By Devanesan Evanson
THERE has been widespread criticism in recent times that the upside momentum of the stock market is no longer guided by economic fundamentals but instead – in a poetic tone – leading a life of its own that is detached from economic reality.
This is especially evident in the Dow Jones Industrial Average (DJIA) which is reputed to be one of the most cited global financial barometers.
For starters, the longest bull market in history is still very much alive and kicking despite the ravages of the COVID-19 pandemic which are likely to affect corporate profits for the next few more quarters – not to mention the health crisis having already inflicted massive unemployment worldwide and disruptions on businesses.
In fact, the US’ foremost benchmark index is not far off its all-time high of 29,551.42 which was reached on Feb 12 this year judging from its close of 28,606.31 points on Oct 16.
By virtue of the DJIA being the financial media’s most referenced US market index, many lay investors have mistakenly leverage the tracker of 30 of the most highly capitalised and influential companies in the US economy (market caps in excess of US$100 bil) as the ultimate gauge of the stock market’s pulse.
Well, even if the DJIA remains a good indicator of general market trends/direction, the benchmark index may not provide an ideal representation of the overall market sentiment given the New York Stock Exchange is home to some 2,800 companies while the DJIA only tracks the performance of 30 component stocks.
Henceforth, a similar argument applies to the S&P 500 and Nasdaq Composite which together with DJIA, make up three of the most-followed stock market indices in the US and the world. Although the S&P 500 represented 500 of the largest US corporations, a subset of truly giant corporations is driving market gains.
Rich man’s game
As Heather Boushey, president and CEO of the Washington Centre for Equitable Growth, aptly puts it, “stocks are overwhelmingly owned by the top 1%” and “most directly, it indicates the financial health of the richest among us” (Source: Washington Post, Sep 10 2020).
Echoing Boushey’s observation is Nobel-winning economist Paul Krugman who said stock prices have never been closely tied to the state of the economy for they are disconnected from indicators such as jobs and economic output.
Krugman argued that the market values of tech companies, for instance, have little to do with their profitability or the economy. “Instead, they’re all about investor perceptions of the fairly distant future,” he justified. In other words, as long as investors expect Apple to be profitable years from now, they barely care what will happen to the US economy over the next few quarters.
As pointed out by McKinsey & Company in a recent paper titled Wall Street Versus Main Street: Why the Disconnect?, the US stock market has remained resilient during the COVID-19 crisis because of three critical factors that reflect certain truisms about (i) valuations, (ii) the market’s composition, and (iii) investors’ expectations.
To begin with, the stock market values individual companies from various sectors, and these companies add up to the whole. Therefore, under current circumstances, performance differs vastly within and across sectors.
Performance of companies in oil and gas (O&G), banking, and travel, have been negatively impacted by the pandemic.
Some companies in pharmaceuticals and in technology, media, and telecommunications (TMT) are actually doing better now than they were at the beginning of the year – in part because the introduction of new products and services affects them more than the health of the broader economy does.
As a result, the stock market’s aggregate value remains resilient.
Underperformers aplenty
In the same merit, it can be observed that the FBM KLCI bears similarity to the DJIA in that it comprises 30 of the largest companies by full market capitalisation on Bursa Malaysia’s Main Board.
As it can be observed, the performance of the benchmark index may or may not have bearing on the market direction of the other 735 Main Market companies or that of 135 ACE Market and 35 LEAP Market companies which altogether make up a total of 934 companies in the local bourse.
In fact, the performance of Malaysian stock market has been very much dominated by glove-related counters in recent times, especially that of the Big Four glove counters which have out-performed many of their peers from other industrial or economic sectors.
This is especially true as many companies in the financial services, construction/real estate, O&G, consumer products/services and plantation (palm oil) sectors are still languishing from the effects of financial devastation stemming from the COVID-19 health crisis.
A good example is the narrowing gap between Malayan Banking Bhd’s (Maybank) market capitalisation and that of Top Glove Corporation Bhd which is touted as the world’s largest rubber glove maker.
Meanwhile, another rubber glove maker, Hartalega Holdings Bhd, has taken the spot as the third largest company on Bursa Malaysia, pushing Public Bank Bhd to the fourth place (albeit a very small gap exists between them).
This has led to speculation that two other major glove counters, namely Supermax Corporation Bhd and Kossan Rubber Industries Bhd, are very likely to replace Genting Bhd and Genting Malaysia Bhd – two lacklustre FBM KLCI component stocks – in the next review of the benchmark’s constituents.
Minority shareholders should not be fixated with the rally in FBM KLCI index which only tracks the top-30 PLCs by market capitalisation. They must be aware of the disconnection between the FBM KLCI index and the other PLCs and invest in an informed and discerning manner.
Devanesan Evanson is the CEO of the Minority Shareholders Watch Group, an independent research organisation to encourage good governance among public listed companies with the objective of raising shareholder value over time. He can be reached at [email protected].
