KLCI registered positive Dec returns in 9 of the past 10 years, ranging between 0.6% and 4.8%. Against ASEAN-5, KLCI’s 90% hit rate on a positive Dec is also higher than the former’s 60%. Drawing from historical probability, Nov has a 70% chance of ending red; suggesting a strategy to buy on any weakness this month to ride on a likely Dec upside. Potential window dressed stocks are Axiata, Digi, Genting, HLBank, IOI, KLK, Maybank, PetDag, PGas, PChem, Public Bank, Sime Darby and Tenaga. Our 12-month KLCI target is unchanged at 1,660.

Getting dressed up for the year end party. The “Oct Effect” came and left without leaving much scars (KLCI +0.9% MoM); ironically this perceived market anomaly has historically not played out much in Malaysia with the KLCI recording negative Oct returns only twice over the past decade. While perhaps being a tad early, we attempt to study the next possible market anomaly, i.e. year-end window dressing. We noticed that regardless of market movement throughout the year (i.e. Jan-Nov), the year-end window dressing phenomenon has been quite significant; the KLCI managed to record positive Dec returns in 9 out of the past 10 years ranging between 0.6% and 4.8%. Even in 2014 which was the exception (-3.3% Dec returns), the KLCI still managed to rebound 5.2% from its month low (around mid-Dec) to the year end. Compared to the ASEAN-5 index, the KLCI’s 90% hit rate on positive Dec returns is also higher than the former’s 60% over the past decade.

Positioning on possible Nov weakness. The question is then of course, when should one position for a likely window dressed Dec? Again, drawing back to historical market movements, we noticed that Nov has traditionally been a red month for the KLCI; negative returns ranging -1.3% to -3.7% in 7 of the past 10 years (exceptions were in 2009, 2013 and 2015). Broadly, we reckon that this could be due to misses on the 3Q results season which are mostly reported in Nov. This suggests that (albeit simplistically), one should position for a possible year-end window dressing if there is weakness this month (Nov).

Case for a year-end upside. While historical probability presents the case for a Dec upside, what might be the fundamental justification for it to do so this time around? For starters, after coming off -5.2% YTD (-5.3% currency adjusted), the KLCI is the worst performer within ASEAN-5 (rest are in positive territory). This prices valuations pretty attractively: (i) PE (1-year forward) is near -1SD, (ii) spread between earnings yield and 10-year MGS is at +2SD and (iii) P/B nearing 10-year low. Externally, progress on the US-China trade talks appears to have a positive tilt, with a possible “phase 1” deal before year end. Yesterday, Bloomberg reported that both nations have agreed to proportionately roll back tariffs in stages; this should help alleviate risk aversion. On the downside, we are hopeful for this to be contained given tell-tale signs that foreigners are already underweight on Malaysia: (i) cumulative net change in foreign holdings (since 2011) is now at its lowest level of -RM20bn and (ii) foreign shareholding of 22.7% (Oct) is below mean (23.1%) at a 2.5 year low. Our unchanged 12-month KLCI target of 1,660 is pegged to 16.5x (-0.5SD) 2020 PE.

Window dressed stocks. We evaluated the KLCI constituents to identify the potential “window dressed” winners. To ensure sufficient data points for probability analysis we only considered those that have been in the KLCI for >5 years; this narrows down to 20 stocks (18 have been in the index for >10 years). Of these 20 KLCI stocks, 17 (85%) have a positive Dec return probability exceeding 50%, suggesting that the window dressing effect is rather broad based. Stocks that have positive Dec returns probability of >75% are Axiata, Digi, Genting, HLBank, IOI, KLK, Maybank, PetDag, PGas, PChem, Public Bank, Sime Darby and Tenaga. However, if we were to screen those that have positive returns which also outperformed KLCI in Dec with probability of >50%, the list narrows down to Digi, KLK, PGas and PChem.

Source: Hong Leong Investment Bank Research - 8 Nov 2019