PERFORMANCE OF CYCLICAL SECTORS ON THE U S E

P.KHIDMAT MAKLUMAT AKADEMIK

PROFESSOR DR. SHAMSNER MUHAMAD

BY

POOBALAN Sf0 TANA SHINGAM

00-02-0549

This project is a dissertation to

Faculty of Economics and Business in University Malaysia Sarawak

(UNIMAS)

to f~tlfill the requirement of being conferred the

Master in Corporate Business Admillistration

UNIVERSITY MALAYSlA SARAWAK

Sarawak

(2000/200 1)

APPROVAL PAGE

I certify that I have supervised and read this study and that in my opinion it confor~ns to

acceptable standards of scholarly presentation and is fully adequate, in scope and quality,

as a research paper for the degree of Corporate Master in Business Administration.

Professor Dr. Shamsher Muhamad

Supervisor

This research paper was subnlitted to the Faculty of Economics and Business, UNIMAS

and is accepted as partial fulfil~nent of the requirements for the degree of Corporate

Master in Business Administration.

Assoc. Prof. Dr. Shazali Abu Mansor

Dean, FEB

UNIMAS

DECLARATION AND COPYRIGHT

Name : Poobalan S/O Tana Shingam

Matric Number : 00-02-0549

I hereby declare that this research is the result of my own investigations, expect where

otherwise stated. Other sources are ach~owledged by footnotes giving explicit references

and a bibliography is appended.

Date : 1514-2002

O Copyright by Poobalan S/O Tana Shingain and University Malaysia Sarawak

DEDICATED TO:

MY PARENTS, TANA SHINGAM AND THILAGAVATHI

MY WIFE, KOKILANDESWARI

MY BROTHERS AND SISTERS

MY RELATIVES

ACKNOWLEDGEMENT

First and foremost, I wish to express my heartfelt gratitude and appreciation to my

supervisor, Professor Dr. Shamsher Muhamad of the Faculty of Economics and

management, University Pntra Malaysia, for his invaluable advice, patient supervision,

unreserved assistance, guidance and encouragement throughout the period of this study,

which subsequently, made this project paper a reality.

Many thanks are also due to the staff of faculty of Economics and Business University

Malaysia Sarawak and Bursa Saham Kuala Lumpur, Central Bank's librarians, Vital

Statistics and International Financial Statistics and also librarians from the National

University of Malaysia for the guidance and services rendered to me in completing my

project paper.

I also wish to express my gratitude to my friends who had passed on me invaluable

knowledge and advices throughout the years of this study. Lastly, I would like to dedicate

this project paper to my dearest parents, brothers and my relatives for their love, support,

encouragement and profound concern for me all these years.

I also would like to send special words of thanks to all my course mates and wish them

all the best for their future undertaking.

CONTENTS

Approval page

Declaration and copyright

Dedication

Acknowledgement

Tables of contents

List of tables

List of appendices

Abstract

Abstrak

CHAPTER ONE

1.0 INTRODUCTION

1.1 Background

1.1.1 Cyclical and non-cyclical industries

1.2 Problem Statement

1.3 Significance of the study

1.4 Objectives

1.5 Organization of the research

PAGES

ii

iii

iv

v

vi - viii

viiii

X

xi

xii

CHAPTER TWO

2.0 LITERATURE REVIEW

2.1 Background

2.2 Risk and returns

CHAPTER THREE

3.0 METHODOLOGY

3.1 Scope of study

3.1.1 Correlation analysis

3.1.2 Colnposite index

3.2 Sample selection

3.3 Data collection and methods of analysis

3.3.1 Retulns

3.3.1.1 Arithmetic return 3.3.1.2 Geometric return .

3.3.2 Correlation Coefficient

3.3.3 Rislts

3.4 Hypothesis

3.4.1 T - Statistics

.- vii

CHAPTER FOUR

4.0 ANALYSIS AND FINDINGS

4.1 Analysis of the overall sample: Correlation with the market

4.2 Analysis of return

4.2.1 Hypothesis Testing of Return

4.3 Analysis of Risk

4.3.1 Beta Values

4.3.2 Market Risk and Hypothesis Testing

4.4 Returns per unit of Risk

4.5 Arithmetic and geometric returns

4.6 Overall Performance of Indices

4.6.1 Cyclical sectors

4.6.2 Non-cyclical sectors

CHAPTER FIVE

5.0 CONCLUSION AND RECOMMENDATION

5.1 Conclusion

5.2 Limitation of the study

5.3 Recommendation

Bibliography

Appendices

LIST OF TABLES

Tables

1.1 KLSE Composite Index - year end values

3.1 Major sectors on the Main Board Companies list for the period from 1995 to 2000

3.2 Major sectors on the Second Board Companies list for the period from 1997 to 2000

4.1 Correlation of Sectorial Returns with the Market Returns

4.2 Sensitivity of Sectorial Returns with the Market Returns

4.3 Average Return (Arithmetic Mean) - Composite index

4.4 Average Return (Arithmetic Mean) - Other sector indices

4.5 Returns of Composite Index and Other Indices

4.6 Returns of Cyclical sectors -Paired Samples Test

4.7 Risk of Cyclical sectors -Paired Samples Test

4.8 Analysis of returns per unit of risk

4.9 Sectorial Returns per unit of Risk - Paired Samples Test

4.10 Comparison between Average return on Arithmetic and Geometric Means

4.1 1 Arithmetic and Geometric - Paired Samples Test

4.12 Cyclical Sectors - Paired Samples Test

4.13 Non cyclical sectors - Paired Samples Test

Page

6

viiii

LIST OF APPENDICES

Appendix 1 - 2 Indices on KLSE base on high, low and average -monthly closing value

Appendix 3 - 4 Calculation on Holding Period Return for three sub-periods

ABSTRACT

This study attempts to examine the relationship between the stock market, risk

and returns before, during and after crisis for the period from 1995 to 2000 of cyclical

and non-cyclical sectors in Malaysia. The Kuala Luinpur Stock Exchange Composite

Index (KLSE CI) represents the stock market, risks (in %) and the returns (in %).

The objective of this study is to identify the cyclical and non-cyclical sectors of

public listed companies on the Kuala Lurnpur Stock Exchange (KLSE). This study

attempts to identify the cyclical and non-cyclical sectors and to ascertain the impact of

risk and returns on the cyclical and non-cyclical sectors. The analysis is done on the

performance of stock prices of sampled sectors pre-, during- and post-crisis.

The findings suggest that eight sectors on the KLSE of this study are positive

correlation coefficient. However, there are sectors with lower positive coefficient

correlation for the period from 1995 to 2000, which can be concluded as non-cyclical.

Customer products, industrial products, construction, tradingtservices and finance sectors

are the cyclical sectors. On the other hand, property mining and plantation sectors are the

non-cyclical sectors. The implication from this study is attempts to help investors to make

better decision in certain time, for example in crisis period, the investors may invest in

non-cyclical sectors and vice versa. /

ABSTRAK

Kajian ini bertujuan untuk menguji hubungan antara pasaran saham, risiko dan

pulangan sebelum, semasa dan selepas krisis sektor-sektor 'cyclical' dan bukan

'cyclical'di Malaysia untuk jangkamasa dati tahun 1995 hingga 2000. Pasaran saham

diwakili oleh I<oinposit Indeks Bursa saharn Kuala Lumpur (KLSE CI), pulangan

diwakili oleh (%) dan risiko juga diwakili oleh (%).

Objektif kajian ini ialah untuk mengenalpasti selttor-sektor 'cyclical' dan bukan

'cyclical' syariltat-syarikat awam di Bursa Saham Kuala Lumpur (BSKL). Kajian ini juga

cuba mengenalpasti sektor 'cyclical' dan bukan 'cyclical' serta meinastikan kesan risiko

dan pulangan terhadap sektor 'cyclical' dan bukan 'cyclical'. Analisa ini dibuat terhadap

prestasi harga-harga saham syarikat-syarikat sample sebelum, semasa dan selepas krisis.

Penemuan menunjukkan bahawa kesemua lapan sektor yang terdapat di KLSE

daripada kajian mempunyai 'correlation coefficient' positif. Namun, terdapat sector yang

mempunyai 'correlation coefficient' positif yang rendah dari tahun 1995 hingga 2000,

dimana sektor ini dikenalpasti sebagai bukan 'cyclical'. Sektor barangan pengguna,

barangan perindustrian, pembinaan, perdaganganlperkhidmatan dan kewagan adalah

'cyclical'. Sebaliknya, sektor-sektor ha~ ta tanah, perlombongan dan pertanian adalah

bukan 'cyclical'. Penemuan kajian ini dapat menolong pelabur untuk membuat keputusan

pelaburan pada masa yang tepat, contohya pada tempoh krisis , pelabur mesti melabur

dalam sektor bukan 'cyclical dan sebaliknya.

, xii

CHAPTER ONE

INTRODUCTION

1.1 Background

The East Asian economic crisis is probably the most important economic event in

the region for the past few years. In July 1997, a number of East Asian economies had

encountered financial and exchange rate crisis. Five countries suffered sharp exchange

rate declines: Thailand, South Korea, Malaysia, Indonesia and the Philippines. Even

Hong Kong, Singapore and Taiwan, countries with impressive foreign reserves, were also

affected to some extent.

The crisis started from Thailand then spread to Malaysia, Indonesia, and

Philippines and later to South Korea. The international establishment (represented by the

International Monetary Fund - IMF) and the G7 countries attributed this crisis to the

domestic ills in the East Asian countries. However, there are economists and politicians

who are of the view that the crisis is due to a number of factors. It is too early to blame

currency speculators for a market-induced devaluation. Second, there are some financial

factors which can explain why those Asian governments kept the pegged exchange-rate

regime so long, and also why the inarltets reacted so drastically.

Third, there are macroeconoinic fundamental factors. With overly ambitious

development targets pursued by the governments, many of the Asian economies were

overheating with high inflation rates and largc trade deficits, contributing to heavy

external borrowing and currency overvaluation. Their stock and real estate values were

inflated too much and ready to collapse at any moment. In any event, their growth

expectations were too high and had to be adjusted to a sustainable level. Fourth, there are

political and structural factors. In the process of economic development in Asia, many of

the political leaders became de-facto dictators, based on their antiquated political systems

with special privileges for their inner circle and widespread corruption in key government

sectors. Finally, IMF has extended its assistance in an attempt to help ease the Asian

crisis and to restore some confidence in the markets, although there is much criticism of

the IMF's remedies for the crisis.

Malaysian stock market was the fifth biggest market in Asia in terms of market

capitalization prior to the Asian financial crisis. The market drew enormous interests

among local as well as foreign investors mainly due to many favorable features of the

Malaysian economy especially stable political environment and sustained economic

growth for more than ten consecutive years after the recession in 1985. During the five-

year period leading up to 1996, its real GDP growth averaged at 8.7% per annum,

whereby inflation was around 3.8%. However the economic and financial turmoil

sweeping this region brought Malaysian stock market on its knees.

From the high of 1271 point level in February 1997, the Composite Index (CI)

plunged to 447 points in January 1998 losing about 800 points or 63% in just one year. At

the high level in 1997, the inarket capitalization was RM917 billion but sank to RM309

billion by January 1998 W A C , 1998). The stock inarket continued to face downward

pressures and that the CI index reached its lowest level of 262 points on 1'' September

1998.

In view of their background, this study intends to research an impact of the crisis

on the cyclical and non-cyclical sectors for the period from 1995 to 2000.

1.1.1 Cyclical and non-cyclical industries

A cyclical industry is sensitive to business cycles and the performance is highly

correlated with the performance of the overall economy. Examples are finance,

construction, tradinglservices, industrial products and customer products industries. On

the other hand, non-cyclical industries are those firms with sales and profits that are not

regularly expanded and do not contract along with the business cycle. For an example,

property, mining and plantation sector. When the economy is booming, the cyclical

industry indices increase in conjunction with the economic conditions.

1.2 Problem Statement

The identification of cyclical performance on the KLSE is important since it can

be used as a financial input by most of the investors to study the trend on business cycle

and forecast the expected changes in the economy.

Yet there are still many who not only question the validity of cyclical phenomena

but who challenge the very existence of such phenomena. Throughout the centuries,

however, there have been a few outspoken thinkers, astute observers, who have

recognized, documented, and analyzed both the existence and the important of cyclical

phenomena.

And so it is in the world of economic and finance. Critics claim to be awaiting

conclusive results of the considerable study necessary to isolate and demonstrate the role

of cyclical sector performance as repetitive rather than random performance. Yet many of

them do not realize that a great deal of evidence has already been accumulated to support

cyclical tools.

The need to consider actual relationships between the risk and the return of the

cyclical and non-cyclical sectors appeared to be urgent.

1.3 Significance of the sturly

The financial crisis in July 1997 is unprecedented, as the magnitude of the crisis

has stretched from a regional to a global scale. It has far-reaching effects on the

economic, political and social spheres of the country.

This study is important as it provides evidence to the current literature on the

relationship between risks and returns of cyclical and non-cyclical sectors during

turbulent times. Particularly, this study will contribute significantly to investors. Such

evidence would enable the investors to make decisions in Malaysia for investment

decisions or investment strategy to diversify the investment in few sectors to gain high

return and to reduce the risks.

Knowing the actual relationship among these variables, on the cyclical and non-

cyclical sectors based on risk and returns analysis. Investors as well the policy makers

would be able to overcolne the deterioration in the KLSE more effectively as guidance

are provided on the short and long term actions in order to strengthen investment

strategy.

Lastly, this study will contribute significantly to financial literature, which helps

investors in many ways as it formulates planning or strategy and investment models to

restore the functions of the markets.

5

1.4 Objectives

This study attempts to examine the relationship between the risk and returns of

different sectors, before, during and after crisis from year 1995 to year 2000 and

identifying cyclical and non-cyclical sectors at the Kuala Lumpur Stock Exchange

(KLSE). The Kuala Lumpur Stock Exchange Composite Index (KLSE CI) represents the

stock market returns against the risk.

The main objective of this study is to assess risk and return of cyclical and non-

cyclical companies listed on the KLSE. Specifically, the study will attempt to answer the

following questions:

i) Performance of cyclical and non-cyclical sectors.

ii) Are there any significant differences in the risk and return of companies in

cyclical and non-cyclical sectors countelyart for the period before, during and after the

financial crisis?

Table 1.1 : KLSE Composite Index - year end values

(Source: Investors Digest, December 1996 to January 2001)

1.5 Organization of the research

This thesis is organized into five chapters. Chapter one highlights the background

of the case in question, particularly the overview of financial crisis experienced by the

country. This chapter also states the objective of the study, the statement of problems,

significant of the study, terms and definitions and organization of the study.

Chapter two deals with the review of the related literature over the subject matter.

Chapter Three specifies the methodology employed, explains how samples and data

chosen as well as the analysis of data in line with the stated hypothesis. Chapter Four

highlights the results and findings of the study and also explains and interprets the results

of various analysis performed in the study. Chapter Five concludes some

recommendations for future research.

CHAPTER TWO

LITERATURE REVIEW

2.1 Background

The analysis of cyclical sectors is important as it can be used as a tool in the

fmancial market. Edward R. Dewey (1894), the "Father of Cyclical Analysis", devoted a

great deal of his research to the study of cycles in stocks, and his efforts were fruitful

indeed. Dewey isolated numerous stock cycles, the most statistically reliable of which are

the approximate 9.2-year, 3.83-year, and 17.1-week cycles. While his work has been

continued by the Foundation for the Study of Cycles, there are only a handful of

contemporary cyclical analysts who have continued his pioneering efforts.

Most of our contemporary knowledge of cycles in the stock market come from the

work of Edward R. Dewey (1 894). His research revealed perhaps more than 50 reliable

cycles in stock prices, all of which he analyzed and updated regularly in the foundation's

publication, Cycles. His work was carried on by Gertrude Shirk, who also researched

cycles in stocks (and other economic data) at the foundation. In the 1990s the foundation

has continued its excellent work, and it is fiom their research where most of the

information in this section is derived.

Shirk tested a number of cycles in the stock market. Findings showed at least

seven of which had F-test significance levels from .001 to .005, extremely good results

suggesting that the cycles were reliable. These cycles are 9.225 years, 10.36 years, 5.014

years, 4.803 years, and 4.15 years. You will note the clustering of cycle lengths in the 9-

10 year and 4-5-year range. These approximate cycle lengths are the most dominant

cycles in the stock market and have received the greatest amount of study. They also have

the largest body of statistical evidence to support them.

2.2 Risk and returns

The study of risks and returns characteristics of individual stocks is the important

key in investment decisions. It is generally accepted that the total risks of investment in

financial assets consist of non-systematic (diversifiable) and systematic (non-

diversifiable) risks. Diversifiable risk is attributed to factors, which are specific to the

firm issuing the security and can be eliminated through diversification of the investment

by holding a basket of dissimilar securities rather than one or a few similar securities. The

non-diversifiable risk is due to factors which influence all securities in a given security

market, and hence constitutes the only relevant risk in investment decision. In this regard,

beta is normally used as a ineasureinent of systematic risk.

However the use of beta as a measure of systematic risk is disadvantaged by the

instability of beta. A stable beta is important to investors for evaluating the performance

of portfolio managers. Studies in various markets found that unlike portfolio beta, beta of

a security is not stable over the time.

In Malaysia, Kok and Leng (1992) examined the stability and predictability of

beta for all component stocks of the ICLSE Conlposite Index and found that the beta

values were reasonably stable from period January 1983 to June 1986, from July 1986 to

December 1989. The beta values in these two periods were significantly and positively

correlated so that the beta values of securities at the later period could be estimated with a

reasonable high degree of accuracy from those at earlier period.

A study to examine the stability and predictability of beta was undertaken by

Ariff et a1 (1998). They found that beta coefficients as measures of systematic risk were

quite stationary under some conditions - for example beta coefficients were stable when

calculated over a-five or seven-year estimation interval using month-end prices. The

study also found that portfolio betas were more stable than individual company betas.

Kent et al. (1977) conducted a study on return preferences of individual common

stock investors. The purpose of the study was to examine the nature of the relationship

between acceptable risk levels and expected annual rate of return and also to determine

the nature of relationship between risk and the components of total return.

10

That study reported positive relationship between risk and expected annual rate of

return. Roger and Sinquefiled (1979) conducted a study on the historical view of the risk

factors of returns in the US capital market, which included common stocks, long-term

corporate bonds and US treasury bills. The finding of the study showed that the returns

could be associated with various levels of risks over years from 1926 to 1978. It also

showed that common stocks had highest annual mean of return of 11.8% with the highest

standard deviations (risk) of 22.2. This study illustrated a general principal whereby when

sensible investment strategies compared with one another, risk and expected return tend

to go together.

Ham and Andrew (1984) examined the securities risk-return relationship as

described in modern portfolio theory. The empirical result showed that the higher the risk

the higher the expected return. Mc Laney (1985) showed that investors have to bear

certain risk in security investments. Total risk involved with an individual security

co~lsists of specific risk plus syste~natic risk. Investors who take more risk are expecting

higher return on investments. It followed that investors would price securities in such a

way that expected returns from high-risk securities are greater.

Dukes et nl. (1987) conducted a study on risk and return relationship for stock

portfolio during the bull and bear markets using three alternative market proxies -the

Standard and Poor's (S&P) 500 composite index, the Dow Jones Industrial Average

(DJIA) index and the Value Line co~nposite stoclc index (VL). The study indicated that

when the VL is used as the lnarlcet proxy, strong and conclusive evidence is found for the

hypothesis of high risk should be associated with high return during bull market and vice

versa.

In Malaysia, not much have been docu~nented on identification of cyclical and

non-cyclical sectors and the risk and return relationship. The causal relationship between

cyclical and non-cyclical sectors with risk and return also received much less attention

from local as well as the foreign researchers. In view of that, it may be essential to

conduct research on cyclical and non-cyclical on the risk and returns relationship.