Economic Growth And Efficiency Of Economic

Published Date: 02 Nov 2017

CHAPTER 1

INTRODUCTION

1.1 Overview

Economic growth and efficiency of economics have been the major goals of every nation. To be able to maintain stable and high standard of living, policy makers and economists are constantly searching for alternatives to assure healthy growth. An efficient market is a market where the security prices reflect all information about the security. An efficient capital market also promotes economic growth by maintaining and stabilizing the financial sector and providing an important investment channel that contributes to attract domestic and foreign capital. In order to predict the movement of stock prices, investors should be able to obtain current information of the market. However, history shows that economic growth was never sustained in the long term. Economic instability occurred from time to time like a storm once in a while. Economists classified this situation as the business cycle due to the out-of-action and rumbles in economic activities.

The movement of stock market price is an important indicator to enhance the stability of economic performance of any nation. A well-organized stock market plays a crucial role in industry and commercial growth of the country. Positive growth of stock market simply depicts a country with progressive development and vice versa. The prices of stock market are determined by demand and supply of company stocks while stock market acts to improve and conditions economic efficiency and financial system of a country. Foreign portfolio investment and liquidity of stocks influence stock market performance and further affects economic performance.

The most recent stock market performance took a huge impact during the economy crisis back in 2008. Evidently, the downturn was attributed to the influence of sensitivity of macroeconomic variables in Malaysia towards stock markets.

This study analyses the relationship between stock market price and consumer price index, money supply, Treasury bill, industrial production index, gold price, oil price by using the unit root test and Johansen’s co-integration test to determine the stationary pattern of the test data with autoregressive model. Malaysia stock prices is none other than the dependent variable while the consumer price index, industrial protection index, gold price, money supply, Treasury bill, gold price and oil price are categorised as independent variables.

1.2 Background of the Study

Stock market stability is a good instrument for investor to guarantee their profitability and generate their wealth. But, stability stock market not always exists in the nowadays Malaysian stock market. There are several issues in the stock market recently, namely the subprime mortgage crisis; it started from 2007 until 2008, oil crisis from 1971 until 1973, Commodity crisis, which start from 1980-1981, following by Financial crisis on 1997 until 1998. (Okposin & Cheng, 2000).

The first oil crisis in 1971 until 1973 in the world has slowdown the industrialised countries and affected the export. A decline of stock prices is due to the rising in oil prices and it shows that change in oil price may cause the stock return to fluctuate Bina & Vo (2007). Moreover, stock return may impacted from changes of the oil price. The negatively response of stock prices to oil price shocks is found only when the oil price rises due to an increase in avoiding demand driven of crude oil. Higher oil prices will lead to economic expansion and it will cause to positive effect on stock market returns. Kilian & Park (2007). This increasing of the oil price eventually leads to increases of price goods, which this will bear a burden to customers that finally will be experiencing inflation. As there is inflation in the country, many sectors will be impacted such as companies and consumers. In order to solve this issue, government introduced a series of monetary measures to increase the deposit and lending rates with purpose to reduce the burden of the company and reduce the unemployment in order to promote economic stability in the country.

During the commodity crisis of the early 1980, it caused slowdown in the Malaysian economy due to the rapid drop in commodity prices and increases in the domestic and external debt, this consequently had created financial imbalances with the gradual rise in the interest rates. In 1985, Malaysian had facing the electronic crisis that caused by the huge dropped in electronic price and this affected the Malaysian GDP.

Following by the recent economic crisis in 1997, which caused by financial crisis, had severely impacted on stock market, exchange rates, banking sectors in Malaysian. The crisis is due to the sudden withdrawal of short term capital flows from the country following the floating of Thai’s baht in July 1997. The impact of the downturn leads to rises in the inflation rate and high unemployment level in 1998, not only that, sales and profits of any companies are expected to decrease. One of the major public policies would be the government would reduce interest rate and encourage spending to stimulate the economy. According to Roubini (2006), months before the start of the recession, a sharp falling the share prices can be observed, leading to poor stock market performance. The performance of the stock market during recessionary periods is clearly reflected. During the financial crisis 1997-1998, the Kuala Lumpur Composite Index (KLCI) of Malaysia showed a down trend from January 1997 and reached its trough in September 1998, moreover the Malaysian currency kept depreciating and reached to 4.545 in January 1998.

Apart from that, industrial production index was also declining due to the fallen of production in electricity, electronic, and manufacturing. In term of inflation rate, it had increasing from 92.68 in the year 1997 to 97.59 in the year 1998. However, in 1999 the real GDP has grown up to 5.6 per cent due to the expansionary monetary policies. But before the financial crisis happened, the performance of KLCI’s point has reached more than 1200 points.

On the other hand, the recent subprime mortgage crisis that started in year 2007, where housing loans were given to individual with poor credit history, this eventually lead to the failure of collecting back the loans. As interest rate begins to rise, housing price follows suit in the opposite direction by taking dips. Consequently this leads to the bankruptcy of several major players in the banking sector as such the Lehman Brothers, a 158-year-old investment bank, declared bankruptcy on 15 September 2008. All these negative news have chain reaction toward the other sectors like manufacturing, housing and mortgage, commodities. Major indices in United States like Dow Jones, S&P500, and NASDAQ are mostly bearish and have been decreased tremendously since then. Earnings prospect are clouded by macro-economic concerns.

Other than the financial crisis, the stock market is affected by many other factors as well. For example, the interest rate, gross domestic product, exchange rate, money supply, inflation, fiscal policy and so on. It is not very practical to include all possible macroeconomic variables to determine the performance of the stock market since many of these variables are closely correlated giving rise to estimation problems. For this study, we are keen to find out the relationship between the Treasury bill, money supply, industrial production index, oil price, gold price, consumer price index and the stock market index (Kuala Lumpur Composite Index, KLCI).

The a priori expected relationship between stock market index and interest rate is that they are negatively correlated. When the interest rate is low, the stock market index will increase and vice versa. This is due to investors shifting their money from their savings or fixed deposits to the stock market in order to gain a higher return. Another investment instrument which compete with investment in the stock market.

In the recent economic crisis, a recession is expected to follow by the crisis. In order to stimulate the economy, government has lowered the interest rate. Overnight policy rate is fixed at 2.00 and as of 29th May 2009, interest rate is 0.0 % - 1.0% for savings and current account and 2.0 - 2.5% for fixed deposits (Public Bank). When the interest rate is low, investors are expected to shift their money to a higher risk instruments in order to gain higher return. Malaysia practised a low interest rate regime due to the need to generate economic growth with price stability. Furthermore, inflation has not been deemed a serious issue since the early eighties. In fact, many daily consumer products especially daily necessities including but not limited to petrol, sugar, rice and etcetera are under a price control system. The graph below showed the Malaysia stock market movement from year 1994 till year 2012.

Chart 1: FTSE Bursa Malaysia KLCI (KLSE) prices from 1994 to 2012.

1.3 Problem Statement

Understanding the relationship between Malaysia stock market price and the macroeconomic variables helps domestic as well as international investors to hedge and diversify their portfolio. Ravazzolo and Phylaktis (2005) indicated that fundamentalist investors have taken into account these relationships to predict future trends.

During the Asian financial crisis in the past few years, the fluctuating share prices of stock market resulted in economic instability. ( Tham Siew Yean, 2004). Kurihara (2006) explained that the fluctuation and instability are due to multiple factors such as current accounts, dividends, enterprise performance, exchange rates, gross domestic product, interest rates, money supply, and stock prices of foreign countries. These factors directly and indirectly affect the stock market causing stock prices to fluctuate periodically. Apart from that, there are drastic dropped in the private investment due to the inefficiencies of country’s new policy namely AFC, a fiscal deficit policy which leads to higher corruption that faced by investors and public. Malaysia was stuck in the phenomena of losing its competitive edge as a low cost producer. Moreover, Malaysia is facing unhealthy public revenue structure which is lower and narrow in tax rate, whereas higher in government revenue up to 40 per cent. This higher revenue is derived from the oil and gas earnings, yet Malaysia is expecting will running insufficient of these resources and expected will not sustainable in the long term. (World Bank, 2009)

During the 2008 global financial crisis also, the gold price has been escalating at an unprecedented level. This have given the investor calm enough to keep gold in their portfolio, whereas for investors who suffered heavily loss from the stock price falling did think invest on the gold. However, gold price is not always shows adverse movement with the stock price over the time, the gold price may boom or crash during the crisis. Therefore, it is important in investigating the study regarding on these issues.

In addition, Ang and Ma (2001) pointed out that financial analysts failed to anticipate the flaws of their corporate subjects which further led to the failure to make sufficient adjustments of original forecasts after the market crash. However, no panic or herding on large scale was evident. The stubbornness of the analysts to improvise and recover from other market and macroeconomic events was attributed to the already wavering forecasts which had ultimately showed that the analysts were totally out of place during the crisis.

On the other hand, the post-crisis era saw improvements due to upturn in global economy and reinforced the importance of the integration of Malaysia with global economy and the bounded implications as explained by Abidin and Rasiah (2009). The injection of fiscal stimulus and accelerated development expenditure were part of the response from Malaysian government to have successfully overturned the economic contraction. As consequences of the government injection, it would affect the aggregate demand, government capital formation and labour incentive, finally it will effect on financial performance of Malaysian stock market.

However, in the November 2007, stock market index was at the highest level which is RM 1396.98 and it experienced the lowest level in 2001 and 2008 which is RM 572.88 and RM 863.61 respectively. This huge reduction from the highest level is due to the economic crisis in USA which also affecting Malaysian stock market index. According to Baharumshah et al., (2002), there are closer relationship between financial market and economic growth. In fact, anything that happened to the financial market will affect the variation in economic activities Ibrahim & Wan Yusoff (2002).

Although previous findings found many factors influencing the fluctuation of stock market, much of the research have showed inconsistent results across countries and time. In general, different studies provide different results. Therefore, it will be essential to have a research to investigate the real situation in Malaysian stock market by using different indicators namely consumer price index, money supply, Malaysian treasury bill, industrial production index, gold price and oil price, which is combination of monetary, production and commodity indicates that might contribute to the stock market changes. Such information will be crucial especially to market participants enabling them to make a better decision for their investment.

1.4 Objective of the Study

1.4.1 General Objective

• This study aims to determine the relationship between stock market and corresponding market variables.

1.4.2 Specific Objectives

• To analyse the pattern of stock market through 1990 until 2011.

• To determine the correlation between macroeconomic variables and stock prices.

1.5 Significance of the Study

As one of the objectives of this study aims to examine the correlation between macroeconomic variables and stock prices, many agencies including but not limited to corporations, investors, researchers, and the public will undoubtedly obtain valuable benefits. The result of this study serves as a guideline to any corporation to attract more investors to increase corporate investment resulting from accurate information, boosting confidence of investors.

Stock market index represents the composite price of many different stocks from various industries; it is an indicator for an investor to measure the performance of the individual stock market. An uptrend in stock index most of the time indicates that there is positive performance in financial market and the reverse in a downtrend. From 1990 until 2012, Malaysian stock market showed an inconsistent trend, which means fluctuation in the stock market.

The existing orthodox interest rate, fiscal and monetary policies did not solve the Malaysian economy during the economic downturn, the contractionary of monetary policy converted the existence financial problem into recession due to the jumped of the interest rates which indirectly raised the burden of the local companies. Consumer consumption fell as the interest rates on consumer loans rose. This deterioration in the company’s performance contributed to the depressed in the stock market performance. Eventually this will deteriorating the real economy, thus GDP will drop. (Bank Negara Annual Report, 1998)

As the stock market derived of listed companies that have actual business operation, the performance of these companies is highly dependent on the fluctuation of macroeconomic factors. The sensitivity of Malaysian economy toward macroeconomic variables is clearly observed especially during the economic downturn that has made impacts on the performance of stock prices. Thus, this reflects the importance of understanding the factors that determine the performance of the stock market as general or more specifically to the listed companies in Kuala Lumpur Composite Index.

Moreover, due to the Kuala Lumpur Composite Index (KLCI) is running in diverse political and economic structure apart from the instability in US economic, thus this may leads to inconsistently in stock market price too. From the investor’s perception, it is important to determine whether KLCI will correspond with the differently of economy situation which is due to the macroeconomic variables, well understanding the behaviour of the macroeconomic variables towards Malaysian stock market is important. Therefore, this study will investigate the relationship between the macroeconomic variables and Malaysia stock prices. If the findings conform to general perceptions, Malaysian policy makers will undoubtedly be able to make use of this information and put together for better plans while deciding appropriate solutions and policies to attract foreign investors into our stock market.

1.6 Scope of the Study

This study intends to examine the relationship between Kuala Lumpur Stock Exchange (KLSE) with the macroeconomic variables in the long term. The data to be used in the analysis span from 1990 to 2011 on monthly basis. The study is presented in multiple chapters beginning from chapter 1 that governs introduction and background of the study. Chapter 2 covers literature review on previous work with similar titles and more detailed information in this study. In chapter 3, the methodology will be explained including data collection, theoretical framework, and empirical model of this study. The results obtained and detailed discussion by comparing and contrasting with previous studies will be displayed in chapter 4 inclusive of the empirical result of this study. As this study reaches its end, chapter 5 reveals the conclusion, policy implications, and limitations of this study.

CHAPTER 2

LITERATURE REVIEW

2.1 Overview

Many previous existing studies attempted to show the reliable relationship between the macroeconomic variables and stock market prices. These studies revealed that macroeconomic variables influenced stock market.

Al- Abadi et al. (2006) in his study stated that there is a linkage between inflation and stock price through the changes on the stock price and the profits on stock portfolio by using the capital pricing model. Hence, consumer price index can be proxy as inflation rate. On the other hand, one of the researches by Flannery and Protopapadakis (2002), their results proved that consumer price index affected the stock market.

In addition, in the studies done by Li, Narayan, and Zheng (2010), they found that unexpected raises in the inflation rate is a bad sign for the stock market, which will leads to reduction in the stock prices. This phenomenon will happen when there is economy downturn such as recession. Whereas, an expected inflation will increase the price of goods and this will leads to increase of stock market price.

Peiro (1996) states that stock returns are influenced by future variations in production. Moreover, McQueen and Roley (1993) argued that there is a positive relation between future economic activity and stock returns. This positive relationship between the future economic activity and stock returns can be seen through a channel mechanism, which means higher stock returns have bi- directional effect on higher consumption and investment level that would ultimate the economic activity. Apart from that, there are several researches such as Muneer et al. (2011), Sill (1995), Chen, Roll and Ross (1986) based on the efficient market hypothesis found same evidence on significance impact between stock returns and industry production.

Hamburger and Kochin (1972) have found positive relationship between money supply and stock returns by using a multi- factor model with inclusion of a third variables to proxy foreign exchange risk. This means when money supply increase, stock returns will increase too. They found that money supply plays a substantial role in determining the stock prices. Badaruddin and Ariff (2000) argued that changes in the amount of loans demanded will affect the deposits by customers, this eventually will lead the slowing in the money supply movement. Thus this will have an effect on its profit generated and in turns its share prices.

According to simple discounted present value model from Lijeblom and Stenius (1997); Ibrahim M. (2002) and Ibrahim and Jusoh (2011) on the other hand states that cash flow and discounting rates will determining the future stock prices of the firm. This change may due to the changes in the macroeconomic variables, and this may in turn affect the stock market. The reason behind probably is due to the macroeconomic variables namely M3, interest rates, IPI and exchange rate will impact on the corporate cash flow, which means the fluctuation of these macroeconomic variables directly impact the corporate cash flow. The currency value might appreciate or depreciate in term of the theoretical perception, these fluctuation of currency value will negatively and positively impact on the stock prices. For instance, when the currency depreciates, it may increase an export and this may increase the firm’s profitability and thereby increase the value of its stock. However, when currency appreciates, it will increase the volume of import rather than export and this eventually will impact on the company’s performance due to the decreasing of stock’s value.

Fama (1981) in his study of stock price returns and macroeconomic variables stated that there appear strong and significant relationships between stock prices and inflation, national output, industrial production index by using the Johansen Co integration test. In the case of Malaysia, the stock market output also studied by Habibullah and Baharumshah (1996), their results indicated that existence of a relationship between stock prices and output in the long run perspective. This results was consistent with the study by Geske and Roll (1983) Chen et al (1986) and Sharma (2002) that positive relationship between the stock price and industrial production index. The economic activity is likely influence the stock price in the same direction as result above, an increasing in the output may increase the future cash, thus this will increase the stock price, while the opposite effect may increase during the recession.

Gan et al. (2006) on the other hand reviewed the relationship between stock prices and the macroeconomic variables from January 1990 to January 2003 using co integration and granger causality test for New Zealand by using the domestic oil retail price, exchange rate, GDP, inflation rate, interest rate, and money supply. The study has proven the existence of long term relationship between the macroeconomic variables and New Zealand stock prices.

The previous study of Islam (2003) used the co integration test to examined the short term and long term equilibrium relationships between KLSE and four selected macroeconomic variables namely exchange rate, industrial productivity index, inflation rate, and interest rate. The findings were similar to other proven studies showing the significant short term (dynamic) and long term (equilibrium) relationships among the macroeconomic variables and the KLSE stock returns.

Another study conducted by Ibrahim (1999) reviewed the interactions between KLSE composite index and seven macroeconomic variables namely consumer price index (CPI), credit aggregates, exchange rate, foreign relationship between macroeconomic variables and stock market Indices 51 reserves, industrial production index, and money supply M1 and M2. The study concluded that Malaysia stock market was deprived of information and inefficient.

A study by Schwert (1989) applied the GARCH model in his study and the empirical result showed a positive relation between trading activities and stock volatility. The study indicated that CPI and money supply are significantly correlated to stock prices and changes would occur if they were changes in CPI and money supply. Other variables were not significantly associated with stock prices. However, the trading volume would not have affected the other five variables namely CPI, industrial production index, money supply, producer price index, and unemployment rate.

Mukherjee and Naka (1995) applied VECM of Johansen (1998) to analyse the relationship between Japanese stock market and exchange rate, inflation, government bond rate, money supply, and real economic activity. The study concluded that a co-integration existed and stock prices contributed to the state of affairs.

Tan et al. (2006) using the Johansen Co integration test to examine the dynamic relationship between macroeconomic variables and KLSE from 996 and 2005. Crude oil price, industrial production index, inflation rate, and Treasure bill rate were found to have long term relation with Malaysian stock market. The study further showed that CPI, crude oil price, and Treasury bill are significantly and negatively related to stock prices while industrial production index gave a positive effect.

The prior findings mostly focused on impact of monetary, production activities and fiscal policies that shows mixtures of results toward Malaysian stock market. As both of these factors are inconsistent, a few more factors are added into this study namely consumer price index, industrial production index, money supply, Malaysian Treasury bill, gold price and oil price to see the correlation between each other.

2.2 Related Literature Review in Developed and Developing Countries

As far as developed countries are concerned such as India, Sharma and Mahendru (2009) conducted a study on Bombay Stock Exchange (BSE) by applying the autocorrelation test in order to judge the efficient of the stock market and found that gold price had high correlation with stock price. However, stock returns seemed to have minimal impact from gold price.

A few studies have been done in the emerging market by Smith (1992), Phylaktis and Ravazzolo (2000), Frank and Young (1972), Granger et al. (2000), they found significant positive relationship between stock price and exchange rate while Mao and Kao (1990), Ajayi and Mougoues (1996) have reported a negative relationship between two variables. On the hand, Fifield Power and Sinclair (2002) in their study investigated the local economic factors that explain in emerging market. They had found that local economic variables namely money, interest rates and GDP were significantly impacted on emerging market stock price which their findings is based on the Co integration test.

The Istanbul Stock Exchange, Turkey, was revealed to have been negatively impacted by exchange rate and GDP. Acikalin et al. (2008) further revealed that interest rate had substantial effect on stock market but could not ascertain the net impact was positive or negative. In addition, Sohail and Hussain (2011) test for causality relationship toward the Karachi Stock Exchange 100 (KSE100) in Pakistan, they explored that GDP had positive impact on KSE100. Money supply and Pakistan Treasury bill had negative impact on stock returns while IPI showed positive impact in the long term. The study suggested that authorities formulate policies to uphold stock prices through the promotion of IPI since the rise of IPI could have boosted the capital markets of Pakistan significantly higher.

Anorou and Msutafa (2007) examined the relationship between oil and stock returns for the US using daily data, they applied the Johansen Bivariate Co integration, and error correction model approach. Their findings indicated that long run relationship between the oil and stock returns. The estimated vector correction model (VECM) proved that there exists causality from stock market returns to the oil market. Apart from that, even though Johansen co integration test failed to prove the co integration between the stock returns and oil market, but Geogory Hansen co integration test provided evidence of both oil market and stock returns are being co integrated.

A research conducted in Greater China Region covering China, Hong Kong, and Taiwan by Lin et al. (2009). The author applied the variance decomposition to test the impact of oil price shocks on stock prices in the region revealed mixed results. Taiwan stock market resembles that of the U.S., a developed country by being associated with the change of world economy. Hong Kong experienced positive effects on its stock market from three oil price shocks which negatively affects the U.S. for precautionary demand of crude oil. In contrast to U.S. stock market, global supply shock is found to have positive impact on China stock return but global demand and oil-specific demand shocks showed insignificant impacts. China stock market is independent to the world economy and its rapid economic growth overshadowed the negative effects of precautionary demand driven effect implying that its stock market is unified with other stock markets and oil price shocks to a certain extent.

In term of the gold price, Borenstein and Farrell (2006) investigated on 17 gold mining firms by using the Capital Asset Pricing Model to examine the yearly data from 1977 to 2004. Their study purposely to examine the gold price may influence on their gold mining and lastly toward stock market. They discovered that that variation of gold price will impact on the gold stock and this will impact on stock market.

Von Furstenberg, Jeon, Makiw, & Shiller (1989) used Johansen’s co integration in their study of the stock indexes of Japan, Germany, US and UK to investigate the determinants of stock price. They included the exchange rate, interest rate, oil price and gold price as the factor in affecting stock price movement. In term of the gold price with stock price relationship, their empirical result suggested that increasing in gold price will negatively impacted on stock averages in Japan but not for the US stock market. On the other hand, Galton (1877) investigates the BSE and certain macroeconomic variables namely gold price, inflation and foreign reserve by using the correlation test. His result reveals that there is high correlation between the foreign reserve, gold price and inflation on the India stock price.

Gogineni, Zahor and Yurtsever (2007) study an asymmetrically changes in the oil price that reflect toward the stock market changes. They used the co integration and granger causality to explain the direction of movement between the stock market and macroeconomic variables. They had found oil prices positively associated with the stock prices. They summarize that, the oil price shock will reflect the changes in demand aggregate, and this changes will negatively associate with the stock price. According to their findings, they concluded that higher oil price is associated with the lower stock prices, while lower oil prices are not associated with higher stock price. Although changes in the crude oil price is considered as an important to understand the fluctuations in the stock prices. But there still no compromise relationship on the stock prices. The previous researches generate mixture views of oil price towards stock prices.

There are study conducted in the Middle East country by Priftakis & Bhatti (2008), they examine the linkage between oil price and the five selected stock market. They tested the co integrating of the variables toward the stock market, their findings revealed that UEA stock market is co integrated with UEA stock market and in the same time also co integrated with others economic variables. Thus, they proved that effect of the oil price is not significantly in determining their stock market.

As an overall, majority of the journal review that stock market in developed and developing countries shows significant relationship with oil price and gold price. As Malaysia is categorized in developing country, it is reasonable to believe that Malaysian stock market process the same relationship with this study. Thus in this study, will put those variables in.

2.3 Summary

Previous studies highlighted the importance of investigating whether macroeconomic variables affect stock prices either in Malaysia or other countries. A detailed analysis is required to examine the findings and verify the consistency of the results from several similar studies toward Malaysian stock market prices.

CHAPTER 3

METHODOLOGY

3.1 Overview

This study will use the data from the years 1990 to 2011 by using monthly data, initially adopts a similar approach used by prior research works. This study is aimed to find out the relationship and effect of the seven variables toward Malaysia stock prices. These seven variables namely, industrial production index (IPI), consumer price index (CPI), treasury bill (TBR), gold price, export, money supply (MS) and oil price. Malaysia stock price that is being used is based on the index value at end of the month. The KLCI is used as it encompasses the largest amount of stocks traded in Malaysia. Whereas the M1 that been used is expressed in domestic currency which is Ringgit Malaysia, RM. Besides that, industrial production index, IPI is an indicator that measures the real production output, it computes the output weights based on annual value added.

Malaysia Treasury bill on the other hand is a short term securities issued by Bank Negara Malaysia with three months maturities and used as working capital. Treasury Bills normally matures within one year from the date of its issue and it as a proxy to interest rate. They are issued with one month, six months or with one year of maturity. Whereas gold price that used is obtained from NASDAQ but in USD. Consumer price index that used is a proxy to inflation.

3.2 Data Analysis Methods

These KLSE and seven macroeconomics variables data will be analyzed by using several methods which is software Eview version 7.0. Those data will be tested by unit root test in order to test the stationary of the stationary of the variables. Whereas, those data will also test by Johansen and Juselius co integration (1990) test with purpose to investigate the long run co integration between the dependent and the independent variables. The Granger Causality test on the other hand is to determine the causality direction between the variables.

Eview

The granger causality method has been carried out by employing the software package of Eview 7.0, which this software can quickly and efficiently manage the data, it perform econometric and statistical analysis, it will provide precise forecast.

Unit Root Test

Unit root test is test for the proposition in an autoregressive statistical model of a time. It tests the stationary of the variables to avoid bias results. Time series is considered as stationary if a series is mean reverting, have no tendency to drift, if the mean and variance of the series are constant, then the data will consider as stationary. There are two common ways to conduct a unit root test, which are Augmented Dickey- Fuller (1979) (ADF) test and Phillips- Perron (1988) test, but in this study all the series are tested by using Augmented Dickey- Fuller only.

Where,

Error term

Stationary of the series

First different operator

Means non stationary of the time series data, there exist unit root.

Stationary of the time series data, there are no unit root.

In order to determine the time series data whether exist unit root, the first difference of on the need to regress to find the coefficient. Below shows the method in determining the time series data are stationary, which is through Augmented Dickey- Fuller Test.

Augmented Dickey- Fuller Test

Augmented Dickey- Fuller is used to investigate the relationship between dependent and independent variables in the long run. It is an augmented version of the Dickey- Fuller that applied when the error terms (µ) are correlated, it also test for a larger and complicated set of time series data. It statistic was showed in negative number, meaning that the more negative it is, the high probability to reject the hypothesis that there is a unit roots at certain level of confidence. ( D.A. Dickey and W.A.Fuller, 1979).

From the equation above, are the parameters that will be estimated. , is represents the number of lagged which is empirical determined. (Gujarati, 1995), t is the time trend, also means the number of lagged in this study, whereas ε is the error term.

The hypotheses show as below:

If found value different from zero in the ADF test, we can conclude that null hypotheses will be rejected, which means that there are no unit root in the time series data and the data consider as stationary. Whereas, we will accept the null hypotheses that there are unit root in the time series data if the value is equal to zero.

Johansen Co integration Test

Co integration test will be conducted to determine whether the time series data display a stationary process in a linear combination. (Soren Johansen, 1995). Co integration means that data from a linear combination of two variables can be stationary despite those variables being individually non- stationary. (Gujarati, 1995). Under co integration test, it suggests the presence of a long run relationship between the variables, which means that any deviations from this long run equilibrium relationship will be corrected. Miller (1991) and Miller and Russek (1990) mentioned that if two variables are co integrated, there must exist temporal causality in the Granger sense between them in at least one direction, which means that two important forces or channels that might cause changes in the variables. One channel may indicate the response of one variable due to the changes another variable, whereas the other one will indicating the adjustment taken by the variables to correct any deviations from an equilibrium path.

With that purpose, the Johansen (1991) method of multivariate co integration is applied. A finding of co integration implies the existence of long run relationship between dependent and independent variables. If there exist at least one co integrating relationship among the variables, the causal relationship among these variables can be determined by estimating the VECM method. Under Johansen and Juselius method, there are two tests namely "Likelihood Ratio Trace Test and Maximum Eigenvalue Test" to determine the number of co integrating vectors. (Adebiyi, 2007).

Where Yt = {LKLCI, LTBR, LCPI, LMS, LIPI, LIP, LGP} is a column vector and with i = 1…, m is a lag operator. Whereas is the error term of constant variables. The lag length of this model is m.

i) Trace Test: Ttrace:

From the equation above, T is the total number of observation, N is the number of variables that be used, ri is the i-th pair of variables. Large value of Trace test proves that fewer co integration vectors, which will reject the null hypothesis.

ii) Maximum Eigenvalue Test:

The null hypothesis of this test is an existence of r co integrating vector is tested against the alternative of r+1 co integrating vectors.

Vector Error Correction Model

The vector error correction (VEC) model on the other hand is a special case for the time series data that stationary in their first differences, it takes into account any co integrating relationship between the variables. If co integration has been detected between the time series data, it proved there have long run relationship among the variables, so we have apply VECM to evaluate the short run properties of the co integrated series. In the case if there are no co integration, VECM are not require and it proceed to Granger causality test to evaluate the causal link between the variables.

In the VECM model, the co integration rank shows the number of co integrating vectors. A negative and significant coefficient of the ECM indicates that short run fluctuation between the independent variables and the dependent variable will give rise to a stable long run relationship between the variables. A Vector Error Correction Model (VECM) can lead to better understanding of nature among the different component and improve longer term forecasting over an unconstrained model. C. W. J. Granger (1987). The VECM is written as below:

If the variables are co integrated in the short run, the error correction model indicates that dependent variables will impact on the long run equilibrium due to the movement of the dependent variable. Usually t- test will be conducted as the lagged error correction term in determining the long run relationship between the variables. The long run disequilibrium in the dependent variable will be corrected during the short term adjustment.

Granger Causality Test

The short run relationship between the dependent and independent variables can be determined by using the Granger Causality test. Paramaia: Akway (2008). There are two processes involved in Granger Causality test, which is the stationary data is needed rather than non-stationary data. Secondly, it is compulsory to test the stationary property of the data. This Granger Causality methodology is sensitive to the lag length that had been used. Granger causality test is used to test on short run relationship between dependent and independent variables. In this section, it is important to determine the stationary of the data, which is sensitive to lag length that used. In order to fulfil the requirement to select the appropriate lag length, there are several criteria have to follow. In this study, Akaike’s information criteria had been applied.

Granger (1969) causality test is to determine the causality direction between the Malaysian stock market and its determinants such as consumer price index, money supply, industrial production index, Malaysian Treasury bill, gold price and oil price. The direction for each determinant can be expressed as below:

Where, is the first difference operator, are parameters, is the constant term, log number of apprehensions i months ago, maximum number of monthly lags for the series, and is an error term, number of months. Hn will fail to reject if result shows =0 which is no impact on Malaysian stock market. The hypotheses of this test expressed as below:

3.3 Data Description

The study causes namely six variables that have been widely applied in previous researches. Yet, the novelty of the analyses is by adding the two new variables which is gold price and oil price in the case of Malaysia. Empirical result of this study has proved that the additional variable has given the impact on the stock market.

Thus, this study is focused on six macroeconomics variables namely money supply (MS), Malaysia treasury bill (TBR), industrial production index (IPI), consumer price index (CPI), gold price, export , oil price and Malaysia gross domestic product (GDP) toward Malaysia stock price (KLSE). This study use monthly data for KLSE and those macroeconomics variables from July 1990 to June 2011. These data were collected from Thomson Reuters data stream Unimas, Sarawak. It works as the platform to provide a huge range of global financial data.

Malaysia market stock prices (KLSE)

Movement of stock market plays a crucial and important role in determining the company returns. There are several macroeconomics factors that affect the Malaysia stock prices, such as money supply, Malaysia Treasury bill and industry production index. Due to this reason, we examine the Malaysia stock prices through the FTSE monthly values of 30 selected companies to investigate how these variables affected the stock market. Hence, we are using the data stream to collect the monthly FTSE values, from the year of 1990 until year 2011. The KLSE performance was showed as below from year 1990 until year 2011. KLSE faced the financial crisis on 1997-1998 when a huge declined during that period. Apart from that, declined in the 2007-2008 was due to the mortgage crisis. The crisis will cause impact on those macroeconomic variables; changes in these macroeconomic variables will indirectly impact on KLSE performance.

Money Supply (M1)

Money supply is the measure of the total money flow in an economy. Money supply is measured by using M1, M2. M1 is a narrow measure of money but M2 on the other hand is a broader measure that includes everything in M1, therefore M2 is better indicator for money supply. According to the Friedman and Schwartz (1963), their study showed that there was a positive significance relationship between the money supply and stock prices. Firstly, the growth of money supply will increase the level of aggregate economy and lastly increase the stock prices. The relation between money supply and stock return is also found to be positive according to the studied by Mysami, Howe and Hamzah, (2004). Their findings are consistent with the findings of Mukherjee and Naka (1995) who examine the effect of stock prices on six macroeconomic variables by using a vector error correction model (VECM). Their findings shows that positive relationship between Tokyo stock prices, the exchange rate, money supply and industrial production with the stock prices, whereas inflation and interest rate have mixed relationship with Tokyo stock prices.

For the case of Malaysia, our findings showed that positive relationship between the money supply and the Malaysia stock market prices with the monthly data from the year 1990 to year 2011 by using the Johansen’s co integration and Unit root test. The existence of this positive relationship can be explained as; increasing in money supply will lead to increase of the stock prices due to reduction of interest rate. From the chart below, we can observe that money supply in Malaysia experiencing the sound performance from 1990 to 2011, except in the years of 1997-1998, the dropped in the money supply (M1) is due to the financial crisis. This impact on the KLSE, this is because when the decrease in money supply, interest of borrowing will rise, this may reduce the investment activity, and lastly decrease the GDP of Malaysia.

Malaysia Treasury Bill Rate

Malaysia Treasury bill is a short term securities that issued by the government of Malaysia for working capital, as a proxy of interest rate. The relationship between short-run and long-run interest rate is found to be positive and negative respectively. There should be the negative relationship between Treasury bill and stock prices because the interest rates can influence the corporate profit through the price that investor willing to pay for the stock. A decrease in interest rates can reduce the cost of borrowing, which will encourage to the economy expansion. Positive relationship means that substantial amount of stocks are purchased with borrowed money. Thus, increasing interest rates will cause the investment in stock market become more costly. Hence, investor will require higher rates of return.

In our study on Malaysia, our result showed that there is positive relationship between the Malaysia stock prices with the Treasury bill. Our result is consistent as some prior findings, with evidence from the study of Trivoli (1991) in the United States and by Mukherjee and Naka (1995) for Japan. They found a positive relationship between the stock prices and interest rates.

The chart shows fluctuation of Treasury Bill Rates, TBR that was rather high during the 1993 Super Bull Run period and also around 1997 before Asia Financial Crisis. TBR is being adjusted from time to time to control money supply. If economy or financial market performs too aggressive, TBR will be raise up to reduce money supply. On the other hand, TBR will be reduced if economy is found slowing down.

Industrial Production Index

Other than policy monetary tools mentioned above, the level of real economic activity is also crucial in determining the stock market returns. Industrial production act as signal of economic growth and is another popular measure of economy’s output. Industrial production index is a proxy to gross domestic product, gross domestic product is defines as the market value of all final goods and services within a country in a given period of time. GDP can be divided into four components namely private consumption, investment, government purchase of goods and services, net export. It rises when the economic expand and will fall when the recession of economy.

In Malaysia, IPI is the measure of the rate of change in the production of industrial commodities. These commodities consists product of manufacturing, mining, electricity commodities that included in GDP components. Theoretically, high IPI indicates that high capacity utilization in industry sector which lead to high profitability of firms. Finally this will leads to higher stock prices. According to the theory, there are positive and significant relationship between the stock market and industrial production index/ gross domestic product, which is consistent with the studied by Geske and Roll (1983), Fama (1990), and Kearney and Daly (1998).

In a similar type of study, Chaudhuri and Smiles (2004) investigate the long run relationship between the stock prices and real macroeconomic activities (GDP) in the Australian stock market, their results indicated that there are long run and significant relationship between stock prices and GDP. The performance of industrial production showed as chart below:

Consumer Price Index

In this study, as mentioned early, for the inflation, we use consumer price index (CPI) as a proxy to price level. Consumer price index is a measure of the overall cost of goods and services bought by a typical consumer. CPI is calculated based on a fix basket of goods and services which a typical consumer will purchase. The rate of changes of CPI is one of the key measures of inflation or deflation. The rising of CPI indicates that high inflation, which will lead to increase of price level and reduce the purchasing power. Whereas, increase in sales and profitability of firms will eventually reduce the stock prices. Theoretically, consumer price index and stock market supposedly have positive relationship. Asprem (1989) put forward that inflation should be positively related to the stock market if stocks provide a hedge against inflation.

Not only that, this also consistent with the results of Ratanapokorn and Sharma (2007).The reason behind is the role of government in preventing price escalation after the financial crisis on 1997. The co integration test results indicate that stock price and consumer price index have negative relationship. Even though this result was contrary with the theory, however this result is consistent with the empirical studies by Barrows and Naka (1994), Chen et al. (1986), their finding conclude that inflation has negative effects on the stock market. Under the normal circumstances, a rise in expected rate tends to lead to restrictive monetary policies, which would have a negative effect on the stock market. They believe that the relationship between inflation and stock market is insignificant.

Gold Price

Gold is the world’s older international currency and has played an important role in most countries’ system. The gold market remained liquid throughout the financial crisis even at the height of liquid strains in other markets. However, the gold price has been escalating at an unprecedented level since the 2008 global financial crisis.

Some studies indicated that there are no causal relationship between stock price and stock market such as in the studied by Dr. S. Kaliyamoorthy (2012). In the study by Smith (2001), Smith examined the short term and long term relationships between gold prices and UK stock prices, but his findings found that there are no causal relationship between gold prices and UK stock market prices. On the other hands, in the study by Dr.Amalendu Bhunia (2012), his results reveal that there exist long run relationship between gold prices and India stock market. In fact according from his results, the gold price volatility and stock return in India over a period of 10 years have significant long run equilibrium relationship between both gold prices and India stock market.

Moreover, the studied by Choi and Hammoudeh (2006) indicated that increasing in the gold prices will eventually decrease the stock price index. However, Gagan Deep Sharma, Mandeep Mahendu (2002) found that there are high correlation between the gold prices and stock prices. On the other hand, one among the previous study reveal that, oil price and gold price as factors affecting stock price movement, gold price increase have been consistently negative for stock averages in Europe and Japan but not for the US stock market. Von Furstenberg et al (1989). In the case of Malaysia, according to Magda Komornikova, Jozef Komornik (2006) concluded that the Malaysia stock market is likely to go up with gold prices.

Oil Price

Oil prices do not appear to have any significant effect on stock returns. In the studied by Okuyan (2008), he investigates the relationship between stock prices and oil prices, but his results reveal that, there are no direct relationship between the stock prices and oil prices. When there is fluctuation in oil prices, it would lead to unexpected in the stock prices (Lee and Chiou, 2011). Several previous studies indicated that gold prices and stock market will move inversely, which mean oil prices shift will negatively related to the stock market, this theory is consistent with studied done by Cifarelli and Paladinon (2009). The reason of this circumstance is increasing in oil prices would result to increase in costs, restraining profits and cause the decrease in shareholder value which finally will decrease the stock prices.

But some of the studies argued that oil price would indirectly effect on stock market. According to Bjornland (2009) and Jimenez- Rodriguez and Sanchez (2005) an increasing in oil prices would positively increase the country’s income and finally increase the stock price. But this only will happen in an oil exporting country, whereas for the oil importing country, any increasing in the oil price will tend to have opposite result, because increasing of oil prices will lead to higher production costs, and this increasing of costs will be transferred to consumers, which will lead to lower demand and reduce their spending and due to higher stock prices. (Hooker, 2002), (Arouri & Nguyen, 2012). In addition, there are several studies that indicated that negative relationship between the oil prices and stock market, Jones and Kaul (1996), they reveal the negative impact of oil price on stock market due to the fact that oil price is a risk factor for stock market. Sadorsky (1999) argued that oil price volatility has also an impact on stock returns, his result specific in US market.

3.4 Theoretical Framework

The selected macroeconomic variables that affect to the Malaysia stock market price has been identified and stated as framework below. These macroeconomic variables are known as independent variables, these macroeconomics variables will affect firm’s opportunity to increase their sale or to make investment. Whereas Malaysian stock market price is the dependent variable in this study.

Any changes in economy factor which influences the firm’s future cash flow eventually will effect on stock price. According to Levine and Zervos (1996), the level of development of stock market will effect on economic growth. On the other hand, Chen, Roll and Ross (1986) argue that macroeconomics will effect on stock return. So, in this study, would like to investigate how these suggested macroeconomic variables affecting and contribute to the Malaysian stock market.

Diagram 3.4.1 : Relationship between Macroeconomic Variables and Malaysian Stock Market

3.5 Empirical Model of the Study

Where,

Y= Malaysia stock prices (KLSE)

Î’0 = Intercept

X1= Consumer Price Index

X2= Money Supply

X3 = Malaysian Treasury bill

X4 = Industrial Production Index

X5 = Gold Price

X6 = Oil Price

µ= Error term

A price index is a measure of the aggregate price level; it is a proxy of inflation due to the annual percentage changes in a CPI act as inflation. Theoretically, inflation has a negative relationship with stock market. The industrial production index on the other hand is act as a proxy for the real economic activity, GDP. Malaysian treasury bill as a proxy of interest rate, it is determined by the monetary policy, higher interest rate in saving will attracting investor to keep their money in bank rather than invest in stock market, so there exist negative relationship between stock return and interest rate. During economic growth the productive capacity of an economy increases which will contributes to the positive impact on stock market. Friedman and Schwartz (1963) explained the growth rate of money supply also will increase the stock returns, this increasing of growth rate will lead to the positive relationship between money supply and stock returns. Gold price also will positively relate to the stock market. However, when the oil price rises, this in turn will lower the stock price.