The Relevance of Ratings Agencies

Do people still look at rating agencies "wonderful recommendations"? To put yesterday's market into perspective, the KLCI lost about 1% while Nikkei lost 1.4% ... did Japan go through a downgrade too? Rating agencies nowadays only affirm what the market already knows. But just to be fair to them, we will fall a bit in sympathy.

Truth be told, foreign funds held a lot of Malaysian bonds and last month they were already exiting based on the turmoil in funds being pulled back. The ringgit did not fall just over night, it was weakening for the past few weeks.

The Malaysian ringgit closed slightly higher at RM3.2455 against the US dollar and RM2.5529 against the Singapore dollar today. The local currency slipped to historic three-year lows of RM3.2934 against the greenback and 15-year-low of RM2.5862 against the Singapore dollar yesterday on fears of capital outflows from bond transactions.

The ringgit has dropped 2.7 percent since June 30 to RM3.2463 per dollar, a loss second only to India’s rupee among 23 other emerging-market currencies. The decline pushed the ringgit beyond the limits of the Bollinger band, signaling a reversal may be imminent, data compiled by news agency, Bloomberg said today, adding that was the biggest deviation in developing markets. Stochastic oscillators also showed the ringgit is oversold.

The ringgit’s 5.2 percent loss this year would be its worst annual performance since a 35 percent plunge in 1997, during the Asian financial crisis. It closed at RM3.2379 to the US dollar yesterday in Kuala Lumpur, the weakest level since July 2010.

Yet we are not denying that there is a problem with our deficit. There is. We need to implement the GST but that seemed to be delayed pending the outcome of another mini election end of the year.

Bloomberg reported today that Morgan Stanley has predicted that Malaysia’s economic growth and current account surplus which is more than twice China’s relative to gross domestic product, will help the ringgit catch up with regional peers.

The central bank can use its US$138 billion war chest to prop up the ringgit, according to Bank of America Merrill Lynch. The GDP is forecast to grow 5 percent this year, after a 5.6 percent gain in 2012, the median estimate in a Bloomberg survey of 21 analysts shows.

The ringgit could underperform as US$2.9 billion of sovereign notes mature today, raising the prospect of capital outflows. The currency slid this month on concern global investors, who owned 33 percent of Malaysian government bonds in May, the highest proportion in Southeast Asia, will pull funds out as the U.S. outlines plans to rein in monetary stimulus. 

Malaysia’s debt-to-GDP ratio of 53.5 percent is higher than the 25 percent in Indonesia, 51 percent in the Phillippines and 43 percent in Thailand. It is also approaching the government’s 55 percent threshold.

While Malaysia’s current-account surplus will narrow to 6 percent of GDP this year, from 6.1 percent in 2012 and 12 percent in 2011, it is higher than the average 2.8 percent in Asian countries and 2.4 percent for China.

Malaysia’s “fundamentals of a current-account surplus and sustained growth should warrant a correction in the recent weakness in the ringgit,” according to a July 25 report from Morgan Stanley analysts. Bank of America strategists including Christy Tan recommended their clients use options to buy the ringgit, saying the central bank will sell foreign reserves to shore up the currency should the decline worsen.

Will this derail the active local equity market? My view is no. The current run is not that dependent on the influx of foreign funds. There has been a willingness for local investors to parlay liquidity to stocks as they take money off the property side. 

The Fears Of The End Of Quant Easing

Markets everywhere have been shaken over the last two weeks. First was the correction in the Japanese equity markets. It has lost substantial ground over just the last couple of weeks. Next came the Bernanke's testimony which led all to conclude that QE would be ending soon. 

If an article in Monday's Wall Street Journal is anything to go by, the U.S. Federal Reserve is getting ready to unwind its massive monetary stimulus program. So, is that prospect as alarming for financial markets as feared?

Fed officials have mapped out a strategy to wind down its $85 billion-a-month bond-buying program in careful steps, although the timing of when that will start is still being debated, noted Fed watcher Jon Hilsenrath wrote in the WSJ. 

Any unwinding of the Fed's quantitative easing (QE) program, which has fueled a rally in equity markets and other risk assets, is generally viewed as negative and any indication of this happening has been highly anticipated in the U.S. since late last week. 

"Having spent two New York sessions pricing in a sharp change in Fed stance, it is not obvious that the article was worth the wait," analysts at Westpac said in a note. "The timing of the unwinding of QE remains data-dependent, not a serious prospect until perhaps late U.S. summer at the earliest."

Analysts say that in essence, the Fed appears to be managing market expectations that its quantitative easing program will not last forever. The Fed has said that it would maintain its key interest rate between zero and 0.25 percent until the unemployment rate fell to 6.5 percent. It has also committed to monthly purchases of bonds until labor market conditions improve substantially. 

And it is the recent signs of improvement in the jobs market that has renewed talk about a possible end to the quantitative easing. The latest non-farm payrolls report showed the U.S. economy created 165,000 new jobs last month, much more than expected, helping push the unemployment rate down to 7.5 percent. Data last week meanwhile showed jobless claims at their lowest level in almost 5-1/2 years. 

It looks like the markets are just grabbing at excuses to do a bit of sell down after a spectacular run in most equity markets since the beginning of the years. The timing is still a bit uncertain, but seriously folks, the end game only looks to peter out by December this year. It is very good that markets are readying itself for the end of QE.

The Fed officials are not going to raise interest rates until unemployment comes down to 6.5 percent, and could only come earliest by 1st quarter of next year. What is likely to happen is when unemployment dips below 7%, we may see a scaling back from the $85 billion buyback figure to maybe halve that. 

The knee jerkers would be better off looking at the positives:
- That [an easing of QE] would be good for U.S. stocks because it would mean the U.S. economy is doing a lot better.
- That at least markets are already trying to price in the end of QE, instead of a surprising one off massive sell down.

The last part is very important as we can easily reference to the 1994 massive sell down, just because Alan Greenspan never gave any indication as to the imminent rise of interest rates in the US. That experience probably forms the backdrop for Bernanke's communication strategy. He is managing expectations very well. By putting it out there with the 6.5% unemployment target, it allows all to see the looming horizon.

I still think halving the buyback when unemployment dips below 7% would be an excellent strategy to manage expectations further. Everyone knows QE cannot be there forever.

I like the equity markets now more than in the beginning of the year. Japan has corrected substantially even though Abenomics will still be in the works. This will drive Japan to retests its high this year soon enough. I believe the sell down was a good profit taking exercise and actually allowing a lot of stale bulls (i.e. those holding onto Japanese shares for over 20 years) to exit - all that will come back to the market place for sure.

The local Malaysian equity market has held up better than the rest, and confidence breeds confidence. Having said that, Malaysia is only up 4.6% so far this, thanks to the uncertainty over the elections period. Other Asian markets have risen a lot more, and hence had more room for downside: Indonesia 15.2%, the Philippines 16.4% and Thailand 10.6%.