KUCHING: A key risk to the emerging markets including Malaysia is the potential of further and more substantial reversal of short-term capital.
The ‘Market Outlook and Strategy 2Q2011’ report by RHB Research Institute Sdn Bhd (RHB Research) pointed out that this, to some extent, hinged on relative market valuations and attractiveness to portfolio investors.
“As Japanese disaster clears out and political tension in the Egypt and other Middle East as well as North Africa (MENA) countries subsides, the Japanese equities for instance, that had suffered significant sell-down and are now looking very cheap would likely appeal to global investors and hence, attracting more capital inflows,” it pointed out.
The research firm further said that the US dollar, which had priced in all the negatives in the short term could potentially strengthen, giving rising expectations of stronger economic recovery in the US.
“Under such circumstances, short-term capital that come to the emerging markets for currency appreciation will find the risk-reward reversing and further capital outflows back to the US market will mean the regional markets could come under some selling pressure from time to time,” it added.
Further out, as global weather conditions improved more significantly, commodity and food prices would start to normalised, translating to easing inflationary situation for some countries.
“As China is ahead of the curve in policy tightening and once it brings its asset prices and inflation under control, some funds might flow to the Chinese markets that have underperformed other emerging markets since last year and are now trading at cheaper valuations,” said RHB Research.
In addition, with the global economic recovery gaining momentum, the technology cycle would likely gradually bottom out and poised to recover in the second half of the year. Nearer to that, the tech-heavy markets such as South Korea and Taiwan, would likely attract greater attention of global fund managers as well.
Nevertheless, the research firm believed after a period of correction and adjustment, valuations of the market would become attractive again and the market would come back and trend up from mid-year onwards.
“In other words, we are of the view that there will be rotational plays for global fund manages and after all, emerging Asia will continue to enjoy a faster level of economic growth, higher level of savings and lower level of debt, whereas many developed countries will need to go through another major round of debt restructuring some 12 to 18 months down the road.”
Another risk would be the potential return of the European debt crisis, exacerbated by sovereign rating downgrades by the international rating agencies in peripheral Europe. As many European nations, including UK, Greece, Ireland, Portugal and Spain were implementing significant austerity programmes to cut fiscal deficit and debt, it could ill-afford another hit to demand from rising oil prices.
“This could be compounded by the need to raise interest rates to combat rising inflation, as reflected in the recent policy statement from the European Central Bank (ECB), and if this comes with further downgrades of sovereign ratings in peripheral Europe and rising costs of restructuring, the balance might well tilt over to a much more severe adjustments for the global economy.
“Though unlikely in our view, these events, if materialised, could result in another round of turbulence for global financial markets,” RHB Research commented.
The research firm believed that market conditions would likely improve from the second half as investors look forward to a brighter economic prospect next year. It viewed that any market pullback would present an opportunity for investors to accumulate fundamentally-robust stocks on weakness as value began to re-emerge.