Malaysia: Truly A Bear Market
The Trend Is Your Friend for the Malaysia’s stock market and currency. Sell the iShares MSCI Malaysia ETF on worsening economic fundamentals, worsening technicals and worsening sentiment. The looming unwind of the global carry trade and a relatively pricey valuation for EWM means a further 20% drop in price by year end is highly likely. Malaysia is in big trouble. Its currency and stock markets are in bear markets with no sign things getting better any time soon. First of all, the country has weak economic fundamentals. Analysis by the Malaysian Institute of Economic Research, dated 4h August 2015, shows that the important indicators of consumer confidence, retail trade, employment and residential property are all pointing to weaker economic growth conditions. Then there is the country’s deteriorating terms of trade situation. In 2014 commodity exports accounted for 26% of exports and 18% of GDP. With palm oil, crude and refined products and natural gas, Malaysia’s key export commodities all heading lower, this is putting pressure on Malaysia’s fiscal situation. But don’t lower commodity prices hit many emerging markets? Yes, but in actual fact Malaysia is the only country within the Association of South East Asian Nations region that does not benefit from lower oil prices. This means that Bank Negara the country’s central banks will likely need to ease, weakening the ringgit further. This would be a bad development for the iShares MSCI Malaysia ETF (NYSEARCA: EWM ). The ringgit which is at ten year lows and broke though the key technical level of 3.7 ringgits to the dollar is in a strong bear market and monetary policy divergence is set to make the currency weaker. (click to enlarge) Although a weaker currency could help exports in theory, Malaysia has little room for credit expansion to spur domestic consumption and investment. According to the IMF Malaysia’s debt to GDP stands at 165% – one of the highest of all emerging market countries. This means the ” monetary transmission mechanism ” by which lower policy rates should help economic conditions may not be very effective. With EWM dropping from its 52 week high $16.32 to below $12, hasn’t the market already priced in a lot of these negative factors in already? I don’t think so – with a trailing P/E ratio of 16 times, the market is not cheap. Additionally, Malaysian stocks are highly susceptible to a de-rating once the Fed raises interest rates and fast money investors with their global carry trades accelerate their unwinding of risky asset holdings. That’s because as funding costs creep up for carry trades, the risk return of carry trades in Emerging Markets looks increasingly less favorable, and with fast money investors all conscious of the positioning of other like-minded investors it’s likely that they will be inching nearer to the exit door in order to get out first. This situation and a potential rush to sell could lead to a self-fulfilling prophecy in so many of the higher risk and especially commodity linked markets like Malaysia. For EWM the $12 mark was also a key technical level, as it has been both a support and resistance level several times since 2007 – see chart below. The next key technical level appears to be $10. (click to enlarge) Furthermore, global investors have no doubt been troubled by the ongoing scandal in Malaysian politics concerning the Prime Minister Najib Razak’s personal finances. At a time when Japan is steadily improving its corporate governance, other Asian countries need to do everything to keep up on this front because unlike Japan, countries like Malaysia are unable to implement quantitative easing without spurring massive inflation. The key risk to my thesis is if oil prices were to rally hard or if the policy divergence between the Fed tightening and Bank Negara’s likely easing were to turn around. These two scenarios would alleviate the economic fundamentals somewhat and support a market valuation of 16 times earnings in my view. However, I view this outcome as very low probability. The bottom line is Malaysia is a falling knife. There is no catalyst on the horizon which suggests attempting to pick a bottom could be successful. Investors with the ability to short, should short EWM. Long only investors who want exposure to Asia can find better alternatives. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in EWM over the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.