KUALA LUMPUR/JAKARTA: September marked a turning point for Southeast Asia’s foreign exchange and stock markets, ending a six-month run of capital inflows as the dollar’s broad rally drew investors’ attention to the currency risk and exalted valuations in these markets.
Even though the cumulative net foreign investment was positive in the four countries that publish such data — Indonesia, Thailand, the Philippines and Malaysia — there was a marked drop in the inflows into the equity markets, with Indonesia and Malaysia even seeing sizeable outflows.
Bond markets have been steadier, although foreign investment flows into the region’s debt markets slowed last month, causing currencies such as Malaysia’s ringgit and the Philippine peso to reverse their rallies against the dollar in the first eight months of the year.
Fund managers and analysts now see September as the start of a fresh downtrend in emerging Asian markets, rather than a brief interruption to the rally. That was certainly borne out on Thursday, the first day of trading in October, as markets tumbled after weak global manufacturing surveys.
“We are now seeing the first signs of foreign investor capitulation,” Credit Suisse analysts said in a note.
Credit Suisse analysts Ashish Agrawal and Martin Yu suspect the resilience seen so far in bond markets will also change as currency weakness prompts foreigners to reassess their exposures to Asian bonds.
The bearish drivers are certainly lining up. The dollar is already at a 4-year high and appears set for further gains as U.S. economic data strengthens the case for the Federal Reserve to raise rates next year. And the restraint so far seen in markets could also give way once U.S. long term yields begin climbing in anticipation of that tightening.
The rally in Asia this year has meanwhile taken stock prices to record highs or near such highs, while uneven growth owing to a collapse in commodity prices and the sluggish pace of reforms in some countries has disappointed investor expectations of earnings.
Despite the recent outflows, net foreign investment in the Jakarta stock exchange is still positive at about $3 billion this year, but the rupiah’s 8 percent decline in six months is a worry for investors familiar with Indonesia’s chronic dependence on foreign portfolio flows.
CARRY TRADE UNWIND
Easy global funding conditions and low global interest rates helped Indonesia attract money to finance its precarious current account deficit, and that instilled confidence both in the currency and equity market.
Its bonds, yielding upwards of 8 percent for longer tenors, were favourites for carry trades in which investors borrow low-yielding currencies to invest in higher-yielding ones.
But analysts see risks for Indonesia, which was one of the group termed ‘fragile five’ during last year’s selloff in emerging markets.
“A sudden capital flight would exaggerate currency volatility. Concerns regarding funding of its current account deficit would re-emerge, which would increase equity risk premiums,” Morgan Stanley analyst Hozefa Topiwalla wrote.
According to Morgan Stanley, Indonesia’s vulnerability is such that for every 10 basis points rise in U.S. 10-year bond yields, the negative impact on Indonesia’s equity market would be about 4 percent in dollar terms.
In addition, investors worry about a new bill Indonesia’s parliament passed last month that will end the process of direct election for regional leaders. That development foretold of the deep opposition faced by President-elect Joko “Jokowi” Widodo, whose promise of reforms drew foreign capital into the country.
“The recent outflow was related to the new government,” said Andriyanto, a portfolio manager at Ciptadana Asset Management in Jakarta. “It indicates how strong the opposition is, which will be a big challenge for Jokowi’s government in enforcing his policies.”
The case for being underweight Malaysia has built up gradually over the year, initially driven by the weakness in corporate earnings and then the deterioration in the outlook for the plantation sector as palm oil prices declined.
“The last straw was the weakening currency from August onwards,” said Gan Eng Peng, head of equities at Kuala Lumpur-based Affin Hwang Asset Management Bhd. “When the central bank went against some people’s expectations of a rate hike in September, the carry trade started a mini unwinding, resulting in outflows and currency weakness.”
Philippine, Thai and Indonesian stocks also trade well above their long-term average valuations, making them more susceptible to a selloff than say equities in Singapore or Malaysia.
Thai stocks are trading at a price-earnings ratio of 13.1, which is higher than a 10-year average of 10.6 times earnings, says Topiwalla.
Even for Thai stocks to return to their long-term average next year, there would need to be a 38 percent growth in earnings per share, he estimates, and therefore his base case scenario is for an 8 percent downside in dollar terms in that market within the next year. – Reuters