Malaysia: wolves return

"We are like wolves on the ridge line looking down on a herd of elk." So said a hedge fund manager two decades ago. Back then, traders focused on vulnerable southeast Asian currencies such as the Thai baht. Thailand suffered massive capital outflows but left its currency to float free. Not so Malaysia. That country shut its capital markets to nasty foreign influences from September 1998 until July 2005.

As the oil price keeps falling, the wolf pack has returned. Though not one of the world's largest oil exporters, Malaysia does rely on oil income. In 2013, oil contributed roughly half of government revenues. Next year that should fall to about a fifth, thinks CLSA. All that hard currency will be missed and could affect the country's investment grade credit rating. Meanwhile, the ringgit has lost 13 per cent against the US dollar since late August, more than any other southeast Asian currency.

Note that foreign investors (as of September) owned nearly half of all local government, ringgit-denominated debt, worth roughly $19bn. Nine years ago they held 5 per cent. This amount is the equivalent of a third of its foreign exchange reserves. Any threat to its credit rating is likely to cause more outflows of capital from the country. So it comes as no surprise that Malaysia's Ministry of Finance earlier this month directed all government-controlled companies to stop purchasing overseas assets.

Malaysia's stock market carries a premium valuation at 15 times forward earnings against 12 for Asia (ex Japan). In 2010, Asia traded just below Malaysia's multiple. For those committed to Malaysian equities, focus on defensive companies such as Axiata (telecoms), which has holdings spread around southeast Asia, and Tenaga (electric power) on a 5 per cent yield.

The combination of a weakening currency and an overvalued stock market is not attractive for outside capital. A fight between wolves and elk is never pretty. Don't get in the middle.

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