Yesterday BNM raised the OPR by +25bps to 2.50% which was within our expectations. We believe the market can stomach the higher rates, seeing that KLCI’s earnings yield spread to MGS10 is still generous at +0.5SD above 5Y mean. Sectorial winners from the OPR hike are banks while losers are REITs and property. While the FFR-OPR spread has temporarily narrowed to -13bps, this could widen again to +38/+63bps if (when) the Fed hikes rates by +50/+75bps on 21 Sep. Sectors that ride on USD strength which we are positive on include Tech, O&G upstream E&P, and Wood-based/Furniture players. Maintain KLCI target at 1,560 (15.6x PE on mid-CY23 EPS).

NEWSBREAK

Yesterday, BNM raised the OPR by +25bps to 2.50% which was within our expectations of 2x25bps hikes in 2H22, specifically in Jul and Sep to end the year at 2.50%. This implies a rate pause for the Nov-22 MPC meeting.

HLIB’s VIEW

Should be able to stomach higher rates. While OPR hikes (or its expectations) generally lead to higher bond yields, we note that the current spread between the KLCI’s earnings yield and MGS10 is still relatively generous at 2.51% (+0.5SD above 5Y mean). Intuitively, this spread is a measurement of the relative attractiveness of investing in Malaysian equities vs the country’s risk free rate – a narrower spread makes equities relatively less attractive, vice versa.

Experience from the last OPR upcycle. The last notable OPR upcycle happened in 2010 (coming out of the GFC) where rates were raised by +75bps that year (from 2.00% to 2.75%). Despite the rate upcycle, the KLCI gained +19.3% that year, spearheaded by the index heavyweight banking sector (KLFIN: +25.4%). Nevertheless, the positive effect this time around could be less profound given recessionary concerns in the US and Eurozone, and its contagion.

Winners and losers. The banking sector (which we are OVERWEIGHT on) is a clear winner from an OPR upcycle as NIM is expected to widen – our banking analyst estimates that every +25bps OPR hike would bump up sector NIM by 5-6bps and earnings forecast by 4-5% (big gainers are Alliance and BIMB, while small gainers are Affin and Public Bank). Sectors on the losing end are likely to be REITs (narrowed spread between divvy yields and MGS10) and property (our property analyst estimates that a 25/50/75bps rate hike would increase monthly mortgage instalments by 3.2%/6.5%/9.9%).

Ringgit weakness. MYR has depreciated -7.5% YTD against USD (ASEAN-5 average currency decline YTD: -7.1%). With yesterday’s OPR hike, the FFR-OPR spread has narrowed from +13bps to -13bps. However, if (when) the Fed raises rates by +50/+75bps during the next FOMC meeting on 21 Sep, this spread would widen again to +38/+63bps. Based on previous projections by the Fed (in Jun), they expect the FFR to hit 3.40% by year end. Any upcoming increase to this projection may lend further strength to the USD (weakening MYR). Sectors that ride on USD strength which we are positive on include Tech, O&G upstream E&P, and Wood based/Furniture players.

KLCI target at 1,560. We maintain our end-2022 KLCI target at 1,560 based on 15.6x PE (-1SD to 5Y mean) tagged to mid-CY23 EPS.

Source: Hong Leong Investment Bank Research - 9 Sept 2022