I would like to share the following quote:

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How irrational it may be, a market may remain “elevated” for a foreseeable future.

How may I describe Malaysia’s FBMKLCI?

From my personal perspective – technically, it is parabolic + free bars + overbought. Again, market may continue to remain elevated.

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Nevertheless, let’s take a look from the opportunity cost perspective. What is the opportunity cost of investing in FBMKLCI / equity market in Malaysia? To answer this, one may benchmark the earnings yield of FBMKLCI (i.e the inverse of price-earnings ratio) against the average yield of 10-year AA3 corporate bonds. Why AA3 – this rating represents the lowest investable grade (for most fund managers / institutional funds in Malaysia). In a nutshell, since equity is more risky, one should demand higher yield on equity if compared to corporate bonds. If the yield spread between FBMKLCI and 10Y AA3 corporate bonds narrows, it may indicate that the FBMKLCI is potentially overvalued.

The following graph highlights the yield spread between earnings yield of FBMKLCI and average bond yield of 10Y AA3 Corporate Bonds since year 2003. Narrowing yield spread usually precedes the fall in the equity index / market (e.g 2006 – 2009, 2013 – 2016). Lately, we are seeing a divergence whereby the FBMKLCI continues to climb whilst the yield spread narrows towards the historical median of about 51bps. Increasing rate hike environment may lead to further narrowing of yield spread, thereby resulting in potential future correction in the equity index / market. Nevertheless, it is imperative to note that the market can remain irrational longer than you can remain solvent.

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