Watch the Federal Reserve – The Star Online

THE recently concluded first quarter (1Q22) reporting season did not entirely disappoint the market despite more misses than hits as the number of companies that fell short of expectations was higher than those that were above market consensus.

As expected, the 1Q22 period was boosted again by the buoyant commodity sector, allowing most companies in the chemical sector, plantation sector, and selected metal producers to report stellar results.

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The biggest drag to corporate Malaysias 1Q22 report card was the glovemakers as earnings plunged on the back of normalised average selling price and the higher cost structure post-pandemic.

Banking stocks were decent while the consumer sector was a mixed bag.

Despite the impact of a fully opened economy, the aviation and the gaming sector, led by Genting Bhd, remained under pressure and continued to post losses. AirAsia X was an outliner, reporting a huge net profit on the back of a write-back for previously made provision for its debt restructuring exercise.1Q nominal GDP expands

Economically, the Malaysian economy for the 1Q22 period was surprisingly strong as the economy expanded by 3.9% quarter-on-quarter (q-o-q) and 5.0% year-on-year (y-o-y), flatly beating market expectations of a 4% y-o-y growth.

Not surprisingly, Bank Negara maintained its gross domestic product (GDP) growth outlook for the year with growth projected at between 5.3% to 6.3% for 2022 despite taking a pre-emptive strike by raising the benchmark overnight policy rate (OPR) by 25 basis points (bps) to 2% from 1.75%.

In nominal terms, the Malaysian economy expanded by 13.9% y-o-y to reach RM422.5bil, although compared with the preceding quarter, the economy contracted by 0.6% q-o-q when measured in nominal terms.

On a y-o-y basis, strong nominal growth was seen in accommodation services, up 87% y-o-y; mining and quarrying, rising by 43.5% y-o-y; the agriculture sector grew by 28.3% y-o-y; while the transport sector experienced a 27.3% y-o-y growth.

With 1Q22 GDP data coming in above market forecast, 1Q22 net earnings momentum, excluding the volatile earnings of glovemakers, rose by 5.5% y-o-y, translating to about 1.1 times GDP growth.

Nevertheless, despite the relatively stronger earnings momentum, the ratio of companies earnings that surprised the market against those that were below expectations dropped as only 22% of companies reported earnings that were above expectations against 30% that were below consensus estimates.

This was weaker than the preceding quarters 4Q21 reporting season when 34% of companies reported results that were above expectations and 25% that were below expectations.

Hence, the earnings disappointment ratio jumped to 1.32 times, against the preceding quarters 0.76 times. The q-o-q trend is not unexpected as the 1Q22 period typically tends to have higher misses than hits. An analysis of the trend of hits and misses over the past three years shows that the 1Q22 performance was only weaker than last years 1Q21 performance as seen in Chart 1 and much stronger than the previous two 1Q periods in 2019 and 2020.

A better 2022?

As expected, post 1Q22 earnings season, there have been minor adjustments to earnings estimates for the year and in particular for resource-based companies mainly due to an upgrade in the forecast for the average crude palm oil price. The banking sector too may see better growth in 2022, mainly driven by economic momentum as well as expansion in net interest margin on the back of higher OPR by another 25bps later this year.

However, pricing pressure is also evident due to the rise in commodity prices which is eating into the profitability of listed companies.

While some can pass on the additional cost to consumers in the form of higher prices, others are seeing a contraction in earnings.

For 2022, from the earlier forecasted earnings contraction of 2.9% at the end of the 4Q21 quarterly reporting period, the revised estimate now shows earnings growth of 0.6%, a 3.7 percentage points improvement.

This is despite the one-off Cukai Makmur, which otherwise would lift earnings estimates by 10.9 percentage points to 11.5% for 2022.

Not many changes were made to earnings for 2023 as earnings are now estimated to grow by 12.6% from the 12.7% that was estimated in the preceding quarter.

Index wise, except for a 25 points upgrade to the FBM KLCIs fair value by one brokerage firm to 1,647 points, most broking firms have maintained their respective FBM KLCI target for this year, which range between 1,635 and 1,745 points, or an average of 1,680 points. This is some 11.3% higher than the 1,509.71 points on the FBM KLCI as at Thursdays close.

Interestingly, while most brokers have maintained their respective target values, it was derived at a lower price earnings ratio multiple of 14.5 times instead of 15.4 times previously, basically incorporating the risk that the market is up against in the second half of the year, which among others may include persistent inflation pressure, slowing growth, tighter liquidity, rising interest rates and the likelihood that the 15th General Election may be called as soon as August or September.

The fear of the three I

Invasion, inflation, and interest rates the three I sums up what to expect for the rest of 2022 as the Federal Reserve (Fed) has not only begun interest rate hikes but its quantitative tightening (QT) plan that will take away US$95bil (RM417bil) per month from the market over the next 12 months.

As for rate hikes, the market now expects the Fed fund rate to reach 2.75% to 3% this year from the current level of 0.75% to 1%, a full 200bsp hike to go, before rising by another 50bps in the first half of 2023 to 3.25% to 3.5%.

As it is, the Fed has already raised rates by 75bps this year as it remains behind the curve against elevated inflation prints but also against inflation expectations.

The Russian invasion of Ukraine recently reached 100 days since Vladimir Putin invaded various regions and is said to have now controlled about 20% of Ukrainian land. While the west has tried many ways to curtail the Russian move against Ukraine via sanctions, Moscow has so far not been perturbed by the moves but instead stepped up its efforts.

It has come with a price, although the ruble has rebounded to levels before the invasion, the Russian economy is suffering from the economic fallout that comes with its aggression.

The war has had an impact not only on Russia but the world over as the World Bank lowered its forecast to 2.9% early this week from 3.2% that it estimated in April.

The International Monetary Fund too will likely follow suit as it last lowered the global growth rate to 3.6% in April, taking into account the slowing economic momentum out of China as a result of recent Covid-19 lockdowns in major cities.

Timing the market re-entry

While the FBM KLCI is down 3.7% year-to-date, its performance when measured in dollar terms shows the market is now down 9.1% and remains an underperformer when measured against its Asean counterparts as seen in Chart 2.

All Asean markets are weaker year-to-date due to the dollar strength as the dollar itself is up 1.9% against the Singapore dollar; 2.1% against Indonesias rupiah; 3.8% against the Thai baht; and 3.9% against the Philippines peso. The ringgit has been the weakest among the regional currencies, falling 5.4% year-to-date.

As mentioned earlier, equity markets are now up against a relentless Fed that is persistent in its view that it needs to bring inflation down, with the hope of manoeuvring a soft-landing for the US economy.

But just like any policy measures, the Feds move will likely be driven by data and how core personal consumption expenditure and the labour market play out over the rest of the year, and if data shows that the economy is headed towards recession or a hard-landing, the Fed will, in all likelihood, engage the handbrakes and either pause or reverse the Fed fund rate hike path.

The Fed may even stop its QT move to support an ailing economy and hence that would be a signal of the market bottom as any measures that are seen to support the financial market, will be welcome.

Pankaj C. Kumar is a long-time investment analyst. The views expressed here are the writers own.

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Watch the Federal Reserve - The Star Online