Executive Summary

Maintain FBMKLCI Index 2024 Year-end Target of 1,720 Points. Our theme is based on the following: (i) government’s fiscal reform and pump priming measures, (ii) a new cycle of reindustrialization as Malaysia benefitting from geopolitical tension, (iii) booming green investment amidst reform in electricity market and energy transition, and (iv) a surge in foreign flow into the equity market due powered by undervalued Ringgit and the easing in policy measures in AEs. We also introduce our FBMKLCI Index 1H25 target of 1,790 pts based on fair PE multiple of 16.7x (a 10-year average) and 8.5% earnings growth in 2025. We also establish our inaugural FBMHS target of 13,450 pts by 2024 year-end.

Investment Thesis

1. Government to Forge Ahead with its Fiscal Reform and Pump Priming. We commend the government’s strong political will for implementing the diesel subsidy rationalization that took effect on the 10th of June 2024. This is expected to generate RM4bn in annual savings which could then be channelled towards other development expenditure. With strong desire to undertake economic reform, we believe the government will continue with rationalization measures for other subsidy particularly for petrol. A larger amount of savings would be apt for pump priming activities ahead. This may provide another leg-up to construction sector, in our view. Not only that, the government has also committed to support local technology industry to encourage the local players to move up the value chain. We expect more details will be given in 2H24 relating to National Semiconductor Strategy (NSS) incentives.

2. Rising FDI as Malaysia Benefitting from Geopolitical Tension. Following the geopolitical tension between US and China, ASEAN and particularly Malaysia has benefitted from “China+1” strategy. The rising investment in data centre project has clearly validate this thesis and thus we expect higher FDI flowing into the country moving forward. Consequentially, this will boost the household income in Malaysia and thus would give the government more headroom to press ahead with its fiscal reform measures. Should we expect a new round of re-industrialization of the economy moving forward? In our view, yes we should. Thus, we advise investors to allocate funds accordingly towards services companies that are involved in Industrial sector particularly in supply chain of semiconductor, automotive/EV, and energy.

3. Third-party Access (TPA) to Electricity Market is Urgently Required. Given the rising FDI into data centre project and the urgent need to address the energy transition (ET) issue to meet the net zero commitment by 2050, we believe the TPA into electricity market will be expedited. At this juncture, the government has indicated that it will implement the TPA in the national electricity supply industry from September 2024 onwards, thereby allowing independent power producers (IPP) to sell electricity directly to end users. Once this is implemented, we believe investment in energy projects will boom, thus benefitting the utilities sector.

4. Foreign Capital Flow to Provide Ample Liquidity in Local Equity Market. Moving forward, we expect the liquidity in the market will continue to be amassed amidst the expectation of the first cut in Federal Fund Rate (FFR) potentially in September 2024. Based on The Fed’s current dot plot (i.e. chart that records each Fed official’s projection for central bank’s key short term interest rate), the median forecast shows the Fed is likely to cut the FFR only once in 2024. This is in stark contrast from three cuts estimated earlier. However, the same forecast also shows that the Fed is expected to trim the FFR by four times in 2025, indicating that the rate cut could be imminent though it has been pushed further to the right. To reiterate, we believe such move will encourage the fund flow towards the emerging market (EM) owing to narrower interest rate differential between the US and EM.

5. Undervalued Ringgit boosts Malaysia’s appeal over other EM currencies. We believe the ringgit is undervalued by 20% as we established a fair value of RM4.20-RM4.30 per dollar in the long run. This is by far the most undervalued currency regionally. Given positive sentiment towards country as well as its growth prospect, we think undervalued ringgit provides another booster for capital inflow into the country vis-à-vis other EM countries.

6. Political Stability should Remain. One of key risk to current government economic reform effort is the political environment. Moving into 2025, the country will be heading for a state election which will be the litmus test to the reform measures. For sure, sentiment surrounding the subsidies cut will be played by the opposition. However, the early signs of economic prosperity with the entry and investment made by the tech giants should be enough to counter opposition’s narrative, in our view. The performing stock market that will lead to higher dividend to be announced by GLICs should also provide feel good factor to the government in the running. However, in the worst-case scenario that there is change to Sabah state government, we still foresee that it will have negligible impact to Federal government which should remain in power until the next GE15.

7. Rebound in China Export a Precursor to Tech Upcycle. As the largest trading partner to Malaysia, China’s economy has a large bearing to the local economy. While it still struggles with the weakness in property market, there is light at the end of tunnel for its economy with better outlook in its export numbers. In May, export continued its upward trend with an expansion of 7.6% (Apr 24: 1.5%). In our view, this is in tandem with the anticipated recovery and new upcycle in tech sector which should bolster the outlook of local tech counters.

Risk to Market

1. Stubborn Inflation Posed Key Risk to Equity Market. Rebound in inflation in the advanced countries posed the main risk to the market, in our view. The unemployment rate in the US remain relatively low against the Fed’s target owing to the underlying strength in US economy. As suggested by the Phillips’ curve theory, there is negative correlation between inflation and unemployment rate. Hence, this is really concerning to the market. To recap, US unemployment rose slightly to 4% in Apr 2024 but there’s still some gap away from its target of 4.5%. Meanwhile, the JOLTS job opening number unexpectedly rose to 8.14mn in May 24 (Apr: 8.059mn) instead of dropping, hence suggesting that US labour market remain sturdy. Meanwhile, the US CPI index stood at 3.4% which is a tad above Fed’s target of 2.1%.

2. Rising Container Shipping Cost a Bane to Inflation. We are also concerned with stubborn inflation outlook particularly as supply chain issue could re-emerge aftermath of Red sea crisis. Recent news headline that reported an increasing congestion at Singapore ports felt like a deja-vu similar to pandemic. That had led the container shipping cost to skyrocket yet again. The World Container Index as assessed by Drewry has shown that the spot container freight rates has risen to USD5,900 per 40ft box (Chart 15) which is unusually high against the long term average of circa USD2,000 per 40ft box. Note that the index had briefly risen to USD10,360 per 40ft box during the pandemic. Against this backdrop, we think port and logistic freight players could serve as a good hedge against market risk.

3. Oil Price could Tread Higher on Seasonally Stronger Demand in 2H24. Brent crude benchmark was trading at average price of USD85/bbl in 1H24 which is largely within our forecast. We think it could be heading upwards in 2H24 owing to seasonally stronger demand for heating during winter season. However, as we believe the price is artificially inflated by OPEC+ production cut (which has agreed to extend until end 2025), any discussion on phasing out the production cut will be negative to oil price. Oil price could also be the subject matter ahead of the US Presidential Election that will be coming by end of the year. This could be putting on pressure to oil price as the US may be pushed to take populist measure to contain the inflationary impact arising from elevated oil price to the people. Should oil price decline substantially, that could affect the government coffers and its planned fiscal reforms.

4. US Presidential Election is Setting the Tone for Geopolitical Risk. Geopolitical risk is set to rise again in the 2H24 as the US Presidential Election will take place on 5th November 2024. This time, the main candidates are the same as in 2020 i.e. Joe Biden and Donald Trump. During the first presidential debate that was held on 27th June 2024, Biden’s catastrophic performance had led to Trump to be ahead of Biden, potentially indicating the change in Presidency. Nonetheless, we believe that geopolitical tension will remain elevated no matter who wins the election. This is because the emergence of China as a new economic powerhouse, together with its allies through BRICS have posed a serious threat to US supremacy. The US and the West will want to retain its influence over global politics and thus will strive to avoid a new world order at all cost. As such, we believe this will benefit Malaysia who has maintained a neutral foreign policy for decades.

Source: BIMB Securities Research - 10 Jul 2024