A year of economic and financial turbulence

31-12-2008: 2008 — A year of economic and financial turbulence
by Chong Jin Hun

2008 will be etched in many national and corporate annals as a period of turbulence. A toxic combination of subprime loans, financial-liquidity crisis, and soaring inflation jolted world economies, hurt corporate earnings, rocked global stock markets, and shattered consumer sentiments.

News on policymakers initiating interest rate cuts, and stimulus packages to spur consumer demand, multinational firms trimming their workforce, and stock markets plunging to fresh lows grabbed media headlines as the global community wrestled with a tougher economic and business landscape.

Major economies including the US and Japan, besides eurozone countries fell into recession, while Iceland declared national bankruptcy. Rapidly expanding China and India, meanwhile, are bracing for a slowdown amid falling exports as consumer demand wanes.

Corporate pages were splashed with heart-wrenching stories of failures in once high-flying firms. US-based Lehman Brothers Holdings Inc and Merrill Lynch & Co Inc succumbed to a financial mess triggered by the subprime-mortgage crisis. Lehman filed for bankruptcy, the largest in corporate history, while Merrill Lynch was taken over by Bank of America Inc in a US$50 billion (RM175 billion) deal.

Malaysia has not been spared. It has seen its exports shrink while domestic demand is expected to slow as the people tighten their purse strings in line with a weaker economic outlook.

Wealth destruction on global equity markets has been unprecedented. Pertinent questions commonly asked include when will the markets botttom out, and when will a global economic recovery happen?

Worst is yet to come
Equity analysts and economists concur that the worst is yet to come before a global economic recovery could be expected to begin in the second half of next year.

RHB Research Institute Sdn Bhd head of research Lim Chee Sing said Malaysia might experience its worst economic downturn as early as the first quarter of 2009, before its fortunes gradually improve in the later part of the year.

“While this will imply earnings risk, the issue is whether the market has priced in the gloomier outlook for the economy as well as corporate earnings. It is likely to be a market of two halves, with greater volatility in the first half and recovery in the second.

“This year (2008) has not been good as the (Malaysian equity) market has fallen almost 40% but it has outperformed most of its regional peers. The worst-performing sectors are plantation, property and construction,” Lim told The Edge Financial Daily.

According to RHB’s “2009 Market Outlook & Strategy” report, the local stock market has fallen less than other bourses in the region, possibly because many foreign investors had already fled the market after the unprecedented results of the March 8 general election which raised the country’s political-risk profile. Existing foreign-equity ownership in the country is estimated to have fallen to below 20%.

Historical trends indicate that stock markets are usually six months ahead of economic updates. How much has been reflected in stock markets amid the current economic crisis hinge on the severity and duration of the global slowdown.

ECM Libra Investment Bank Bhd economist Dr Lai Mun Chow sheds some light on the global economic landscape.

In an emailed reply, Lai said a soft recovery in the US could be expected during the second half of 2009, hence the anticipation of a global recovery towards the end of the year.

The predictions are based on several factors. First, around US$1 trillion of the US-originated mortgage-related toxic assets in the global banking system have been written off.

Based on estimates by the International Monetary Fund, about US$1.4 trillion needs to be written off, hence the global banking system is expected to have a clean slate by the middle of next year.

Second, the fact that past recessions in the US lasted between 10 and 16 months, could lend credence to expectations that the current recession in the world’s largest economy will taper off latest by the fourth quarter of next year.

Third, improvement in existing-home sales in the US, of late, could indicate that prices of such homes will stabilise within the next two quarters. Existing-home sales constitute some 90% of home transactions there.

Fourth, the effects of fiscal and monetary initiatives besides quantitative-easing measures undertaken by US policymakers are expected to take about six months to filter down into the nation’s economic landscape. And fifth, credit markets in the country are expected to normalise within the next two quarters.

“Going by the issuance of commercial papers, mortgage loan fixed rates and money market rates over the past few weeks, there are signs that the frozen credit market in the US has slowly thawed,” said ECM’s Lai.

“All in all, we expect the global economy to get worse before it gets better towards the end of 2009. As the US economy makes a mild recovery in the second half of 2009, we should see the Malaysian economy gather pace, especially in the final quarter of next year.”

Time to bottom-fish for battered stocks?
Many Malaysian stocks are trading at post Asian-financial crisis lows. RHB said now could be the right time for investors to accumulate liquid fundamental stocks whose prices had substantially depreciated.

Anticipation of a global economic recovery in the second half of next year lends support to expectations that Malaysian cororate earnings will rebound in 2010, hence, a potential earnings upgrade during the year.

“It is generally difficult to gauge where the bottom lies as the market will likely bottom out when the economy is still gloomy. Increasingly, we see a case for investors to gradually switch out of the defensive stocks into liquid fundamental stocks that had suffered from significant price depreciation.

“This is because defensive stocks tend to be the last to be sold out when investors begin to position their portfolios for recovery, which is a question of timing, in our view,” according to the research firm which expects the KLCI to rebound to between the 1,000 and 1,100-point level towards the end of 2009.

UBS Investment Research analyst Colbert Nocom said fiscal and mone-tary pump-priming, and normalisation of corporate earnings would be key themes for the Malaysian equity landscape in 2009.

This is in anticipation that the government would pursue expansionary policies to prevent the country from sinking into a recession, a move which is expected to augur well for banking and construction stocks.

“We also think that by the second half of 2009, investors will begin to look forward to 2010, and identify companies poised for a sharp earnings rebound,” said Nocom, who expects the KLCI to hit the 1,000-point level by end 2009.