Nixon Wong, chief investment officer at Tradeview Capital.
PETALING JAYA: While narrowing yield differentials following a rate cut by the US Federal Reserve (Fed) will help make local assets more appealing and attract foreign portfolio funds, investor focus will likely shift to how the global and domestic economic conditions evolve post cut.
This is more so if major economies start to underperform in the coming months. The red flags are already there.
Major trade and investment partners like Germany are heading for a recession while China’s economy remains in malaise and weakening growth prospects of the United States economy is partly why the Fed is starting its cutting cycle.
The Bank of Indonesia was quick to reinforce its growth driver with a first cut in three years to its policy rate by 25 basis points yesterday, hours ahead of the Fed decision.
Hence analysts said, in the short term, some foreign funds and traders on Bursa Malaysia may be taking opportunistic positions, particularly in larger cap stocks like banks, which serve as a safer bet during periods of heightened global risk.
In the backdrop, the expectation of a US rate cut has led to a strengthening of the ringgit and narrowing of the yield differential between Malaysian and US interest rates, which acts as a tailwind to the fund inflows.
“As the yield differential narrows, the ringgit may continue to strengthen, making it more attractive to foreign investors to seek higher returns in emerging markets like Malaysia,” said Nixon Wong, chief investment officer at Tradeview Capital.
On a broader, longer term basis, he said the inflows could be sustained due to Malaysia’s strong economic growth outlook and the continuous implementation of growth oriented policies.
“Initiatives aimed at increasing foreign direct investments and domestic direct investments are likely to support long-term economic growth.
“This, in turn, makes Malaysia an attractive destination for investors looking for more sustained returns beyond short term geopolitical risks,” said Wong.
Uncertainty around the United States elections and ongoing geopolitical tensions between the United States and China is also prompting investors to seek refuge in stable, lower-beta markets like Malaysia, he said.
Price action suggests the rate cut by the Fed appears to have been priced in by investors, with the benchmark FBM KLCI closing 3.7 points lower at 1,660 yesterday ahead of the Federal Open Market Committee decision.
Foreign funds have net bought some RM3.2bil worth of stock in the four trading weeks, much of the money flowing into local bank stocks as the data centre and semiconductor thematic plays appear to have punctured.
The foreign fund inflows have offset outflows from local institutions on profit-taking moves following the strong rally in the first half of 2024.
Wong said the small-to-mid cap stocks, which were the focus of thematic trades earlier in the year, are typically favoured during risk on environments.
Despite these companies having solid fundamentals and healthy order books, many local investors and retailers have opted to take profits following the early year rally.
“This profit taking has led to a lull in buying interest. Instead of a rally exhaustion, local investors are merely waiting on fresh catalysts, such as Budget 2025, to reignite enthusiasm,” he predicted.
Some believe the introduction of the Employees Provident Fund (EPF) Account 3 may have prompted the EPF to liquidate some of its positions.
Retail investors also appear less enthusiastic about the local market, consistently selling their stakes nearly every month in 2024, indicating they have yet to regain confidence after a decade of seeing the market trend lower.
The upcoming Budget 2025 on Oct 18 could be a critical test for the momentum of Malaysian equities, said analyst Kevin Khaw of iFAST Capital.
He said the inflows so far have been driven by the thematic play and risk-on sentiment from foreign investors, but thematic play including infrastructure revival and economic transformation are yet to fully materialise.
“We anticipate the budget might not be exciting for the equity market as the government is unlikely to announce any new mega-scale projects due to current budgetary constraints.
“Furthermore, potential subsidy reductions or the introduction of new taxes, such as a sugar tax or the reintroduction of goods and services tax could weigh on market sentiment,” he told StarBiz.
From a trading perspective, Khaw said the current inflows of both local and foreign funds are a sign of confidence and he anticipates a more cautious investment strategy, where long-term stability will take precedence over short-term gains.
“Investors are likely to scrutinise key indicators such as global developments, fiscal deficits, debt levels and government spending efficiency to gauge the impact of measures on economic growth.
“Any potential risks or uncertainties in policy implementation will become focal points, as they could significantly influence market sentiment and drive investment decisions in the months ahead,” he warned.
The repatriation of ringgit positions by government linked companies and government linked investment companies will provide a floor for the ringgit around current levels (RM4.25), while the final catalyst for a further boost in the ringgit has yet to materialise.
“Domestic transformation efforts are still in the early stages and more clarity is needed before they can have a more significant impact. We think the ringgit could hold at 4.4 by end-2024 while the equity market has entered a phase where investors are focusing on the execution part instead of a story-driven rally like what we used to experience in the early of year,” Khaw said.
Meanwhile, the valuation of local banks remains attractive and could support the local benchmark further according to Fortress Capital.
The fund said that the concerns about potential loan impairments from the Covid-19 aftermath, which had previously weighed on valuations, have also largely subsided.
Furthermore, foreign shareholdings in Malaysian banks were at a 10-year low, creating additional upside potential as foreign investors returned to this sector. These factors have collectively contributed to the recent rally in bank shares.
At the same time, bank stocks were still trading below pre-Covid 19 valuations, close to a minus one standard deviation from their mean forward price-to-earnings ratios.
This discount is increasingly seen as unjustified, particularly as earnings growth is projected to average 40% to 50% higher over the next two years, compared to the pre-pandemic average of 4%, the fund added.
