- Our base case: 2015 fair value for the FBM KLCI at 1,880 – based on 16x PE – implies limited upside potential from the current level of 1,753. The key challenge is the lack of conviction over the market’s earnings cycle, which continues to contract unabatedly. As it is, we are witnessing a broadening of earnings downgrade on banks and more recently, oil & gas stocks. Earnings expectations will surely need to be lowered again, particularly if oil prices stay depressed for a sustained period. With domestic headwinds gaining force even before the expected demand slowdown post GST implementation in April 2015, the market could fall into another downgrade spiral moving into 1Q 2015. We have again trimmed our earnings growth estimate to -2.3% in 2014, before growing by 11% in 2015.

- By now, the market would have priced in expectations of a hike in the Fed Fund rate. While the risk of a pullback in external liquidity may still be a lingering concern, we do not believe that the exit of foreign funds will have a significant impact on the FBM KLCI. This is because foreign ownership is already very low at 23.5% in Oct 2014. This level of foreign ownership is just a tad higher than its all-time low of 20.4% in Dec 2009. Furthermore, foreign funds account for less than 25% of total value traded as compared to more than 50% by local institutional funds. The latter’s domestic orientation should underpin downside support for the market. Otherwise, the FBM KLCI would already be at lower levels from earnings disappointment throughout 2014.

- The risk is in the MGS market where foreign ownership had remained stubbornly high at 45.9% (RM146.7bil) as at end- October 2014. The steady rise of foreign ownership in the MGS market from less than 15% started in 2009 when US interest rates collapsed in the aftermath of the global economic crisis. What has changed now is that the US Federal Reserve is widely expected to start normalising interest rates in 3Q 2015 and the USD is strengthening. In the last three months, USD had appreciated by 5% gainst the ringgit, and triggered some RM7.3bil in foreign outflows from the MGS market from the peak of RM154bil (48.4%) in July 2014.

- Our concern is that the foreign outflow may be just the start of a trend, as consensus is pointing towards a USD bull market. Thus far, foreign outflows have been relatively well absorbed by excess domestic liquidity as evidenced from the small increase in MGS yield to 3.88% currently (10-year average: 3.96%). But flow dynamics may accelerate if the Fed moves faster than anticipated with the associated kick to the USD. The timing and magnitude of the reversal in foreign ownership may have significant repercussions on either the Ringgit or the MGS yield. This twin challenge poses a policy dilemma because rising MGS yield signifies higher risk free rate, and by extension, equity risk premium.

- The sudden collapse in oil prices is casting some uncertainty over the government’s target fiscal deficit of 3% for 2015 because oil-related revenue contributes to about 30% of government revenues. Petronas’ guidance for a RM25bil fall in contributions to the government revenue is larger than the fiscal savings from the scrapping of fuel subsidies, estimated to be about RM20bil. The urgency to achieve the target fiscal deficit takes on greater prominence in order to fend off further pressure on the weakening Ringgit. This means that development expenditure may be scaled back.

- We are underweight on the banks. The weak commodity prices, retrenchment newsflow and select loan defaults have renewed worries over credit costs. The loan loss provision cycle may rise sharply from its historic low of just 19bps in 3Q 2014. Earnings may undershoot due to the upturn in the provision cycle together with perennial concerns over cost of funds. The 25bps hike in OPR in July 2014 did not materially ease margin pressure. We believe that it is premature to bottom fish for oil & gas stocks despite the steep selldown. Earnings expectations still look somewhat inflated as we move into an era of lower oil prices and Petronas’ slowing capex cycle (to be cut by 15%-20% in 2015).

- We like companies with USD exposure. The risk-reward trade-off is turning attractive after the pullback in share prices of plantation companies. With CPO prices retracing down to around RM2,150/tonne currently, the negative earnings revision cycle may be bottoming out. Sequentially, we expect CPO prices to recover to RM2,450/tonne in 2015 because of slower supply growth from lagged impact of the drought this year and lower maturing Indonesia acreage. Our picks are KL Kepong and Genting Plantations. We are BUYers of Kossan AirAsia remains a BUY. Jet fuel accounts for close to 50% of operating cost. Every 1% change in jet fuel price impacts AirAsia’s FY15F earnings by 2.4%, we estimate.

- We are seeing selective strengths in the purchase of cars and properties. Take-up rate for the latter is primarily driven by location where there may be a mismatch of effective demand and physical supply at the micro level. Mah Sing is a BUY on account of its attractive valuation and high locked in sales of RM5bil. We are BUYers of Berjaya Auto for its market share gains. We remain committed to our strong conviction on Eastern & Oriental. Reclamation works for its long awaited ‘jewel-in-the-crown’ Sri Tanjung Pinang (760 acres) will commence soon. This is a very lucrative development because of its excellent sea-fronting location, low break-even cost, and rising land values in Penang.

Source: AmeSecurities