While fundamentals are subdued, this will likely remain masked by liquidity factors. Domestically, the “retail liquidity fuel” is showing no signs of abating while externally, the Fed’s unlimited QE arsenal could see some spill over to EMs, Malaysia included which now has foreign shareholding at a decade low. The playing field seems unfavourable for the bears with short selling ban extended coupled with an asymmetric revision to stock price limits. US markets have generally performed positive in their election years (74% hit rate for S&P500 and 70% for DJIA), possibly boosting trading sentiment for Malaysia. We revise our KLCI target from 1,460 to 1,640 (18.5x “liquidity driven PE” tagged to CY21 earnings).

Subdued fundamentals masked by liquidity flush. It wouldn’t be a far cry to say that fundamentals are subdued on several fronts: (i) new daily Covid-19 cases are charting new highs and spreading at a faster rate, (ii) souring US-China relations risking adherence to its Phase 1 trade deal, (iii) fluid domestic politics with the ruling PN coalition having an estimated slim majority of 4 seats in Parliament and (iv) worsening reported numbers for 2Q20 (both GDP and corporate results). Despite these, the KLCI has staged an unprecedented rebound (since 19 Mar; 1,220) to recoup all prior “Covid-19 losses”, spearheaded by rubber glove tailwinds and a liquidity flush (both domestic and external).

Rejuvenated retailers. We previously expected some downward normalisation in retail participation post MCO as more return to work and gambling avenues reopen. However this doesn’t seem to be the case as (i) average retail participation in July of 38.8% is higher than during the MCO period (18 Mar to end-Apr: 32.5%) and (ii) retailers net bought RM2.82bn from June to 24 July, mirroring the levels seen in the MCO (Mar-Apr: RM2.70bn). YTD, average retail participation is at a decade high (32% vs 10 year mean of 24%) while net buys of RM8.05bn has more than tripled 2019’s full year sum of RM2.4bn. However, we are mindful that some of this “retail liquidity” could diminish once the loan moratorium ends on 30 Sept; take up rate by households for the moratorium now stands at 85% (initially 90%).

Unlevelled playing field. In addition, with (i) short selling ban (IDSS and RSS) extended to year end and (ii) asymmetric revision to stock price upper limits (+30%/+30sen) and lower limits (-15%/-15sen) until 18 Jan 2021, this creates an uneven playing field to the disadvantage of the bears.

Fed’s unlimited QE arsenal... Since the outbreak of Covid-19, the Fed’s balance sheet has expanded by USD2.9trn in the past 4 months (Feb to June) to USD7.1trn. For perspective, the same magnitude of increase took >5 years to achieve during the initial “GFC-QE days”. While there is no indication of what this “unlimited QE arsenal” will amount to, economists surveyed by the WSJ projected the Fed’s balance sheet to end 2020 at USD8.7trn, implying another USD1.6trn to be pumped in. During the 10 June FOMC meeting, the Fed maintained its dovish stance, stating: (i) forward policy guidance of zero rates through 2022 and (ii) it will continue to purchase Treasuries and agency MBS “at least at the current pace”. With daily Covid-19 cases chalking new highs lately, leading to risks of reinstating lockdown measures, we reckon that the Fed’s dovish tone will continue to play during Wed’s FOMC meeting (Thurs morning Malaysia).

…to spill over to EMs? Part of the liquidity flush from the Fed’s unlimited QE is speculated to find a home in equities, first in the US and developed markets before subsequently spilling over to emerging markets, Malaysia included. By studying the monthly net changes in the Fed’s balance sheet against net foreign flows to Bursa, we note that this positive relationship is relatively apparent from 2H12 to end -2015. This horizon coincides with 2 key periods: (i) QE3 (Sept 2012 to Oct 2014) where the Fed increased its balance sheet by 60% (USD1.7trn) and (ii) the subsequent tapering/ halting of the repurchase program. During QE3, the KLCI’s PE rerated from 14.6x to 18.5x with mean of 16.6x. With the Fed’s balance sheet expansion happening “so fast, so soon” this time around, chances are that this “situational spill over” could happen again (similar to QE3). Furthermore, with foreigners already underweight on Malaysia being (i) net sellers in 6/7 years and (ii) shareholding of 21.4% (end -June) is a decade low (10-year mean: 23.0%). Given such, the base now appears much more palatable to envision their re-entry.

Possible positive sentiment from US elections? With Americans heading to the polls this Nov, it is possible that an “election rally” could ensue for the US market. To test this hypothesis, we studied the returns of the S&P500 and DJIA during past US elections. US has held 23 elections since 1928, of which, annual returns were positive during election years a total of 17x for the S&P500 (74% hit rate) and 16x for the DJIA (70% hit rate). Should historical probability play in favour of positive returns this time around too, this spells further upside for US equities. In turn, we may see some positive sentiment spill over to the Malaysian market. The correlation between KLCI and S&P500 and DJIA stands at 48% and 47% respectively (measured since July 2009; i.e. commencement of the FBMKLCI). This correlation reading has increased in 2020 YTD to 92% (vs S&P500) and 89% (vs DJIA).

Revise KLCI target to 1,640. Taking into consideration the abovementioned liquidity factors alongside the heavier weightage of gloves in the index (which we are OVERWEIGHT on), we revise our KLCI PE target from 16.6x to 18.5x, tagged to CY21 earnings. To capture the liquidity phenomenon into our valuation, the applied multiple of 18.5x corresponds to the KLCI’s peak PE achieved during the QE3 period, as elaborated earlier. Our earnings growth forecast for CY20 stands at -18.7%, followed by a recovery of +17.9% in CY21. All in, our KLCI target is raised from 1,460 to 1,640.

Top picks. Our top picks are relatively unchanged save for (i) including Bumi Armada (comfortable entry point at current levels) and (ii) call and TP for Bursa is Under Review pending its 2Q20 results today; since our upgrade and inclusion to our top picks on 12 Mar, the stock has appreciated 97%.

Source: Hong Leong Investment Bank Research - 28 Jul 2020