What does a strengthening ringgit do to our stock market?
TA Securities analyst Stephen Soo explains a firm ringgit is a boost to the stock market as it encourages fund inflows.
Although he sees bonds as the main beneficiary of a stronger ringgit, with equities next, he is more bullish on equities for the second half of the year, on the back of the tabling of the 10th Malaysian Plan and the release of more details on the New Economic Model.
“In the last two years, Malaysia has experienced a net outflow of foreign direct investments (FDIs). As the ringgit strengthens, this will at least stop some of the outflows and support liquidity flows. This liquidity will need to go somewhere and stocks will benefit,” says Soo.
Bank Negara data points to an FDI reversal in 2007, with net outflows of direct investments of RM9.14bil. This increased to RM26.06bil in 2008 and to RM14.62bil in the first nine months of last year.
Portfolio investments in Malaysia booked a net inflow of RM8.8bil in the third quarter of 2009 after four quarters of significant outflows.
JF Apex Securities Bhd CEO Lim Teck Seng feels that the recent inflow of funds have not had much impact on the stock market as most of the foreign inflows were for fixed income and not equities.
“A strong currency may not favour stock markets as theoretically, Malaysian stocks have become more expensive. For the moment, foreign funds prefer to enjoy yields rather than the riskier returns from equities,” he says.
Private equity banker Sherilyn Foong says portfolio inflows seem to be faster and nimbler than FDIs. “We’re coming from a low base on the bonds front. My main concern would be if it is, to a significant extent, hot money,” she says.
MCIS Zurich Insurance Bhd head of fixed income Michael Chang shares Lim’s views. “Buying government bonds is probably one of the easiest ways if I am expecting the country’s currency to rise,” he says.
“The risk is deemed moderate and bonds are also fairly liquid investments. Offshore investors can buy into the Malaysian Government Securities (MGS) as it is as good as buying the Malaysian currency,” says Chang.
Long-term hazard
While most people are of the view that a rising currency signals more investments flowing into the country, and therefore contributing to a rising stock market, this is a mere correlation and not a direct impact.
Past studies by ABN Amro Bank and the London Business School have shown that strong currencies do not lead to generous profits from the equity markets.
According to the research, countries with weak currencies saw greater stock returns than ones with strengthening currencies.
A broker from a local house says that a strong currency only offers short term benefit for the market. “Over the longer term, it is not good for an exporting economy and for the stock market,” he says.
Investing in stocks can be viewed as risky compared with other assets. When the central bank raises interest rates, government securities such as the MGS are often regarded as the safest investments and will usually experience a corresponding increase in interest rates.
In other words, the risk-free rate of return goes up, making these investments more desirable and a lot safer than stocks. With stocks, one has to factor in the risk premium as well.
The ringgit has strengthened some 7% to 3.2015 against the US dollar since the beginning of this year. This will impact the earnings of Malaysian exporters and various other sectors of the economy.
Over the short term, exporters such as those in the rubber glove, technology, and electrical and electronics sectors may suffer setbacks.
Says OSK Research director and research head Chris Eng: “A stronger ringgit is better for the country as long as it strengthens gradually. Lately, the ringgit has strengthened rather quickly and this may not give exporters time to pass on (additional) costs to their customers.”
Winners and losers
Rubber glove stocks have come under selling pressure of late as investors worry about a repeat of the share price collapse in 2008, when investors assumed that record latex prices, high energy prices and a weakening US dollar would dampen glovemakers’ earnings significantly.
Those who remain bullish about the industry contend that the demand for rubber gloves is resilient and that the listed manufacturers, because they are market leaders, will be able to hike selling prices to absorb cost increases.
A stronger ringgit means imports tend to cost less. Manufacturers that rely significantly on imported raw materials stand to benefit and will likely see their margins improve, provided their output is largely sold in the domestic market.
With the US dollar weakening against the ringgit, commodities such as oil and gold, which are bought and sold in US dollars, will be cheaper for purchasers in Malaysia.
Eng says in this context, the local airlines are beneficiaries, as fuel is denominated in US dollars while sales are mostly in ringgit.
“In Malaysia Airlines Bhd’s case, their revenue is mostly derived in Australian and Asian currencies. So they benefit from the strengthening ringgit,” he says.
Others gaining from the surging ringgit include automotive and food-based companies that import products in US dollars but sell them to Malaysian buyers. Companies that have large foreign debts – Tenaga Nasional Bhd for example – will also benefit. On the flip side, MISC Bhd, whose revenue is mostly in US dollars, may be at a disadvantage.
Profit impact
Eng says a stronger ringgit helps control inflation, hence strengthening domestic consumption.
One line of argument is that a strong currency also means that imported raw materials are cheaper, thus lowering inventory cost. This leads to lower borrowing obligations and hence less interest to pay.
Says a senior analyst: “The price of the finished good also goes down and this leads to a lower cost of living. The strength of a currency is an indicator of economic health.”
According to the Big Mac index, the ringgit is 40% below its fair-value benchmark with the US dollar as at March 16 (at 3.3245 per US dollar).
The Big Mac index is based on the theory of purchasing-power parity, the notion that a dollar should buy the same amount in all countries.
“Based on a trade-weighted index, the ringgit should be fairly valued at 3.23 per US dollar, which is almost close to the current level,” says AmResearch senior economist Manokaran Mottain.
He is forecasting exports to grow by some 7% to 8% and Malaysia’s gross domestic product to hit 5% this year.
Says Chang: “While some exporters lament the stronger currency, a lot of them are importers too and their costs of production have fallen. The most substantial profits are often made in finished goods, not in raw materials.
“Profits made from finished goods are more sustainable as it gives better margins on a longer-term basis. It allow us to move up the value chain.”
An observer says that while raw materials may be cheaper due to the strengthening ringgit, Malaysian exporters will still be in the losing end when selling finished goods to the global market as their products will be denominated in US dollars.
