(The Edge filepix by Zahid Izzani)

KUALA LUMPUR (July 11): JP Morgan has upgraded its ratings for Malaysia’s equity market, recognising it as a standout performer within the Asean region, according to the firm’s recent note.

JP Morgan has consequently raised its KLCI target base case to 1,650, up from the previous 1,500, with a bull/bear scenario of 1,700/1500.

The firm noted that the Malaysian market has posted an about 9% return year-to-date (YTD), positioning it as the highest earner among Asean countries, where MSCI Asean is down 4% YTD.

This notable performance is supported by significant policy reforms, investments in data centres, and continuous infrastructure developments.

The firm highlighted that these tailwinds align with its 2024 outlook but are progressing at a much stronger pace than initially anticipated.

This unexpected acceleration, combined with increased deployment of domestic funds, has led to a “material re-rating of KLCI/MSCI Malaysia (MXMY)”.

Foreign investors’ positioning in Malaysia remains light, but JP Morgan believes there is “greater upside once it inflects upwards”.

While foreign investment lags, the firm remains “increasingly constructive on the Malaysia equities outlook”.

The upgrade is buoyed by strong tailwinds, with the firm raising its target for the KLCI index to 1,650, from 1,500 previously.

Key tailwinds policy reforms and investments

“Policy reforms, data centres investment and infrastructure build-out have become key tailwinds for Malaysia,” noted JP Morgan.

These factors are driving the country’s strong performance and are in line with the firm’s 2024 outlook.

The upgrades leverage ongoing positive developments, which are progressing “at a much stronger pace than anticipated”.

JP Morgan has identified its preferred sectors in the Malaysian market, which include construction, utilities, technologies, healthcare and ports.

Key stock picks are Gamuda Bhd (KL:GAMUDA), Tenaga Nasional Bhd (KL:TENAGA), Frontken Corp Bhd (KL:FRONTKN), IHH Healthcare Bhd (KL:IHH) and Westports Holdings Bhd (KL:WPRTS).

The firm is also staying selective in the data centre space, preferring “picks and shovel names”.

Renewable energy (RE) and electric vehicle (EV) sectors could also see accelerated growth, driven by higher fuel prices. Although immediate economic adjustments may result in short-term volatility and uneven sector performance, JP Morgan believes that “downtrading exposures [Mr DIY Group Bhd (KL:MRDIY) — ‘overweight’] could benefit in a worst-case scenario”.

External volatilities: Interest rates and geopolitical risks

Despite the optimistic outlook, several challenges remain. These include external volatilities from interest rates, commodity prices and geopolitical risks.

“As jobs data show resilient inflationary pressures in the US, the JP Morgan economics team has shifted its expectations for Fed cuts to now start from November 2024,” the firm noted.

This delay could likely result in continued currency weakness, tepid portfolio inflows and high domestic interest rates in Malaysia.

Additionally, Malaysia’s energy balance has been on a declining trend since its peak in 2011, posing risks from oil price volatility impact on trade balances and current account flows.

The upcoming US elections in November 2024 are another key event that could impact Malaysia’s trade-oriented economy. JP Morgan advises focusing on USD (US dollar) beneficiaries and high-quality dividend yield plays under such circumstances.

Valuation concerns

Since 2018, Malaysian equities have seen a consistent de-rating, with price-to-earnings (PE) ratios falling from 17 to 19 times, to below 15 times.

Valuation premiums compared to emerging market (EM) equities have also contracted from approximately 30% between 2014 and 2020, to 10% to 15% since 2021.

This de-rating is attributed to factors including political uncertainties, risks to external demand, and declining profitability in commodity stocks.

Despite these challenges, after about a 10% rally YTD, MSCI Malaysia’s FY2024 and FY2025 PEs reached 14.8 times/13.6 times, respectively.

Although this is below the 10-year average, it is the third-highest within EM (emerging markets) Asia, behind Taiwan and India, and 17% higher than the MSCI EM valuation.

While relatively high valuation might limit near-term upside, JP Morgan believes the current valuation should be supported by “structural growth in tech/data centres, light foreign positioning, and policy reforms”.

Foreign inflows in 2Q2024 offset outflows in previous quarter

Foreign flows into Malaysian equities were resilient in the first half of 2024 (1H2024), with US$196 million inflows in 2Q2024 offsetting outflows in 1Q2024.

This performance contrasts positively with the rest of Asean, which saw approximately US$500 million to US$2 billion in outflows during the same period.

Increased allocation to Malaysian equities from government-linked investment companies (GLICs) has also buffered the market.

Malaysia has seen incremental improvements in its financial account over the past 12 months, driven by a decline in net portfolio outflows and increased investment income repatriation.

JP Morgan estimates that new investments from GLICs could inject around RM2 billion monthly into Malaysian equities.

Domestic funds have also played a significant role, being major buyers over the past 18 months. Cash allocations in these funds have decreased from approximately 14% by December 2022, to 6.4% as of May 2024.

Sectors like industrials, utilities, and energy saw most inflows, driven by companies like Press Metal Aluminium Holdings Bhd (KL:PMETAL), Tenaga, YTL Corporation Bhd (KL:YTL), and Dialog Group Bhd (KL:DIALOG), while the information technology and financials sectors experienced outflows, led by Inari Amertron Bhd (KL:INARI), Malaysian Pacific Industries Bhd (KL:MPI), CIMB Group Holdings Bhd (KL:CIMB) and Public Bank Bhd (KL:PBBANK).