This article first appeared in Forum, The Edge Malaysia Weekly on April 8, 2024 - April 14, 2024

During the 1997/98 Asian financial crisis, US Federal Reserve chairman Alan Greenspan famously said that Asia got into trouble because it was mainly a bank-dominated financial system that lacked a “spare tyre”. In American parlance, the spare tyre is the stock market, with the US stock market being the largest and deepest in the world, accounting for 47% of global market capitalisation (according to the World Federation of Exchanges).

American companies rely on the stock market and profits to fund their growth and less on the banking system. Which was why American companies and the US economy recovered faster after the 2008 global financial crisis than the bank-dominated European, Japanese and Chinese corporate sectors.

Here are some interesting facts. The Chinese economy grew three times faster in gross domestic product (GDP) terms (averaging 6% a year) than the American economy between 2012 and 2023 (averaging 2% a year), but its stock markets — the Shenzhen and Shanghai stock exchanges — grew 3.5% and 2.7% a year, with market cap growing 34% to 47%, respectively, over this period. The Nasdaq’s market cap grew 4.6 times, with the index growing 17% a year on average over this period.

By comparison, Hong Kong’s Hang Seng Index declined 1.2% on average over this period and the FTSE100 London also lagged at 2.7% growth a year. Japan has lagged in GDP growth, but the Nikkei 225 averaged 13.2% per annum over the last decade or so.

In essence, the US stock market added US$10 trillion to investor wealth in 2023, even though real estate prices, especially commercial real estate valuation, was flat. According to the latest Fed Flow of Funds accounts for end-2023, the foreign sector added US$2.7 trillion to their holdings of US equities at market value last year, which means that foreigners added in terms of new flows as well as share price gains.

The question we must ask therefore is whether growth is ultimately driven by the state (government), corporate, finance or household sectors? In the US, the state is a net absorber of resources, since the federal government’s net savings for 2023 was negative US$1.9 trillion, meaning it was a net dis-saver and borrower from the rest of the economy, including foreigners. The household sector is a net saver and also consumer that drives domestic growth.

The latest (December 2023) Flow of Funds data showed that the US corporate sector, plus Wall Street, is truly acting as the hedge fund of the world — it borrows through the US government’s large issuance of sovereign debt that commands a cost of roughly 3% to 4% per year for 10-year bonds. The returns on investments abroad by the corporate sector and households would be at least double to triple that. The US earned a net income from the rest of the world of around US$160 billion to US$180 billion per year between 2021 and 2023.

Unlike bank-dominated systems, US corporations run on a low debt-to-equity ratio of between 19% and 27%. Bank-dominated corporates in Asia typically run debt-to-equity ratios of 50% or above. Having shifted production outside the US, American corporations are concentrating on asset-light strategies where the return on equity (ROE) is higher. Non-financial assets account for just under 40% of total assets, of which intellectual property rights have risen by US$521 billion between 2021 and 2023 to US$3.55 trillion, or 7.2% of total corporate assets at end-2023. In other words, US corporations focus on research and development in software, rather than just production of hardware.

The bottom line is that if US corporations continue to drive profits and the monetisation of their technology (especially artificial intelligence, or AI) whereas the rest of the world stays in the old economy (agriculture, manufacturing), the rest of the world will still be investing in the US stock market, and pay annual software charges to the Magnificent Seven, which will concentrate on top AI software, chips, data centres and smart equipment. Sounds like a Microsoft model of new tech development?

As military historian Yuval Noah Harari says, the ultimate aim of AI is the mental colonisation of the users. If the rest of the world believes and is willing to pay for American ideas and concepts, the American business model will be the top dog for years to come.

What are the implications for economies like Malaysia?

Bursa Malaysia’s Composite Index was 1,530.73 at end-2011, not much different from the current level of 1,550. During this period, the Malaysian economy grew twice as fast as the US economy (4% to 5% versus 2% per annum) and yet our stock market has been flat. As explained above, the US stock market is purely private led, whereas the Malaysian stock exchange is dominated by government-linked companies. These account for 36% and 54% of Bursa Malaysia’s market cap and the Kuala Lumpur Composite Index respectively.

Therefore, we need to ask — is the current corporate strategy for the country as a whole sustainable? If Malaysian listed corporations continue to lag in profitability (ROE) and with the ringgit depreciating against the US dollar, is the economy dragged down by the performance of the corporate sector, and why? After all, a depreciating ringgit actually gives Malaysian corporate exporters higher revenues in ringgit terms.

The answer is clearly very complex, but using the US model as a benchmark, we need to rethink whether we should concentrate on knowledge-based growth, rather than commodity (oil and gas, and palm oil) earnings. Technology is well accepted as the way forward, especially how we can use AI to improve total factor productivity (TFP).

Will the state or the corporate sector lead this AI/TFP revolution or transformation? Other emerging markets are clearly thinking through these issues, with India, Singapore, South Korea and Taiwan taking the lead. In short, if the corporate sector does not take the lead in AI and ESG (environmental, social and governance) transformation, expect the stock market to underperform even GDP growth.

We intend to explore these issues in depth in forthcoming articles. Watch this space.

Tan Sri Andrew Sheng writes on global issues that affect investors

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