Malaysia as Safe Harbor During Emerging Markets' Storm?

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Source: The Wall Street Journal Asia, 11 February

ASIA'S STOCK-MARKET volatility led investors to yank huge sums out of Asian stock funds, with seven consecutive weeks of net redemptions. Though stockholders seem worried that selloffs will ripple through much of Asia if the U.S. economy slides into recession, they are treating Malaysia as a haven among emerging markets.

Equity funds focusing on Malaysia took in $28.4 million in the week ending Jan. 23, according to EPFR Global, a Boston firm tracking stock-fund flows. That is a tiny amount, yet stock funds that invest in the rest of the Asia-Pacific region, excluding Japan, saw net outflows of $1.6 billion the same week.

Malaysian shares aren't immune to ailing global markets, but as a group, they have held up better than shares on any other exchange in Asia. The country's benchmark, the Kuala Lumpur Composite, is a mere 0.01% off last year's high of 1447.04 -- a hiccup compared with the double-digit losses in Singapore and South Korea, and far steeper declines in Hong Kong and Shanghai, where indexes are more than 20% below their 12-month highs.

"Malaysia is always countercyclical. When things go down, it's a place to hide," says Bhaskar Laxminarayan, chief investment officer for Asia at Swiss bank Pictet & Cie. So what makes the country so resilient?

One major difference between Malaysia and the region's other markets is the makeup of the country's bellwether stock index. Malaysia's economy relies heavily on manufacturing -- the vast majority of its exports to the U.S. and Europe are manufactured products, especially in the technology sector.

Despite this, most of those exporters aren't publicly traded. For example, about 50% of Malaysia's exports consist of electronics goods. One big exporter, semiconductor giant Intel Corp., operates its largest overseas manufacturing facility in Malaysia but Intel Malaysia doesn't have shares listed on the local bourse.

Another driver of the country's economy: rising commodity prices. The country is a big producer of palm oil and mineral oils, which it exports mostly to Japan and developing markets. "Malaysia is the beneficiary of commodities prices that the government can put back into the economy," by providing stimulus measures, such as corporate tax cuts, and financing needed infrastructure projects, says Melvyn Boey, the Malaysia strategist for Merrill Lynch.

Palm-oil producers make up about 20% of the Kuala Lumpur Composite index. Domestic financial institutions represent 23%; utilities, 12%; and telecom companies, 7%.

Analysts remain bullish about palm-oil plantation stocks in the coming year. Among the sector favorites are large-capitalization plays, such as IOI Corp. and IJM Plantations. Now the second-biggest stock on the exchange, IOI shares provide the added advantage of being widely traded, making them easier to buy and sell than many of the smaller stocks available. IOI shares have lost about 2% so far this year, ending the Feb. 6 trading session at 7.60 ringgit ($2.35).

For Wai Kee Choong, Malaysian equity strategist at Citigroup, the price slip is a buying opportunity -- he expects IOI stock to reach 10.05 ringgit in the next 12 months. Among palm-oil producers, Mr. Choong also recommends IJM Plantations, whose shares have defied the broader selloff by gaining 15% so far this year, closing at 3.78 ringgit on Feb. 6. Mr. Choong's 12-month price target is 5.63 ringgit.

Both Messrs. Choong and Boey give the Malaysian index as a whole an "overweight" rating. U.S. investors could profit further from a strengthening ringgit, one of the best-performing currencies in Asia this year. A strong ringgit boosts stock gains when they are converted back to U.S. dollars.

One investor who has accumulated shares in Malaysia amid recent trading volatility is Khiem Do, portfolio manager in Asia for Baring Asset Management, who agrees that the country's publicly traded stocks are somewhat shielded from a pullback in spending by U.S. consumers. "We thought that it would be a safer market while the world struggles," Mr. Do says.

Bank stocks, which are focused domestically, have also attracted analysts and investors. Because they don't invest overseas, Malaysia's financial institutions aren't teetering under bad U.S. subprime credit and aren't expected to disclose that they are holding bad debt.

Citigroup's Mr. Choong particularly likes Public Bank and Hong Leong Bank, which, he says, have expanded domestic lending and are positioned to benefit from rising credit-card expenditures in the country. Hong Leong's shares have dropped 7% so far this year, closing at 5.90 ringgit on Feb. 6, while Public Bank's stock rose 3.6% to finish at 11.4 ringgit. Mr. Choong's 12-month targets for those stocks are 7.46 and 12.53, respectively.

Despite concerns about its exposure to a slowdown in U.S. spending, Malaysia's economy is still expected to grow at a 6% rate this year. One economist, Robert Prior-Wandesforde of HSBC, calls the country "a test case for decoupling." The theory, somewhat discredited in recent weeks by sharp declines in Asian stocks, is that emerging economies have diversified sufficiently to withstand an adverse turn in the U.S. economy. Mr. Prior-Wandesforde, in a report dated Jan. 22, points to increases in domestic consumption; local spending on infrastructure; rising exports to new markets, such as China and India; and a flow of capital from the Middle East that is establishing the country as a center for Islamic finance.

Still, Malaysia's stock market doesn't warrant unbridled optimism. Analysts caution that the index could wind up in negative territory for the year if economic news out of the U.S. worsens and prompts a mass exodus from emerging markets. Also, investors have long complained of Malaysia's lethargy when it comes to revamping its financial system and building incentives for corporate reform. For years, the stock market was burdened by a complicated history with foreign investors. In the throes of the 1997-1998 Asian financial crisis, then-Prime Minister Mahathir Mohamad blamed foreign-currency speculators for causing a plunge in the country's currency, ringgit.

To stop its fall, Mr. Mahathir pegged the ringgit to the U.S. dollar and imposed strict capital controls to prevent foreigners from exiting ailing investments, sparking a firestorm of criticism from the financial community overseas. Although Malaysia has lifted crisis-era controls, foreign investors remain reluctant to invest. The index surprised some investors last year by returning 32%. More commonly, Malaysian shares have underperformed the rest of the region, gaining 21.8% in 2006 and 0.8% in 2005.

Personally, I'm not as bullish as the guys above. Apart from the upcoming election, there is not much excitement in the local stock market, especially if you are taking a trading, rather than an investment view.

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