Malaysia: Staying defensive as political uncertainty rises

Dr Mahathir Mohamad resigned as Prime Minister of Malaysia and chairman of his party, Bersatu on 24th February, as politicians defected from the ruling Pakatan Harapan coalition in an attempt to form an alternative government. While Dr Mahathir remains as interim prime minister at the point of writing, the political upheaval added further volatility to the Malaysian stock market, which was already weighed down by the fallout from the Covid-19 virus.

At the point of writing¹, the KLSE Index is down 8.8% year to date, the third worst performer in Asia, behind Thailand and Korea. The yield on the 10-year Malaysian government bond rose to a high of 3.006% on 24 February although bargain hunting by investors saw the yield retreat to its current level of 2.842%. Meanwhile, the Malaysian Ringgit has fallen 3.6% year to date.

Heightened political risk and uncertainty over the new government are likely to hurt investor sentiment in the short term. Reform agenda will clearly take a backseat, and Malaysia’s economic growth may be impacted as investment decisions are held back due to rising policy uncertainty. Before the political upheaval, there was risk that the rising tourism-related headwinds from Covid-19 could cause Malaysia to miss its official 2020 GDP target of 4.8%.

Further selling cannot be ruled out as foreign investors reduce their exposure to the Malaysian market until there is greater clarity. While Covid-19 presents a short-term risk, political risk, on the other hand, can be a longer-term drag on the market.

Equity Strategy

We expect the market to remain weak in the short-term. As such, we prefer to reduce local equity exposure and raise cash in the near term. Any intense foreign selling is likely to impact the large capitalisation (cap) stocks. Meanwhile, local investors may look to sell the small to mid cap stocks as risk premium rises. The small to mid cap stocks had performed well last year, so some profit taking is not surprising in the face of heightened political uncertainty.

While the current market weakness presents opportunities to accumulate stocks with good fundamentals, our approach will be gradual and selective as we monitor the evolving political situation. In the event of a change in government, the most likely losers would include companies which are seen to be linked to the current government coalition. Meanwhile, companies whose revenues are denominated in USD, such as exporters, are likely to benefit from the weaker Ringgit.

Fixed Income Strategy

The bond market is also expected to remain volatile until there is greater political clarity. Prolonged uncertainty however is likely to give rise to buying opportunities for longer term investors. With the economic outlook already weakened by the Covid-19 impact, and the lower than expected inflation reading in January (1.6% yoy), we cannot rule out further rate cuts by Bank Negara Malaysia

Downside risk is likely to prevail until political certainty returns. While we have raised cash and have limited our exposure to the more vulnerable areas of the market, we are also increasing the defensiveness of our portfolios through high quality stocks and credits. We remain prudent and selective as we take advantage of potential opportunities which may emerge. We continue to monitor the situation closely - the upcoming announcement of an economic stimulus package meant to mitigate the economic effects of Covid-19 may help to calm some nerves in the near term.