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Malaysia in deep #### (according to iCapital)
Posted on 16 May 2016
The most interesting article I read this weekend was a story by iCapital about the Malaysian economy.

The article starts by talking about the Sarawak election which was a victory for the ruling Barisan Nasional party which was attributed by iCapital to the leadership of Adenan Satem.

According to them, Adenan is a statesman who thinks and acts for the state, and not just for any one race. He is able to make long term decisions which benefit the community and not just take populist measures to win the next election.

iCapital is concerned because they say the last populist leader who was elected by a landslide, Abdullah Badawi, was kicked out by UMNO. iCapital says Badawi should have been less brave, more subtle or more cunning.

The article then changes tack and talks about the economy.

Its conclusion is that the economy is heading for a recession in 2017. It uses a series of charts to prove its point.

The first chart shows Bursa’s valuation. With a PER of 17.77, it is not cheap.

ChartA

As mentioned in  a previous article, the KLCI index consists of only 30 stocks. Local funds such as EPF and Khazanah hold large and significant positions in these companies. EPF has previously stated that as the nation’s pension fund, it has an additional RM16 billion to invest every year with some 60% being invested in equities.

Khazanah also has substantial funds to invest and one metric it uses to gauge its own performance is the enhancement of the value of its portfolio during the year.

Tabung Haji, another large local fund, also has to ensure that its portfolio increases in value every year if it wishes to pay dividends in the long run.

Therefore, the management of these funds will be incentivised to ensure that the value of their investee companies rises steadily every year.

However, this also means that other investors, such as local retail investors or foreign institutional investors, may find valuations a bit rich for their tastes.

Figure 1 shows private consumption, the growth of which has slowed sharply since the end of 2015 and is now at about 5.3%. Previously, it was at about 7-8% with a peak of 14% in 2007. The slowdown in private consumption is often attributed to reduced purchasing power due to price increases (weak ringgit, GST), low wage growth and economic slowdown.

ChartB

Excluding necessities such as foodstuffs, Malaysian consumers spend a large proportion of their income on three items – property, cars and education.

Sales of properties have been slowing drastically. You can read about that here.

The second item that Malaysians spend a lot on is cars. Although we have some of the highest car duties in the world, and some of the highest depreciation rates in the world, Malaysians have been buying cars like there is no tomorrow because most Malaysians live in the urban centers and because public transport is bad, a car has been considered a necessity.

On the other hand, highways are actually pretty good and with petrol having been subsidised in the past, many Malaysians found it worthwhile to live in the suburbs and commute to work.

Car sales have been booming for the last few years with some 600,000 units being sold annually. Car ownership is already the 3rd highest in the world at 93% and 54% of households have more than one car. Can Malaysians continue to buy cars at the previous rate? The answer is no. You can read more about car sales here.

In previous years, car sales have been fuelled by easy financing which have been up to 9 years in duration. I wouldn’t say the loans are cheap, because the effective interest rate is 4-5% but it wasn’t difficult to get a loan approved at a high valuation (especially for reconditioned cars) with a high margin of finance from 90-110%. Yes, 110% because some second hand cars were actually overvalued so the loan sum could be more than the purchase value.

In 2016, car sales have been plummeting. Two main reasons. Second hand values are terrible because there are too many used cars for sale and not enough buyers and secondly because banks are more careful with loans. The margin of finance has been reduced, the banks are scrutinising used values more and loan tenors have also been shortened.

The result is that car sales have plunged by 30% in 2016. This might be a downward spiral. As used car values plummet, banks might become ever more cautious leading to further downgrades in used car prices.

ChartC

Car companies continue to import cars and so they have to discount heavily to move inventory. Consumers, having become accustomed to discounts, will not buy unless they get a great deal. And, if you are trying to sell one of your cars, the only certainty is you will be disappointed with the price you are offered – whether at trade-in or by a private buyer.

The picture is no better with house prices which are out of reach of the average buyer at current levels. Below is a chart showing the affordability of house prices in KL, PJ, JB and Penang. The actual house price is some 2X the affordable rate.

ChartD

It is likely house prices have to adjust lower if demand is to be stimulated but this is unlikely due to cost pressures – construction materials are much more expensive now.

The Malaysian consumer is being stretched thin. I read last week that cash advances on credit cards are having their highest growth rates of the last few years at 21% year on year.

Certainly, the Debt to GDP level is very high at 89.1%.

ChartE

The inevitable is already happening.

The market is slow, especially for properties over RM400,000. Sellers are having to give discounts to sell. Malaysians are very house proud. After buying a property, they will usually renovate the property immediately. They will also spend on flatscreen TVs, aircons, curtains, fitted kitchens and so on. One need only visit exhibitions such as Homedec and Perfect Livin to see the huge number of companies depending on this industry. So, the slowdown of the property market will have a huge effect on the economy.

With autos and property being weak, it is little wonder that the Leading Index is also not looking good and its growth has turned negative.

ChartF

For information about how the Leading Index is constructed, you can refer here.

Narrow money supply, M1, has also had a sharp slowdown in growth. In the past, such a sharp slowdown in M1 has normally been followed by sharp falls in the KLCI.

ChartG

As a result, iCapital concludes that it is likely that the Malaysian economy will be in recession within the next 12 months and that the KLCI is heading for sharp falls.

Chart8

Based on the evidence presented, it is hard to argue with iCapital’s conclusion. The Malaysian economy will slow down but nobody knows if it will fall into technical recession. Various factors might come into play such as the price of oil and the strength of the ringgit.

As to whether the KLCI will have a sharp fall – again the situation might be bad but with the KLCI only comprised of 30 stocks and these stocks having long term investors such as EPF and Khazanah, even if it drops, it is unlikely to crash, and if it does crash, it will not be at rock bottom levels for long before the funds step in.

iCapital predicts in the immediate term, the KLCI will be at 1,500 to 1,700 level. Short term, iCapital predicts 1,350 to 1700 points. Medium term, iCapital predicts 800 to 900 points. iCapital still expects the KLCI to drop to below 1,000 points for its long term outlook.

Certainly, technical indicators such as moving averages, MACD, etc are all giving bearish signals for the KLCI but there should be some support at 1350 and then at 1200.

For the KLCI to drop below 1,000, there would have to be some sort of crisis, which just doesn’t seem to be apparent at present

 

Article by King from Investlah (Reposted here)