The disconnect between growth and investor sentiment

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Malaysia’s third-quarter (3Q) gross domestic product (GDP) growth rate exceeded 6% for the first time since the 2Q of 2014.

According to Bank Negara Malaysia, Malaysia’s economic activity grew at 6.2% year-on-year (YoY) in the 3Q, outperforming the consensus estimate of 5.5% growth and the 2Q’s 5.8% expansion.

The main driver was the private sector. Both private consumption and private investment remained robust in the 3Q, registering 7.2% YoY and 7.9% YoY of growth rate respectively, despite the drop in consumer confidence and business sentiment in the period.

Moving forward, we believe consumer spending is likely to further improve due to the cut in personal income tax rate and the several measurements proposed in Budget 2018 to increase the average household disposable income.

From the supply side, we saw a broad-based expansion in all five major sectors. The services sector, which accounts for about 54.4% of Malaysia’s GDP, grew by 6.6% YoY in the 3Q, mainly benefitting from the South-East Asian games effect that lifted the local tourism and services activity.

The local manufacturing sector also expanded by 7% YoY, underpinned by strong demand for local electrical and electronics products, given the rise in global technology sector.

Despite the strong growth in economic activity, we continue to notice grouses over the state of things in the country.

One reason that can explain why the feel-good sentiment is not felt on the ground is probably due to the higher living cost in Malaysia.

Over the past couple of years, several subsidies have been removed by the government, while the implementation of the Goods and Service Tax back in June 2015 has added to the cost of living.

The average inflation rate in Malaysia as of end-September was about 4% compared to the 2.2% in 2016.

The Malaysian equity market, as represented by the FTSE Bursa Malaysia KLCI (FBM KLCI), has underperformed compared to its peers since the 2Q of the year.

We believe the sustained foreign outflows over the past couple of months is one of the factors for the poor performance of the local equity market.

The local equity market has registered more than US$480 million (RM1.96 billion) of fund outflows over the last two months.

The uncertainty regarding the timing of Malaysia’s election could explain why foreign investors pulled out their funds from the local equity market.

Market participants were anticipating the 14th general election (GE14) would be held inthe3Qorbythe4Qof2018.

As we are now approaching the end of 2017, there is still no clear indication of when the GE14 will be held.

We believe once a clear date of the local election is known, foreign investors might buy in the local equity market, given the fundamentals of Malaysia’s economy.

The disconnect between the local economy and the equity market performance is also probably due to the differences between the drivers of the local economic activity and the FBM KLCI constituents.

Sectors like the semiconductor or the tourism-related industry were the main drivers for the local economic activity, but the local equity index is heavily exposed to financials, telecommunication, industrial and utilities sector.

Hence, the local equity index is not a good reflection of economic growth and is the reason why we always emphasise that exchange-traded funds, which replicate the performance of the local equity index, might not necessarily be the best investment tool for local investors.

The stronger economic growth means there’s improving flexibility for the central bank to manage its monetary policy.

In fact, the last monetary policy statement delivered a rather hawkish message, with the intention to normalise the interest rate next year.

Although the high inflation this year is a result of higher petrol prices, we have started to see inflationary pressures from the demand side, with local private consumption continuing to grow at a robust growth rate of more than 6.5% for three consecutive quarters this year.

We expect the central bank will increase the benchmark interest rate next year, but it shall not indicate the start of a series of rate hikes.

Generally, rate hikes would benefit the banking sector, as the net interest margin for banks is likely to improve.

On the flip side, a higher interest rate is likely to translate into a stronger ringgit.

The strengthening of the ringgit might not favour local exporters, as they might lose their competitive advantage.

We believe the impact will not be significant, given the improving global demand is likely to offset the effect of a stronger local unit.

Investors in the foreign bond markets should be cautious of possible foreign-exchange losses should the ringgit rise in line with the local rate hikes and improving domestic economic fundamentals.