Monday, 7 May 2018


Malaysia goes to the polls. Image link (and great article) here.

In my previous posts I've expressed my enthusiasm on the general election as a trading catalyst. I can only speak from the perspective of a risk averse trader with limited funds and a desire for capital preservation, but I will not hesitate to pull the trigger if I see a good trade in the short term.

While there are pockets of opportunities (banking stocks) to be found in what has been a horrendous decline for the KLCI over past few weeks, you can't be too risk averse that you deprive yourself of the opportunity to achieve short term yields of at least 5% on your stocks portfolio. You can only get this by accumulating a position before May 9, somehow, somewhere.

This is not a post about interest rates, Federal Reserve policy, inflationary expectations, or the trampling of emerging market currencies. This post is about my expectations on how the market will look on May 10, and the possibility of taking on a trade with a very favourable risk-to-reward ratio - this is all that matters.

But first, let get the unseemly stuff out of the way. You need to make up your mind about the state of Malaysian politics. And given the poor media coverage of the state of the country and the failure of our so-called experts to understand the Malay/Chinese/Lain-lain psyche, you won't get any help from the outside; these things you will have to think for yourself.

There are a few potential angles and possibilities that I'm considering to justify my main theory : that the market is overpricing risk and underpricing a larger than expected Barisan Nasional victory. This means only one thing : FBM KLCI call warrants are underpriced right now. You can trade them on the expectation of a large one-day gain on May 10, if status quo prevails.

This is the part where I list out the reasons why BN can win big in short and sweet sentences without turning this post into a biased, totally out-of-touch political thinkpiece (nobody wants to read that) : redelineation of urban seats will weaken the Opposition's strong foothold in these areas, the infighting between Opposition component parties, particularly in PKR, the lack of a coherent strategy for Pakatan Harapan, the parachuting of new PH candidates from out-of-town into supposedly 'safe' seats (potential complacency there?), PAS splitting the Malay votes, three and four-cornered fights in key state and parliament seats to hurt PH representatives the most, money politics, expected status quo in both Sabah and Sarawak, money politics, etc, etc...

That wasn't very interesting, was it? Moving on.

I believe that the markets are underpricing the following possibilities at the moment. This basically means that the FBM KLCI is fully pricing in prevailing concerns and risk aversion, but not the potential upside (and downside) catalysts :

1) A decisive victory for BN, defined as : a recapturing of the popular vote (51%), and a better than expected number of seats won/recaptured. An added bonus would be a decisive majority in Perak and Kedah, as well as the potential capture of Kelantan (it's probably their best shot at winning the state in at least 30 years). 

2) Significant gains for PH without winning a simple majority at the Parliament level, defined as : Victory in Perak and Kedah, plus a huge swing in the voting demographic in key BN vote banks of Johor, Sabah and Sarawak. Status quo for PH elsewhere, including in Penang and the major urban seats.

3) A hung parliament where neither side has the requisite number of seats to form a government. This is where PAS and minor component parties become kingmakers. Take a guess on who they will side with? (hint : there's only one direction this dacing is going to sway).

4) A huge, historic win for PH. But if the markets were taking this possibility seriously the KLCI would've tanked a long time ago.

The one thing that the market is pricing in properly at the moment? Pessimism, global market uncertainties, and the staying-in-the-sidelines mentality.

My personal opinion is that (1) is much more likely than (2). (3) and (4) are unprecedented; we don't know if such a thing will bring about martial law, social unrest, or peace on Earth. So they're the least likely possibilities.

Visions of a post-apocalyptic Malaysia. Image link.

Here's another personal political viewpoint for you : I firmly believe that the election results will swing strongly in one way or another, making a hung parliament situation unlikely. But the key here is this; even if BN performs meekly during GE14, let's say with roughly similar results to GE13, the market rebound will still be strong. The expectation of a status quo will be enough to propel the KLCI upwards on May 10, not to mention the promised infrastructure projects and relative economic stability.

My expectation is this. Obviously I can be completely wrong on any or all of these points :

A) Status quo prevails.

B) A larger than expected BN victory is an added positive boost for the markets.

C) A conservative projection of an immediate increase of 3% to 5% in the FBM KLCI in the week immediately after May 9.

D) The current pessimism in the market is causing a short term mispricing in the FBM KLCI. This is purely a short term sentiment thing, not so much a reflection of valuations or fundamentals.

So what can you do with this? You can accumulate FBM KLCI call warrants. They're cheap, they cover the breadth of the index, and they're much easier to accumulate than buying a basket of politically sensitive stocks. Think of them as a short term index fund.

Here's the caveat though : the favourable risk-to-reward expectation lies in the assumptions that BN's going to win, that the market is underpricing the upside, and that the market is disregarding a larger than expected BN victory. The downside is very real (consider situations (2) and (3)) , so your convictions must be strong enough to pull of this trade.

In other words, you must be willing to lose 5% to gain 15%.

Consider one of the many call warrants out there : FBMKLCI-C3V. Assuming that the current relationship between the breakeven point (1,862.50) and call warrant price (0.125) holds, these would be the call warrant's price given a market rally scenario, using today's price:

1) FBMKLCI gains 3%, based on current KLCI price of 1,828 (11:30AM, May 7) =  1,882.84
    Theoretical FBMKLCI-C3V price = 0.165*
    Potential upside = 32%

2) FBMKLCI gains 5%, based on current KLCI price of 1,828 (11:30AM, May 7) =  1,919.4
    Theoretical FBMKLCI-C3V price = 0.23*
    Potential upside = 84%

Note that these are for illustrative purposes only. But I believe they do help convey the potential magnitude of gains that are feasible from an immediate market catalyst, such as a post-election relief rally.  

To sum it up : investors' risk aversion may have caused the market to be undervalued right now. Once the election is done with, there is real cause of optimism on the state of the Malaysian economy (I'll go into PE ratios and GDP expectations on another day).

Still unsure of the KLCI's prospects? Take a hint from the banking stocks; these behemoths ultimately determine the market's direction due to their outsized influence in the index, of course.

Big names like Public Bank, Maybank and CIMB are already flirting with their all time highs in recent weeks. Some of them made record profits last year in spite of benign interest rates.What do you think will happen to their stock prices once all the uncertainties are over? 

Let's see what happens on May 10.

* This is purely based on the current relationship between the call warrant price and the KLCI's price. This link can fluctuate at any time, so approach with caution. The basic calculation is this: (1,882.84 - 1,800 (the call warrant's exercise price) / 500 (the exercise ratio) = 0.165