The driving force of GE14
Stephanie Jacob 
Election years tend to be a boon for market sentiment, says Kaladher
ELECTIONS will somehow impact a country’s financial markets. In the case of some developed countries, an election outcome may even impact the global economy.

With Malaysia due for the 14th general election (GE14) somewhere between now and August next year, there is likely to have some effect on both the markets and economy in the build-up to the polls and after results are made known.

In the Malaysian context, election years tend to be a boon for market sentiment, according to a recent TA Research (Q2 2017 Market Outlook) report. “Historical data showed that market sentiment generally improved in election years,” its head of research Kaladher Govindan points out.

The general perception is that the equity market is used as an avenue to raise funds for the election machinery. Stocks seen to be linked to certain political parties are likely to appreciate in price prior to the election.

As most blue chip counters are owned by government-linked funds, rallies in these stocks have contributed to a rise in price-earnings multiples in past election years.

“The multiples averaged 16.9 times in the last four election years [excluding the outlier 2008 due to the subprime crisis],” Kaladher observed. “History is poised to repeat itself, mainly driven by sentiment.”

During the 13th general election in 2013, one-year forward PE ratio multiples expanded to 17.6 times from the 15.8 times it had been a year before.

Stock market booster

Kaladher believes a similar scenario is very likely to repeat itself prior to the dissolution of Parliament. Furthermore, the benchmark could hold on to its gains if the ruling party can at least maintain their current majority in Parliament and hold on to its states.

Technically, the election can be held as late as Aug 24 next year. Till then, the prime minister might decide to dissolve Parliament anytime. On this note, Kaladher believes there is strategic value in holding the elections at some point after October’s Budget 2018.

This is given the government can use the occasion to make gestures of appeasement to voters by addressing their raft of concerns. Moreover, the Chinese president is expected to visit Malaysia that same month, thus opportunity abounds for the government to announce more details on the slew of mega projects between both countries.

In light of such events, Kaladher sees a likelihood of the polls being called at the end of the first quarter (Q1) or early second quarter next year.

“We believe an election would only be [held] somewhere in March or April next year,” he says. “Thus, if the benchmark index fails to hit our 1,890 target by the end this year, we believe it will eventually with the rally possibly extending into Q1FY18.”

Meanwhile, Alliance DBS Research’s Monthly Strategy report believes that markets are expected to be quieter in Q3CY17 after an exciting H1CY17. Nevertheless, market sentiment is expected to pick up in the final quarter after Budget 2018 is announced and ahead of the general election.

“We believe a much more vibrant Q4 is in store. It is historically the strongest quarter as the government unveils its last budget in October before it calls for a general election that is due in 2018,” its head of research (Malaysia) Bernard Ching points out.

Investor sentiment

Since 1978 investors have shown little signs of risk averseness from the point of the dissolution of Parliament to election day, noted TA Research’s Kaladher.

About six out of nine times, the FBM KLCI ended the period on a positive note. Average gains were notably higher compared to losses during the period.

However, market reaction post-election is heavily dependent on the outcome of the polls, says Kaladher. If Barisan Nasional (BN) retains its current position without much changes, a minor rally can be anticipated.

In the event the ruling coalition can secure a two-thirds majority, a greater rally is possible. “We would not be surprised if the KLCI PE multiple for CY18 expands to 17.5 times which values the index at a new all-time high of 1,955,” he noted.

On the contrary, in the unlikely event that BN loses the election, an adverse reaction, including a possible sell-down due to uncertainty over the new government’s policies, can occur. If this happens, Kaladher foresees the KLCI taking a while before returning to normal.

“Under this scenario, chances for the index to plunge to around 1,400 level is highly possible [about -1.5 standard deviation from its long-term mean PE multiple of 15.1 times],” he added.

Earnings and fundamentals

Based on its in-house research of elections held over the past 35 years, research analyst Jerry Lee is of the view that during the 90-day period post-election, the local equity market sees about 6% of returns (while one year on markets usually deliver about 16% returns).

However, he stresses that investors react too strongly to election-related news cycle. “We believe that investors tend to overreact to the news and the rumours,” reckoned Lee. “And this is the thing that leads to fluctuations in the equity market.”

He further argued that what actually drives the equity market are earnings and fundamentals of the economy. Therefore, these are the factors which should also drive investor decisions.

“Hence, should there be a fall in the market as a result of election-related factors but no changes to the economic fundamentals, we would encourage our investors to increase their holdings given the earnings and fundamentals are intact,” added Lee.

This article first appeared in Focus Malaysia Issue 241.