News

• The UK had voted to leave the European Union.

Comment

• Short-term impact of Brexit is mainly centred along a recession scenario in the UK. The IMF had earlier assessed that the UK GDP will be lowered by 1.4ppts by 2019 (negotiation to similar EU status) and by 5.6ppts by 2019 (if default to WTO trade rules). Global growth will be dampened by circa 0.1-0.2ppt in both scenarios (Figure #4).

• Long-term implications of Brexit are still largely unknown. In our opinion, long-term risks of Brexit include (i) fragility of EU as a political union; and (ii) the rise of populism & nationalism. We expect sentiment of populism to introduce uncertainty to global political landscape (2016: US election; 2017: German & French election). The abovementioned risks may lead to unpredictable political developments which result in sub-optimal global economic policies.

• Global markets have swiftly priced in Brexit impact running up and after final result announcement. However, we still expect continued short-term volatility given uncertain longterm risks. During the major global events after GFC (i.e. US debt ceiling, Grexit, Yuan devaluation), repercussions usually lasted for 1-2 weeks (Figure #5). To note, average decline of S&P 500 during these events was -10.7%, FBM KLCI (-5.5%) and USDMYR rate (-5.0%). Judging from the 1-day Brexit performance, currency reaction could have peaked but there is still room for stock markets to fall.

• On a positive note, major central banks are committed to inject additional liquidity. Latest guidance from the BOE was to pump £250bn into markets to ensure sufficient liquidity. The ECB also stands ready to provide additional liquidity, if needed.

• Closer to home, direct impact on Malaysia is limited. Malaysia’s trade with UK amounted to 1% of total exports while FDI from UK is 4% (2008-15 average). Risk to Malaysia emanates mainly from financial contagion.

• For companies under our coverage, Sime Darby, SP Setia, Genting Malaysia, YTL Power, BToto, IJM and KNM have exposure to the UK economy (Figure #6).

• On technical front, immediate support is situated around 1612 (16 May & 25 Jun low) levels. Failure to hold at 1612 could see index drifting lower towards 1580-1600 territory.

Target

• Maintain our end-2016 FBM KLCI target at 1,690 based on 15.5x (historical mean) one-year forward earnings.

Strategy

• The ongoing risk aversion is expected to further strengthen US$, leading to weakening bias in MYR. This still bodes well with our advocate for exposure in export stocks. We continue to advocate exposure in companies that are less prone to earnings shocks.

• Top picks remain unchanged: Big caps: Digi, Gamuda, IJM, Tenaga and Top Glove. For small/mid cap space, our picks are Evergreen, Mitrajaya, SunCon and Unisem. Westports is removed due to uncertainty on future volume (trade) growth.

Source: Hong Leong Investment Bank Research - 27 Jun 2016