensional. The BCA's chart is a lot more persuasive in that it is based on forward and de-trended (I don't even want to attempt to know what that word meant, but it sounded so sophisticated) trailing PERs, price to book ratio, and dividend yields shown relative to the average of 18 countries".

Hence it is a peer-to-peer analysis. There is one major shortcoming in that tabulation, in that it does not take into account the historical average valuation of each specific market say over the past 5 years. The BCA chart only looks at how each country is faring in valuation terms relative to one another. For example, if Malaysia's historical PER forward valuation was 18x, and HK's historical PER forward valuation figure is 15x - naturally if we just look at PER, HK will always look cheap relative to Malaysia. However if the current forward PER for Malaysia and HK are 14x and 13x respectively - HK would still be cheaper on a straight out valuation but in actual fact, we should look at its PER now compared to the historical valuation for a more nuanced and value-add commentary, whereby Malaysia's market would be the 'cheaper' one.

Malaysia - You wouldn't get many houses recommending Malaysia, but the BCA thesis puts Malaysia as highly attractive. Bank Negara's recent decision to leave rates unchanged makes things hotter still till the next BN meeting.

What has been happening over the past week or so - I am beginning to see a trickling of fund flowing back into Malaysia. The first two charts basically imply that we are at a low and foreign holdings and funds inflow can only turn positive from here on. The lack of foreign funds inflow for the past 6 months can be largely attributed to the uncertain political environment - the situation is much better now despite rumblings here and there.

When we least expect it, we are likely to see 1,260 being hit at least in this run alone on momentum - just look at the top volume stocks and top gainers today.

Dissecting The Economics Of Malaysia

The size of Malaysia’s export sector is huge at more than 100% of GDP. Hence its importance in driving domestic demand should not be exaggerated. The manufacturing industry is under severe assault due to the collapse in exports. Consequently, manufacturing employment has plunged by 10% from year ago and wages are also falling. In contrast, private consumption fell only 0.7% year over-year in the first quarter, and imports of consumer goods have been relatively resilient.

One reason could be that, even though exports are a significant part of the economy, manufacturing employment is relatively small – about 18% of total employment. By contrast, service sector accounts for close to 60% of total employment. Meanwhile, agriculture and plantation make up 9% of employment, and the construction sector 13%.

Resources/plantation exports such as palm oil, petroleum, natural gas and minerals account for about 30% of total Malaysian exports and the share is rising. China, being the past decade’s fastest growing economy with an seemingly insatiable appetite for resources, has naturally increased in bilateral trade with Malaysia. Trade between the two countries has increased four-fold since 2002.

Malaysia’s exposure to manufactured-goods exports to the G7 is still large, commodities and China are playing a more prominent role in terms of overall exports. The better outlook of these segments – compared with that of manufactured goods exports – will help pull the economy out of the slump.

Malaysia’s banking system is healthy and in a position to support a recovery in household spending. Remarkably, the lending rate of Malaysian banks has fallen to new lows in response to the central bank’s rate cuts and the authorities’ efforts to facilitate borrowers’ access to credit. There are already signs of stabilization in indicators of domestic demand. Housing approvals and loan disbursements for car purchases are bottoming.

Resources-related industries contribute over 50% of government revenues. Since late 2008, both palm oil and crude oil prices have rebounded strongly. Unless they collapse anew, exports of crude oil and palm oil, which accounts for 15% of total Malaysian exports, will boost both domestic income and government coffers and help plug the fiscal deficit.

The odds of recovery in domestic demand are notable, despite continued contraction in the export sector. The 1997-1998 Asian financial crisis was a watershed event for Malaysia’s banking industry. Although some post-crisis policy measures adopted by the Malaysian authorities – mostly notably capital controls – have long been a source of controversy and outright criticism, banking industry consolidation and much stricter supervision from the central bank have fortified the position of banks and largely insulated them from the current global
credit crisis.

Industry consolidation and continued enhancement in risk management have borne fruit in the form of enhanced returns on capital. Currently, the Malaysian banking sector is well capitalized, with a risk-weighted capital ratio of 14.2% as of March 2009. The private credit-to-GDP ratio has fallen since the Asian crisis, implying there has been no froth in bank lending over the past several years. Within the structure of banks’ loan portfolios, household loans account for 54% of all loans, while lending to the manufacturing sector is only 11%.

Malaysian banks are awash with liquidity as the country runs a large current account surplus (17.5% of GDP in 2008). The loan-to-deposit ratio in the banking system is 74%. Bank credit accounts for about 90% of gross financing to the private sector.

Still, Malaysia’s banking system is not without problems. Bankruptcies are rising sharply, access to credit has deteriorated markedly since the onset of the global credit crisis and banks remain somewhat wary of extending credit. The problems in Malaysia’s banking sector pale when compared with the difficulties in many other countries around the world. A relatively healthy banking system puts Malaysia in a better position to cope with economic challenges stemming from the synchronized global growth slump.

The government’s recent move to scrap the long-standing Bumiputera ownership requirement for 27 service sectors and to increase foreign ownership of its commercial banks (from 49% to 70%) could help unlock growth potential by encouraging investment and boosting productivity within domestically-oriented segments. This, along with other reforms within the public sector aimed at reducing red tape, corruption, government intervention and overall inefficiency, could unleash positive forces that will produce stronger growth in domestic segments of the economy.

Malaysia small caps offer a better outlook profile than many other emerging markets. They will benefit most from potential political and economic reforms. Besides, small-cap valuations are decent on both an absolute basis and relative to the emerging market small-cap universe. The currency’s outlook is bullish versus the U.S. dollar. The country has huge external surpluses and the ringgit will benefit from the U.S. dollar’s decline. Relative to other Asian currencies, the rating the outlook for the ringgit as neutral as the central bank is unlikely to allow for much appreciation due to export sector concerns. As for currency valuation, the currency is cheap versus the greenback but is fairly valued versus the Singapore dollar.


p/s photos: Hanako Takigawa