A Brief on Global & Local Markets, Investment Strategy.

Week in Review | 13 – 17 November 2017

Market Stays Choppy, With US Tax Reform in Limbo

The House Republicans has passed their version of its tax bill last week, making important steps to overhaul the US tax code by slashing the corporate tax rate, eliminate state & local deductions – but also potentially add to its federal deficit by nearly US$1.5 trillion over 10 years.

The Republicans’ bill had presumptuously included a provision to repeal the Affordable Care Act or Obamacare – the namesake of the former US President which extends health insurance coverage to poor Americans who are uninsured. Obamacare has been a constant bugbear of the Republicans, who have desperately tried but failed to repeal the law, decrying it as unwanted intrusion into the affairs of private business and raised the cost of business.

The bill is unlikely to be passed in its current form, blocking a potential double-victory for the Republicans to accomplish both tax and healthcare reforms. The bill faces continues to fresh resistance from various stakeholders over its perceived tax giveaways to the rich and potential blow-up of its deficit. The Trump administration is still seeking its first major legislative-win, especially in the lead-up to mid-term elections next year with still no significant policy breakthrough by the Republicans.

Meanwhile, markets continue to remain choppy as fund managers continue taking profits off the table, as the year draws to a close.  US Treasury yields dipped by 6bps, closing at 2.34% w-o-w. The US dollar also broadly weakened by 0.8%, as political uncertainty surrounding tax reform continues to weigh down on the greenback.

Stronger inflation data released last week and pick-up seen in retail sales would further embolden the US Federal Reserve to raise interest rates in December, with markets almost 97% priced-in for a rate hike next month.

Germany Coalitions Talks Collapse

Efforts by Germany Chancellor Angela Merkel to form a three-way coalition government failed last week, following a breakdown in talks by the respective parties – thrusting Germany deeper into political uncertainty. Merkel has been trying to forge a coalition between her Christian Democratic Union (CDU), the pro-business FDP party and the Green party, following federal elections at the end of September. Speculation is rife that Germany could now call for fresh-elections next year to resolve the deadlock.

On the flip-side, growth in the Eurozone continues to expand – though looming political risks including the Catalonia secession saga, and upcoming Italian elections could cause the European Central Bank (ECB) to remain dovish until it receives more clarity on these risks.

Inflows to EMs and Asia Remains Strong

Some pullback in markets were seen last week, with Emerging Markets (EMs) broadly down by 2.1% w-o-w, as fund managers continue locking-in profits before the year-end, although hiccups seen in US tax reform have also given global fund managers further excuse to take profits.

Despite the weakness in markets, we still saw strong inflows into EMs specifically into Asia Pacific ex-Japan funds. On a country-specific basis, China and Korea continue to draw the bulk of the inflows, as expectations of further US dollar weakness continue to divert inflows towards the EM-space.

China Tightens Rule on Asset Management

China’s regulators has moved to tighten rules on its asset management sector to rein-in excessive risks in the industry. Among the rules proposed include for prohibition of non-financial institutions from selling asset management products, and the leverage for publicly-raised funds & private funds to be capped at 1.4 and 2.0 times respectively.

The moves comes as one of China’s strongest signal yet of its commitment  to painful but necessary reforms, with more of such policy measures seen in 2018, as China continues on its deleveraging exercise.

Malaysia 3Q GDP Accelerates

Malaysia’s 3Q’17 GDP exceeded expectations expanding 6.2% y-o-y, underpinned by strong domestic demand and increased private sector spending. Economic data had pointed to a strengthening trend, with exports growing 22.1% y-o-y in 3Q’17, its strongest since 2010 and from 20.5% in 2Q mainly from the increase in exports of Electrical and electronic (E&E) products.

Meanwhile, industrial production grew by 5.9% YoY in 3Q’17, its fastest pace since 2015, from 4.3% in 2Q on the back of robust manufacturing activities. Elsewhere, the services index retained a healthy growth of 6.9% YoY in 3Q17, albeit easing from +7.1% in 2Q.

The Ringgit has appreciated 7.3% YTD against the greenback, and is expected to strengthen further, on the back of expectation of another interest rate hike by Bank Negara Malaysia (BNM) in the 1Q’18. Markets aren’t viewing the hike as a tightening measure, but more of a normalisation of rates. Recall that BNM had unexpectedly cut the OPR by 25bps last year, when growth was still seen as strong. The 10-year MGS yield settled at 4% after release of the GDP print.

DBKL Property Freeze  Long Overdue

According to business publication The Edge, Dewan Bandaraya Kuala Lumpur (DBKL) has been instructed by the Cabinet to freeze approval for application plans of new shopping centres, offices, serviced apartments and luxury condominiums above RM1 million. The news came as a shock to property developers who were apparently caught off guard by the announcement – but the freeze was probably seen long overdue in view of overbuilding done in the last few years.

We’ve seen rental and occupancy rates fallen as a result of this overcapacity, affecting smaller sized malls such as Glo Damansara and Sungei Wang in spite of their prime locations. Huge incoming supply from Bukit Bintang City Centre, Pavilion Damansara, Empire Damansara, Tun Razak Exchange, and Bandar Malaysia are only expected to exacerbate the situation. That said, large malls will continue to fare better due to comprehensive offerings to families and shoppers.

Within the office segment, the total Klang Valley office space has already ballooned to be greater than that of Singapore & Hong Kong. Current occupancy rate is only 80% and will be under pressure from incoming supply (refer above). Old offices and those without integrated facilities (eg. mall, train station) will suffer.

In the residential segment, BNM’s latest statistics pointed to over 130,000 unsold units worth over RM40 billion in the 2Q’17, which is double the historical average unit of 60,000 – 70,000 units. It will take awhile for the market to absorb and adapt to the supply-demand imbalance.  We’ve seen most developers are already scaling down unit size to bring absolute price to below RM1 million.

There will be a lot of confusion for other states because land matter is under the purview of the state government. It may not come as a surprise if the government backtracks or relaxes on a case-by-case basis after extensive lobbying (e.g. foreign labour issue). Latest reports already show conflicting statements by various ministries.

On our portfolios, we are positioned towards more defensive names including Sunway Berhad whose revenue streams are more diversified and UOA Development whose units are located in more mature areas such as Bangsar South and Sentul.

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