Perspective

The good and bad of south-east Asian markets


Many global investors have been reassessing their investments in China following the recent regulatory crackdown on the internet and education sectors.

As a result, attention has increasingly shifted back to the Association of South-east Asian Nations (ASEAN) markets. 

Continued lacklustre returns mean that ASEAN’s underperformance versus broader Asian markets has now lasted almost a decade.

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What I don't like in ASEAN: Malaysia

Malaysia, in particular, has been receiving interest from some sell-side strategists of late as they extolled the market’s cheap valuations, reopening potential, and the country’s enviable status as a net commodities exporter operating amid the current environment of high commodity prices.

Unstable political landscape with a weak fiscal position

Despite these headline attractions, I am a lot more circumspect on the prospects of the Malaysian equity market. For one, politics in the country remain incredibly messy.

Following the resignation of Prime Minister Muhyinddin Yassin in the middle of August, Ismail Sabri Yaakob has now become the country’s ninth prime minister, the third in the last three years. A former deputy PM, Ismail Sabri has inked a cooperation pact with key opposition bloc Pakatan Harapan that will give him the support of the majority in a fractured House. This should hopefully provide some much-needed political stability to a country that remains wrought by the pandemic.

This political respite is, however, tenuous. Pundits expect it to last only until August next year when they expect a general election to be called. This therefore puts considerable impetus on Ismail Sabri to quickly build up popular support ahead of the anticipated election. A well-calibrated reopening of the economy, on the back of the execution of a successful vaccination plan, will undoubtedly go a long way in boosting public sentiment. However, the current weak fiscal position represents a considerable obstacle to achieving that. With nominal GDP growth having flat-lined for the better part of the last five years, the narrow gap between nominal growth and nominal interest rates means that even moderate fiscal deficits will trigger a rapid hike in public indebtedness relative to GDP, making it near-impossible for the government to introduce sustained budget stimulus.

With limited fiscal headroom, the government is increasingly likely to coerce the private sector into performing some forms of national service as it implements its populist policies. Initial signs of this coercion are already showing. In recent reports. the government has said that it is now looking to compel banks to waive interest payments for the bottom half of all Malaysian income earners for three months.  Parts of the House are calling for the moratorium to be extended to SMEs (Small, Medium Enterprises) too. Meanwhile, the government is also said to be mulling the imposition of windfall taxes. In the face of heightened policy risks, this means that almost half of the market, comprising of sectors such as banks, utilities, toll roads and consumer staples, do not look like attractive investments.

ESG risks abound

That is, of course, not to say that other parts of the market are not facing worries of their own. On 2 July, the US State Department announced that it is downgrading Malaysia to the lowest tier in its annual report on human trafficking.

The downgrade follows a string of complaints by human rights groups and US authorities over the alleged exploitation of migrant workers, and drops the Southeast Asian country from Tier 2, where it had spent much of the last three years, to Tier 3 where it will sit alongside countries such as North Korea, Afghanistan and South Sudan. According to Acting Director of the State Department Kari Johnstone, “the sectors primarily where [they] see the greatest forced labour – which is the predominant form of the crime within Malaysia – includes on palm oil and agriculture plantations, in construction sites, in the electronics, garment and rubber product industries.”

Indeed since last year, products from Top Glove, the world’s largest rubber glove manufacturer, were already placed on the import ban list by US Customs after it found reasonable evidence of forced labour in its factories, including debt bondage, excessive overtime, and squalid living and working conditions.

As a result, the company has had to scupper a $1bn listing that it had originally planned in Hong Kong. It has also seen the company report double-digit declines in its revenues and net profits in its latest quarterly results release, as sales volumes in North America fell 68% on the back of the US ban.

While Top Glove has been able to sufficiently remedy its labour practice shortcomings for the US Customs to consider lifting its ban this month, for the rest of Malaysia, addressing the US State Department’s human trafficking concerns will require time and considerable local governmental effort. However, both of these are unaffordable to the country given the current fragile political equilibrium. Even if compliance is eventually achieved, it will still mean a significant ratcheting up of costs, as chart 2 shows, and this will be detrimental to near-term earnings.

With the shadow of the US downgrade looming, this renders another one-sixth of the index un-investable to us.

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In the meantime, the broader market itself remains mired in a domestic economy that has been weak even before the pandemic hit. The private credit growth rate has now dwindled to its lowest level since 2004, while the entire property sector has actually gone into reverse, with nominal prices outright declining under the combined weights of rising new supply and falling sales. It is therefore little wonder that our Composite Business Cycle indicator for the country continues to point at tepid future equity performance.

Having not invested in Malaysia for as long as I can remember, I see little reason for this to change any time soon.

What I do like in ASEAN: Indonesian banks

One sector within the ASEAN region that is looking interesting is Indonesian banks.

We have been wary of Asian banks for quite some time as we worry about the disruptive impact that fintech will have on their profitability. It seems that the Covid pandemic has only served to give these disruptive influences greater impetus.

With digital adoption accelerating across the region, new forms of payment have emerged. These new payment systems are now being used by market entrants as key enablers to create platforms that generate customer flow.

For banks in general, this is bad news. Fortunately, industry and regulatory differences mean that the disruption risk for domestic banks do vary across countries.

Recently, our esteemed veteran analyst Sherry Lin undertook a detailed study of the impact of fintech on Asian banks, focusing on four particular drivers of disruption risk: (1) the technological prowess of incumbents, (2) regulatory regime, (3) penetration of banking, and (4) competitiveness of challengers. Interestingly, she found that, versus their regional peers, Indonesian banks are in fact relatively well-positioned to tackle the risk of disruption.

In her view, contrary to conventional beliefs, Indonesian banking incumbents (especially the big three) are actually tech-savvy companies who already boast of digital platforms that are both competitive and appealing to consumers.

Their competitive positions are further enhanced by a benign regulatory landscape where regulators are often collaborative and supportive of them. While she acknowledges that digital banks such as SeaBank and e-wallet platforms such as ShoppeePay and GoPay represent formidable foes in the evolving Indonesian financial landscape, the key point is that the country remains severely under-banked.

This not only means that there is still ample room for all players to grow, it also suggests that there is little incentive for new entrants to directly compete with local banks at the moment.

This represents a valuable window of opportunity for incumbent banks to continue beefing up their digital capabilities, which should stand them in good stead in the longer-term.

With the sector now trading at depressed valuations versus its long-term average, this is an area of real interest.