Following stronger 1H22 recovery, we upgrade 2022 GDP forecast to +5.9% and maintain expectations for another +50bps OPR hike the second half. While market headwinds are aplenty, it is crucial to delve beyond the headlines – supply chain woes are past the peak, Malaysia is relatively more insulated amid the war, the market has room to stomach higher rates, appreciation bias to ringgit from current weak levels and US recession contagion risk has already battered valuations on the local bourse. We have a year-end KLCI target of 1,610 premised on 15.6x PE (-1SD) tagged to mid-CY23 EPS.

Renewed challenges for the global economy. Shortly after exiting the pandemic, the global economy is seeing yet another major shock. The Russia-Ukraine conflict has intensified strains left by past Covid-19 lockdowns – supply chain disruptions and elevated commodity prices leading to heightened inflation. To keep a lid on inflation, central banks around the world are accelerating on monetary tightening, risking a sharper slowdown in global growth. Consequently, global growth forecasts have been cut by both IMF (4.4% to 3.6%) and World Bank (4.1% to 2.9%).

Malaysia’s economic recovery still on track. Despite the external headwinds, Malaysia’s recovery remained favourable in 1H22. With the transition to endemicity and EPF withdrawal scheme supporting consumption, we upgrade our 2022 GDP forecast to +5.9% (from +5.5%) but expect it to slow in 2H22, especially in the fourth quarter. We lift our 2022 CPI forecast from 2.7% to 3.2% as we continue to see upside risk to food inflation. On OPR, our expectation is for another two +25bps hikes in 2H22 (Jul and Sep) to bring the benchmark rate to 2.50% by year end.

Market headwinds aplenty but... We won’t deny, there isn’t a shortage of market spooking headwinds – however, it is imperative to delve beyond the headlines. Despite the onslaught of war and China’s lockdowns in 1Q22, supply chain disruption indicators (though elevated), haven’t worsened, with some in fact easing, suggesting these woes are past the peak. While still tough to imagine how (or when) the Russia Ukraine conflict will end, Malaysia (and ASEAN) remains relatively more insulated from this compared to the developed West. On domestic monetary policy tightening, we believe the market can stomach it, seeing that the spread between the KLCI earnings yield and MGS10 is still generous at 2.88% (+1.1SD). While FFR-OPR spreads could potentially widen to +90bps by year-end (now: -38bps), we deduce that this has already been priced into the ringgit’s weakness. In fact, we foresee ringgit appreciation bias from Aug onwards with 2H22 average USD-MYR projection of 4.33 (year-end: 4.23) – ringgit strength has historically augured well for the local bourse. Granted, the biggest risk seems to be a “hard landing” scenario for the US, bringing recession contagion fears to our shores. However, we reckon that battered valuations have reflected a reasonable degree of this as KLCI’s (i) forward PE is at a 5Y low and (ii) trailing PB is at -1.7SD; the only time it momentarily went lower was in Mar-20, during the initial pandemic outbreak. Headwinds aside, perhaps it would be useful to also reflect that Malaysia is on a much stronger footing now (from its sustained reopening) than it was during the 2020-2021 pandemic.

KLCI target at 1,610. We project CY22/23 KLCI earnings growth at -4.0%/+6.6%. Our end-2022 KLCI target of 1,610 is premised on 15.6x PE (-1SD to 5Y mean) ascribed to mid-CY23 EPS. While market choppiness isn’t going to dissipate anytime soon, we feel that bottomed out foreign shareholding (20.1-20.4% over the past year; below GFC’s bottom of 20.7%), offers some solace for nibbling. Our top picks are a combination of interest rate upcycle (RHB, Affin), commodity plays (PMetal, KLK, DNeX), reopening (Sunway, Evergreen, FocusP) and value/sold down stocks (Tenaga, Dialog, Armada, Kobay).

Source: Hong Leong Investment Bank Research - 30 Jun 2022