Most of Malaysia should be reopened by end-Oct/ early-Nov and this speedy pace prompts us to upgrade 2021 GDP forecast to 4.1% (from 3.1%). We reckon the negatives dragging the Malaysian market are waning – glove stocks are closer to pre-pandemic levels, the economy is reopening on back of declining Covid-19 cases and the political impasse has been resolved. While the market may stay choppy in Oct given fears of market spooking leftist taxes, we think upside will resurface in Nov-Dec (not forgetting the year end window dressing). For those that missed out on Aug’s mini-rally, this could be the next boat to catch following Sept’s decline. Our end-2021 KLCI target stands at 1,640.

Covid-19 situation improving. After gyrating at 19-25k daily cases for the most of Aug, numbers have fallen -41% from the peak (based on 7DMA). Infectivity rate (or R naught) has tamed to below 1.0 in Sept, averaging 0.95 vs Aug’s 1.05. A point of caution is that testing (88% correlation to cases) has also slipped – average daily tests in Sept were -10% lower than Aug. Despite so, we take some comfort in the declining test positivity rate from 15.3% (end-Aug) to 9.8% (end-Sept).

Encouraging signs from vaxxing. With 61.5% of Malaysia’s population fully vaccinated (at least 1-dose: 71.6%), several positive signs have emerged: (i) ICU cases and ventilator use have come off, declining by -21% and 34% from the high in Aug, (ii) symptomatic cases have gradually eased from Aug to Sept, both in absolute numbers and as a percentage of total cases and (iii) while still premature to ascertain, reported deaths may have hit a tipping point in late Sept as the ascending cumulative mortality rate appears to be plateauing.

Enter the endemic. The sombre reality is that the pandemic isn’t likely to end anytime soon and may very well continue as an endemic. Coupled with the economic repercussions of lockdowns, world governments are shifting their thinking from “eradicating Covid” to “living with it”. This sentiment is shared by newly minted Health Minister “KJ” (as he is fondly known) who expects Malaysia to move to an endemic stage by end-Oct. This stage is one where most economic and social sectors reopen but with SOPs in place – normalcy in a new normal, put simply. We are comforted by the government’s endemic view on Covid-19 as opposed to a “zero Covid” strategy as the latter is unrealistic with dire economic consequences.

Reopening gaining traction. With vaccination making good headway, the government has allowed most businesses to reopen for fully vaccinated consumers with workforce capacity depending on staff vaccination levels. The decision to allow “leisure type businesses” (Langkawi travel bubble, gym, spas, etc.) is a clear sign that the government’s appetite is for more reopening. Interstate travel and domestic tourism will also recommence once the adult population hits 90% vaccination rate, which we expect within this month (currently 85.7%). Existing reopening initiatives have already shown a positive effect on mobility (a proxy for economic activity) with Google Mobility Report showing an 11-16% increase from July to Sept. We expect most of Malaysia to be open for business by late-Oct/ early-Nov, pretty much putting it in Phase 4 of the National Recovery Plan (NRP).

Upgrade 2021 GDP but cautious on inflationary risk next year. Following the government’s departure from its original NRP “phased based” restrictions, resulting to speedier reopening (since mid-Aug), this prompts us to upgrade our 2021 GDP forecast to 4.1% YoY from 3.1%. On inflation, soaring gas and coal prices globally may have a knock on effect to other goods if electricity tariffs are eventually raised. While our 2021 inflation (CPI) forecast of 2.2% YoY should be intact – as the next electricity tariff review will only be towards end-Dec – there is upside risk to next year’s number. We expect the OPR to remain unchanged at 1.75% for the remainder of the year and begin its upward normalising process in 2H22. The current low rate is still accommodative, alongside various fiscal and financial measures rolled out to support the economy.

Budget 2022. This will be tabled in Parliament on 29 Oct and we expect to see continued (but gradual) fiscal consolidation. We project 2022 fiscal deficit at -5.0% to - 5.5% of GDP vs 2021’s -6.5% forecast. Broadly, we believe existing Covid-19 stimulus measures will continue showcasing in Budget 2022 (e.g. Covid-19 funding, wage subsidy, electricity discounts, auto SST exemptions, etc.). Property should see a push for affordable housing and financing accessibility. However, construction (a Budget favourite for investors) could be rather muted judging from the 12MP’s tone which saw no new mega projects unveiled.

Tax bite? An evaluation of capital gains tax (CGT) on stocks and one-off higher corporate tax rate for “pandemic beneficiaries” (think gloves) was brought up in Parliament last month. We believe the negative economic ramifications from such socialistic leaning taxes (e.g. loss of investor confidence and competitiveness) far outweigh the incremental government revenue. Nevertheless, we find some solace that FM Tengku Zafrul (a former banking honcho who understands economics) has repeatedly voiced out against such taxes. We note that none of the countries in ASEAN-5 have CGT on stocks for retail investors, although some (i.e. Thailand) treat gains on stocks by local companies as revenue for tax purposes.

Bipartisan politics. Perhaps a first for Malaysian politics, the main opposition bloc PH inked a MoU with PM Dato Seri Ismail Sabri’s federal government. Broadly, the government agreed to embark on a transformation program – Covid-19 measures, anti-hopping laws, Undi18, PM term limit, parliamentary reforms, judiciary independence and MA63 – in exchange for support from PH (or its abstinence from opposing). Both sides of the divide have agreed not to dissolve Parliament before 31 July 2022. Although this landmark development paves way for a more stable political climate, it could also give rise to new policy directions which may not augur well with the market (i.e. leftist tax spooks).

Catch this boat. KLCI has declined -5.5% YTD (currency adjusted: -9.2%), underperforming ASEAN-5’s -4.3% owing to (i) sell down in glove stocks, (ii) highest Covid-19 cases per capita amongst peers, leading to relatively more restrictive lockdown and (iii) fluid politics. However, we reckon these negatives are waning – share price of glove stocks are now much closer to pre-Covid levels vs the start of the year, the economy is reopening with high vaccination rates (3rd in ASEAN) and the political impasse has been resolved. Timeline wise, we expect the market to stay choppy in Oct, ahead of Budget 2022 given risk of “market unfriendly” taxes. Nevertheless, an upward trajectory should resurface in Nov once the dust settles and investors refocus on a rejuvenated economy. We also expect this upside bias to sustain into Dec given the traditional window dressing phenomenon whereby KLCI posted positive Dec returns in 11 of the past 12 years (i.e. since GFC) with the average positive return at 2.6%. For those that missed out on the “mini Aug rally” (+7.1%), this could be the next boat to catch following Sept’s -4.0% retracement.

Foreign buying returns. After 25 months of consecutive selling (-RM36.6bn from July 2019 to July 2021), foreigners finally turned net buyers in Aug-Sept (+RM2.1bn). We believe that Aug’s foreign shareholding of 20.2% has scrapped the bottom of the barrel and is likely to have rebounded slightly in Sept. The return of foreigners should be positive for the market (70.3% correlation between KLCI and foreign shareholding).

KLCI target at 1,640. We project KLCI earnings growth of 18.6% and 4.2% for CY21- 22 while our end-2021 KLCI target of 1,640 is based on 16.7x PE (-0.5SD) tagged to mid-CY22 EPS. Considering the reopening trajectory, valuations look appealing with 1Y forward PE at c.-1.5SD below 5Y mean. Our top picks are Maybank, Tenaga, TM, MRDIY, Dialog, Sunway, VSI, Astro, Armada, Kobay, MBM and FocusP.

Source: Hong Leong Investment Bank Research - 1 Oct 2021