When skies are all blue

• The broader market is poised for recovery from a 3-month consolidation on FY18-induced earnings derived from synchronized economic growth

• Commodities uptrend correlates well with Malaysia and will provide tail wind for the equity market

• Geopolitics, plus trade protectionism policy remains key risks but a concession likely

• Our above-consensus KLCI target revised to 1,950 from 1,900.

Malaysia has remained resilient

We retain our positive view on the Malaysian equity market. We had advocated a buy and hold strategy in our 1Q18 note and remain steadfast in our core recommendations during a turbulent February 2018 period. Our view of the market remains unchanged, as we believe the KLCI is poised to see a new record set this year.

The market has begun to fulfil our 2018 investment themes of sustained GDP growth, commodity (oil price), and digitalisation for the future. Additionally, notwithstanding valuations in certain stocks, we had recommended on focusing on the business aspect of companies, and their ability to maintain profit margin and generate free cash flows that will result in a manageable balance sheet and debt level. In our January note, we had also caution on the expected increase in volatility as valuations in several sectors move higher than their long-term averages, i.e the technology sector. Hence, the downdraft seen in global stocks and tech sector in particular did not really come as a surprise.

On the global front, equity markets entered 2Q18 on the defensive after the worst quarter in global equities in more than 2 years. Significant events are a surge in volatility, rise in US bond rates and trade tensions primarily between the US and China that have impacted equity markets in its track since February. We continue to hold the view that a rise in rates will be gradual and should be looked from growth outlook perspective.

We expect that there will be more volatility in the US as the markets try to manage several changes that are taking place over the last several months. The global equity markets are trying to deal with a renewed risk on geopolitics, and an increasingly protectionist trade policy. The shift in US trade policy deviates significantly from a global trade standpoint.

We note that the trade tensions are currently the largest worry for the market. China needs a sustainable economic growth for its transition into service-oriented economy, while the US requires foreign capital to finance its huge near-term deficit. One country may have the upperhand – at this point it is the US – but we believe a negotiated settlement on trade between the 2 countries is the most likely scenario by May.

KLCI target at 1,950

We raised our above-consensus KLCI target of 1,900 – introduced in January – to 1,950 for end-2018. The new target is premised on the following factors and assumptions:

• Key macro drivers for Malaysia, ie ringgit, oil price and commodities remain conducive for the market over the next 6 to 12 months. The ringgit has done well, appreciating from RM4.49 in late 2016 to RM3.86 currently. Brent oil has seen its price rising to the highest level in 4 years on supply/demand balance geopolitics. While semiconductor sales growth are slowing, the 7% expansion projected for 2018 is still an admirable rate from our perspective.

• Malaysian equity market has done well in a period of rising commodities. The positive correlation between the KLCI and Brent crude oil is 0.51 and with S&P GSCI Industrial Metal (GSCI) is 0.58. Both Brent and GSCI are currently firmly in an uptrend. In addition, the KLCI is inversely correlated with the USD index at -0.52.

• Malaysia’s stock market, represented by the KLCI, is stepping out from its 3-year consolidation. Malaysia has a smaller exposure to the MSCI than larger markets in Asia – hence the sell-off in the US in February 2018 has seen a lesser impact, if any, on large-capitalisation stocks.

• The “reconstruction” in the KLCI component stocks last December and next one taking place in June 2018 will see a better representation of the economy, as exports and commodity-oriented Press Metal and possibly Hartalega are included in the index.

• Malaysia’s GDP is expanding at more than 5% annual rate for the second year running. This has been achieved despite low loan growth and lesser involvement from the Government, i.e. public spending. Export and private consumption have been the main drivers, with E&E and commodities recovering well since early 2017.

• Although corporates in Malaysia have seen their aggregate debt levels rising, profit margin has stayed relatively stable – a positive. The average net profit margin for these companies has remained between 11.6% and 12.1% in 2016-2018. Companyspecific, expansion in capacity will continue to help improve profitability, i.e rubber gloves sector.

• We believe there is low risk of a recession in major economies. The IMF’s April 2018 forecast strongly implies the expansion the global economy is currently experiencing. Europe has been a strong driver to growth in 2017 and this year, as the US was between 2012 and 2015. Malaysia, in our view, will be a prime beneficiary of this growth. We also see low risk of capital flight from Malaysia’s debt market due to an improving economy.

• Markets have now caught up with Federal Reserve’s implied interest rates path for the year. We believe there are 2 more additional rates priced for 2018. We expect interest rates to rise gradually from the current 2.80% for the US 10-year treasury and thus will not have a significant impact on Malaysia’s equity valuation or result in a derating.

• The 14th general election base case scenario is for the ruling party to retain its majority.

• Our breakdown of the KLCI target is detailed in the table below. Additionally we forecast FY19 EPS for the KLCI to grow by 6.5% yoy.

Stock picks for 2Q18 evolve on our 2018 themes introduced in January

In January 2018, we introduced our key themes for the year as highlighted below:

1. continued expansion in GDP;

2. rising commodities, led by crude oil and industrial metals;

3. digitalisation of the economy;

4. robust growth in private consumption – we still like selective consumer stocks on market weakness however; and

5. elevated multiples in dominant sectors/companies – rubber gloves and technology are still our preferred choice in this space.

The market has begun to deliver on several of these themes, especially on our expectation for the commodity market to recover this year. Indeed several stocks in the oil-related sector such as Pet Chem, Hibiscus – our key recommendations – alongside Dialog and Yinson have all done well YTD 2018.

Our top 10 stock picks for 2Q18 are highlighted in Table 2. We retain Top Glove (Target Price: RM11.40), Petchem (TP: RM10.00), Myeg (TP: RM3.75), TNB (TP: RM17.00), SOP ( TP: RM6.00) and Inari (TP: RM2.17) as our top picks from 1Q18. We have added Yinson (TP: RM4.30) and Dnex (TP: RM0.52) for exposure to the oil sector theme. We also introduced our newly-covered stock as one of top 10 recommendations, Press Metal (TP: RM5.69) as we believe the company will be a prime beneficiary from the geopolitical turmoil impacting the aluminium industry.

Meanwhile, our recommendation for 1Q18 showed mixed performance (please refer table 3). Our best pick was Myeg which rose +10.3% during the recommendation period, followed by Top Glove at +5.3%. However, Inari fell a hefty 27.5% during the period. Indeed, given the market turbulent during the first quarter, it was a rather decent performance for our aggregate of stocks.

Source: BIMB Securities Research - 20 Apr 2018