Heightened volatility was noticed after Trump’s protectionist measures and the Fed’s interest rates outlook, dampening the sentiments across the globe. Investors have shifted the focus to heavyweights from small cap and lower liners, with the help from foreign inflows in 1Q18. Moving forward, with the progressive macro developments and ringgit appreciation bias may provide support to market once GE14 is settled. We remain cautiously optimistic on Malaysia’s equities with the focus in (i) construction and infrastructure-related, (ii) defensive sectors, (iii) small cap and lower liners and (iv) oil and gas.

Market review - The Trump card

Snapping the 9-quarter winning streak. Wall Street closed first time in the red after 9 consecutive quarters of rally. There were several reasons that put the pause to the rally such as the Fed’s monetary policy normalisation and the rising interest rates environment, where consensus are expecting 2 and 3 more rate hikes in 2018 and 2019, respectively. The melt down on the major indexes (Dow, S&P500 and Nasdaq) were intensified as President Trump presented with his wild card (protectionist measures), imposing import duties on steel and aluminium products and tariffs at the world’s second largest economy, China, which investors fear that it may escalate into a trade-war and dampen global growth, eventually. Moreover, the reshuffling of Trump’s administration with a few high-profile departures (replaced by candidates with more combative approach to foreign and trade policies) created the uncertain market sentiment and heightened geopolitical tensions. Investors were also worried on the rich valuations of S&P and Nasdaq against historical 3Y/5Y average with lacklustre earnings growth.

Shifting Focus on Heavyweights With Sustained Foreign Participation

Small cap and lower liners being side lined. Ahead of GE14, investors were shifting their risk appetite from small cap and lower liners towards heavyweights, resulting in the fall of FBM Small Cap and FBM ACE by 12.9% and 17.4%, respectively throughout 1Q18, while FBM KLCI rose 3.7%. We believe the subdued sentiments were due to the perceived political risk in Malaysia, as well as expectations of lacklustre earnings prospects in 1H18 considering heightened external headwinds, resulting in the cautious trading tone on Bursa Malaysia (1Q18: there were 78% decliners vs 22% advancers). Nevertheless, defensive stocks within consumer sector and finance were focused and average daily trading volumes on Malaysia’s exchange in 1Q18 stood at 3.19bn (4Q17: 2.54bn).

Foreign Participation Intact. We noticed improving foreign participation (Figure #3), which stood near the 2.2bn inflows (vs 0.7bn inflow in 4Q17) and the FBM KLCI was being supported well above the 1,860 level. Meanwhile, ringgit trend observed a sharp appreciation towards RM3.92/US$ (vs. average RM4.16/US$ in 4Q17).

Market Outlook and Retail Strategy for 2Q18

Improving macro developments and ringgit appreciation bias (short term)...Judging from the stronger Malaysia’s GDP (2017: +5.9% YoY, 2016: +4.2% YoY), we may anticipate much stable trading interest within Bursa Malaysia and provide better opportunities for the rest of the 2018 once the political uncertainty is being removed post GE14. Our house view on 2018 ringgit trend would be within a band RM3.85- 4.00/USD, while the end-2018 FBM KLCI target would be located around 1,880.

…flowing Towards Domestic (consumer and Construction) Businesses. Following the softer news flows and construction activities in 2017 and the reiteration of the focus on Rakyat in the expansionary 2018 Budget, we believe it is likely to expect the resumption of potential awards of mega projects such as ECRL (RM55bn), MRT3 (RM40bn), Pan Borneo Highway (RM13bn) and HSR (RM60bn) in 2018-2019.

Strategy 1: Construction and Infrastructure Proxies. Given the anticipation of higher construction awards to be dished out in 2018-19, we think it may excite some construction stocks. While biggest beneficiary may be on the rail-related contractors, we expect the contracts would flow down the value chain, supporting the building material segments, eventually. For this infrastructure theme, we like CHOOBEE and SUNWAY.

Strategy 2: Defensive Theme May Cushion Out Volatility. Moving into 2Q18, investors will be focusing on few key events such as GE14, Russia 2018 World Cup, the old adage “sell in May and go away” and the 10-year cycle meltdown, coupled with any potential wild cards that may be presented by President Trump in the future that could trigger another round of heightened volatility. These events are likely to shift the risk appetite of some traders into defensive sector such as pharmaceutical or healthcare like CCMDBIO. Investors would also favour stable yield sector like REITs.

Strategy 3: Prudent Picks Within the Small Caps Space. Generally, stocks under small caps and lower liners were an outcast in 1Q18 as investors turned risk averse during the period of uncertainties. We believe trading interest may return after the political uncertainty is being removed. Within the severely oversold small caps and lower liners, we like ENGTEX, FRONTKEN and PUC.

Bottomed out Brent crude oil to lift O&G sentiments

Encouraging Measures by OPEC Members. Despite the recent increase in stockpiles reported by EIA, we believe the OPEC’s production-cutting measures and President Trump’s administration to pressure OPEC member Iran (which may escalate into a geopolitical tension), coupled with Saudi Arabia-Russia long term pact that could extend controls over world crude supplies in a 10-20 year agreement may provide support towards the current crude oil prices (Brent crude oil could trend higher towards US$75-88; based on technical analysis’s projections), resulting in a positive trading interest within O&G stocks in 2018.

Strategy 4: Buying Interest to Sustain O&G Stocks. With the expectation that the Brent crude oil could trend higher above US$70 amid the production cutting measures by OPEC-members into full 2018 (may extend into 2019), the potential upward cycle on the crude oil may attract traders’ attention, where most of the O&G stocks could surprise on the upside. Within O&G related, we like ARMADA.

Nevertheless, Given the Number of Potential Downside Risks and External Shocks That May Emerge in 2Q18, We Need be Versatile and Proactive in Managing Our Portfolio by Having Higher Cash to Equity Ratio. Also, Futures Products Such as FKLI and Gold Futures May be Another Way to Hedge Against the Downside Risk.

FKLI Futures: At This Juncture, We Still Think the KLCI Futures Would be on An Upward Bias Tone. Resistance Will be Located Around 1,875, While Support Is Set at 1,820.

Gold Futures: Ascending Triangle Formation That Could Poise for a Breakout Above 1,350, Targeting 1,450. Support Will be Anchored at 1,300.

Source: Hong Leong Investment Bank Research - 6 Apr 2018