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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.