(July 8): Investors cheered at the start of July, after the US and China called for another truce while trade talks resumed. There was little in terms of concrete details. US President Donald Trump agreed to hold off on his threats to impose tariffs on the remaining US$300 billion ($406.9 billion) or so of Chinese imports and also ease restrictions on Huawei Technologies. In return, China agreed to an unspecified increase in the purchase of US farm products. Talks could still stall, but the truce effectively averted a worst-case scenario, at least for now.
The improved sentiment gave global stocks a reason to consolidate gains, delivering one of the best 1H returns in years. The Dow Jones Industrial Average and Standard & Poor’s 500 Index hit fresh all-time record highs. Bellwether indices in Singapore, Thailand, Taiwan and Hong Kong are sitting on double-digit gains for the year to date.
Bursa Malaysia continues to be the worst-performing market in Asia. The FBM KLCI remains marginally in the red for 2019.
The main reason for the below-par performance is the country’s underwhelming corporate earnings, and not just for the current year. As I had shown a couple of weeks ago, total market net profit has been falling for years — at a compound annual growth rate (CAGR) of -6.8% from 2014 to 2018. As a result, despite the poor stock price performance, market price-to-earnings valuations have risen — from 16.3 times in 2014 to 21.2 times in 2018.
Was the downtrend in profits due to the global economic cycle? Is this a phenomenon shared by our neighbours?
We repeated the deep analysis for Singapore companies. The results are presented in Tables 1 to 4. Total profits for the 625 companies that were listed throughout 2014 to 2018 showed an average CAGR of 2%. While growth was low, it was still a far cry from the steep decline for Malaysia companies.
In fact, the biggest sectors in terms of total profits and total number of companies — Finance and Manufacturing — registered solid CAGR of 5.3% and 5.2% respectively. Another big sector, Properties also saw stronger-than-average growth, with CAGR of 6.5% while profits for real estate investment trust expanded at an average clip of 4.1% annually.
Overall profit growth was dragged down by sectors mostly related to the slump in global commodity prices as well as exploration and development activities in oil and gas. This includes downstream businesses such as commodities trading (Olam International, Noble Group and KS Energy Services under the Commerce sector) and support services (Ezion Holdings, PACC Services and Pacific Radiance, which are classified under Services).
Construction is a small sector and heavily influenced by weak performance from Chip Eng Seng Corp over the evaluation period. Profits for some sectors were also distorted by extraordinary gains/losses (likely owing to accounting standards) such as the exceptional gain in OUE’s 2014 earnings (in the Hotels/Restaurant sector). Within the Transport/Storage/Communications sector, HPH Trust reported big one-off losses in 2014 and 2018, whereas Singapore Telecommunications recognised a big one-off gain in 2018.
In short, Singapore companies actually fared much better than those in Malaysia. Notably, the overall market net margin has been trending higher, from an average of 7.1% in 2014 to 8.8% in 2018.
This is in stark contrast to that observed for the Malaysia market, where margins for all sectors came under pressure. Average net margins dropped from 11.3% in 2014 to 7.7% in 2018.
We also tabulated some broad numbers for neighbouring countries, Vietnam, Indonesia, Thailand and the Philippines (see Table 5). Corporate profits in Vietnam registered the strongest growth: CAGR of 12.4% between 2014 and 2018. Earnings in Indonesia and Thailand grew 6.4% to 6.5% annually while CAGR in the Philippines averaged 3.5% over the same period.
It would be interesting to do a similar deep dive into these countries, to determine which companies and sectors are performing the strongest. We might do this in the future.
The evidence strongly suggests that the challenges facing Malaysia are unique. Why has the country lagged so badly? It may have something to do with the different stages of economic development in these countries. It cannot be about the new government, which has been in power for only one year, despite recent politically driven finger pointing.
In fact, I will say it has to do with years of policy neglect, complacency and rent-seeking behaviour perpetuated by the previous government. The result is the middle-income trap and structural decline.
Our important manufacturing sector is stuck in the low value-added segment, heavily reliant on cheap foreign labour as investments in R&D, technology, automation and mechanisation slowed.
Malaysian companies are losing competitiveness against other emerging countries where labour is abundant and even cheaper, such as Vietnam, and at the other end, against global competitors because of digitalisation and technological disruptions. Declining margins and profits go on to perpetuate the vicious cycle.
Reversing all these deep-seated issues will take time, political courage and change in mentality of the entire Malaysian population. The new government has taken a few baby steps, including clamping down on corruption and plugging leakages. Much more, especially in terms of pro-growth measures, needs to be done.
Turning around the corporate earnings decline will rejuvenate the Malaysia stock market.
Case in point: Benchmark indices in Vietnam, Indonesia, the Philippines and Thailand registered positive CAGR over the past five years — underpinned by robust earnings growth.
To be sure, their stock market gains have lagged the pace of growth. I attribute this, in part, to currency risks. Except for the Thai baht, all the other currencies have depreciated against the US dollar. So, it makes sense for a US dollar investor to discount local earnings growth for expected currency risks.
Nevertheless, thanks to consistent earnings growth, PE valuations for these markets have been declining, making them more attractive investing destinations — especially when viewed against their prospective growth. Malaysia has a lot of catching up to do.
My Global Portfolio surged 2.9% for the week ended July 4. Nine of the 11 stocks in my portfolio registered gains, including newly acquired Adobe. Total portfolio returns have risen to 11.2% since inception. The portfolio is outperforming the MSCI World Net Return Index, which is up 8.5% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
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