Global equity markets endured another mixed performance in 2Q2016 amid the continuing slow economic environment, but the various Central Bank stimulus measures, coupled with the recovering commodity prices, helped global stockmarkets to regain most of their lost ground, particularly as the Federal Reserve kept interest rates unchanged and after the shock Brexit decision.

Malaysian stocks, however, endured substantive foreign selling in May as the 1MDB issue loomed large, sending investors to the sidelines. Investors then grappled with intense volatility as key index tumbled some 110 pts, before finding support at the 1,610 level. While FBM KLCI stocks found support, the lower liners and broader market shares were sent lower amid the difficult domestic operating environment that affected corporate earnings and stretching valuations.

The global economic environment remains tepid in 1Q2016, albeit it was an improvement over 4Q2015 and 1Q2015’s respective performance as the uncertain global economic environment and anemic recovery prospects continue to affect growth in many countries. While the global economy was poised for further growth- albeit cautious in 2H2016, the Brexit decision has thrown a spanner into the works and the already uncertain economic outlook has turned murkier with the potential fallout from the U.K.’s exit from the EU potentially affecting the global economy in 2H2016 and 2017.

Meanwhile, Malaysia’s 1Q2016 GDP was slightly ahead of expectations, but the economy is still displaying weakness alongside the challenging external environment that will continue to dampen the country’s economic prospects in 2H2016. The domestic economic environment is also tepid due to the slower recovery of oil & gas and plantation prices, lingering effects of the GST as well as higher cost. The government, however, is banking on higher infrastructure and consumer spending to cushion the impact of the slower growth. Meanwhile, the GDP forecast of 4.0%-4.5% for 2016 appears achievable as crude oil prices are above the government’s estimates.

Global markets have done well to climb higher despite the Brexit decision, but we think it could just be a calm period before the decision is formalised. We think the downside risk could return as investors start to digest the potential ramifications of the withdrawal and heighten the market’s volatility. Until then, however, we think global markets are likely to maintain a mildly positive tone as investors bet on Central Banks adopting more stimulus and monetary measures to counter the potential effects of Brexit and to help lift the prevailing weak global economic growth prospects.

However, we expect Malaysian equities to remain moribund over the near-to-intermediate term as sentiments remain guarded over the 1MDB issue and the difficult economic environment that will continue to affect corporate earnings recovery. Foreign participation is also likely to stay thin amid the cautious market environment and already fair PER of 16.cx for 2016, in line with its five-year average. This could leave the FBM KLCI to hover within the 1,600-1,680 levels with domestic institutions providing ample support to offset the still thin broader market participation.

Amid the cautious and changeable market environment, we continue to advocate a defensive strategy. Nevertheless, we expect construction stocks to outperform, buoyed by the plethora of upcoming infrastructure projects, as well as buy on weakness on companies with recurrent earnings.

Source: M+ Online Research - 27 Jul 2016