Although we forecast subpar 2023 GDP at +3.8% (below official target of 4-5%), we expect this to regain momentum in 2024 at +4.8%. On back of better growth, we envision OPR to further normalise upwards to 3.25% in 2024 (2023: 3%). While the KLCI has done well in 3Q23 (best performer in ASEAN-5), we reckon there is still room to go on back of (i) Fed’s upcycle nearing its peak, (ii) gradual ringgit reprieve, (iii) clearer political runway allowing the UG to roll out its strategic plans and reforms and (iv) robust tourist numbers. Battered foreign shareholding (a record low 19.6%) and their significant underweight position should help contain external sell-down risk. We maintain our end-2023 KLCI target at 1,530 and introduce our preliminary target for 2024 at 1,650.

GDP may fall short of official range. We maintain our 2023 GDP forecast at +3.8% YoY, which is below the official range of 4-5% – reflecting the high base effect last year, weak external demand and subpar recovery in China despite its reopening. For 2024, we introduce our preliminary GDP forecast at +4.8%. On inflation, we continue to expect CPI to moderate to +2.8% in 2023 (2022: +3.3%) and ease further to +2.5% in 2024 (pencilled in small subsidy rationalisation impact). While we envision BNM to stay pat for the remainder of 2023, we project OPR to further normalise upwards to 3.25% (+25bp) in 2024 following expectations of better growth momentum.

Outperformed in 3Q23 but lagging YTD. The KLCI staged a commendable +4.9% recovery (+4.4% currency adjusted) thus far into 3Q23 (as of 25 Sep), making it the best performer within ASEAN-5 (-1.9%). Bottom fishing aside, we reckon the reprieve was due to (i) revived investor sentiment from the Unity Government’s (UG) strategic plans such as the Madani Economy and NETR and (ii) abating political risk premium post six state elections. Nevertheless on a YTD basis, KLCI remains a laggard at -9.3%, largely on ringgit weakness (ex. currency: -3.5%) vs ASEAN-5’s -6.0%.

The peak is nigh. During last week’s FOMC meeting, the Fed maintained rates, marking its second pause since its upcycle began in 2022 (totalling +525bp). Although the halt was a hawkish one – hinting that elevated rates could stay for longer – we stick to our view that the rate hike trajectory is peaking, with just one more +25bp hike left (likely this year). While headline CPI showed a slight uptick in Jul-Aug (after 12 consecutive months of decline), core numbers continued to ease. Real interest rates are also in positive territory (since May-23), a rarity since the GFC. Given the banking rout witnessed in 1H23 and rating agency downgrade risks emerging, we reckon this could limit the extent of further rate hikes.

Hopeful for gradual ringgit reprieve. Given peaking FFR, we expect USD strength to gradually subside – this should bode well for ringgit given the 92.6% correlation between USD-MYR and DXY. Looking at interest rate differentials, the FFR-OPR spread has widened considerably (+400bp since 2022) following the Fed’s tightening. While there is a noticeable connection between the USD-MYR and FFR-OPR spread (both moving somewhat in tandem), we flag that past periods of peak spreads actually witnessed ringgit recovery (see Figure #5: Jun-06 to Aug-07, Feb-09 to Feb-10 and May-Jun-19). We are inclined to believe the situation could be somewhat similar this time around too – with the FFR-OPR spread likely peaking in 4Q23, the ringgit could see some reprieve from then on. We expect a gradual appreciation bias to the ringgit with USD-MYR projected to hit 4.60 by end-2023 (average: 4.54) and 4.30 by end- 2024 (average: 4.44).

Positives via two channels. We hypothesise that toppish FFR-OPR spreads is positive for the local bourse via two channels. Firstly, there is a -53.1% inverse correlation between the KLCI and FFR-OPR spread. As such, with the latter possibly peaking in 4Q23, this signals that the negative impact on the KLCI from its widening could soon be over. Although the Fed’s expected rate cut in 2024 is now slower than previously hoped (-100bp to -50bp), the resulting narrowing spread should still augur well for the KLCI given the above explained correlation. Secondly, is our case for an eventual ringgit recovery from 4Q23 as elaborated previously – KLCI has reacted positively during times of ringgit strength, vice versa (see Figure #7).

Clearer political runway. Political risk premium should continue diminishing with the six state polls concluded, resulting to a status quo outcome. Although the UG is one seat shy of a 2/3rd majority (following MUDA’s support retraction), it still commands decent support in the August house relative to its recent predecessors. With GE16 due only in late-2027, this gives the UG a decent remaining runway of four years to implement its necessary reforms (e.g. targeted subsidies) and strategic plans (e.g. Madani Economy, NETR).

Tourist numbers coming in strong. Tourist arrivals for 1H23 totalled 9.2m, accounting for 57.1% of the government’s initial target of 16.1m this year. Judging from the strong showing, Tourism Malaysia guided they could possibility hit 18m (+78.7% YoY) tourist arrivals this year. We note that these robust numbers were achieved despite minimal tourist contribution from China which only made up 5.4% in 5M23 (pre-pandemic 2018-2019: 11-12%). While still at a low base, we highlight that tourist arrivals from China have been increasing exponentially since its reopening earlier this year (Figure #9). Looking ahead, 2025 is earmarked as the “Visit Malaysia Year” campaign with a tourist target of 23.5m (33% CAGR from 2022) – which in our view, is conservative considering that it is still below pre-pandemic (2019: 26.1m). We believe the tourism theme will stay topical over the next few years and remain upbeat on sectors that offer exposure – Aviation, Brewers, Healthcare and Genting Group.

Budget 2024: Continued fiscal consolidation. Budget 2024 is scheduled to be tabled in Parliament on 13 Oct. We project fiscal deficit to consolidate further to -4.1% of GDP in 2024 (2023 target: -5.0%) – supported by a pickup in GDP and absence of 1MDB bond repayment (2023: USD3bn). The government is expected to advance its targeted subsidy rationalisation plans, which we think will focus on electricity and diesel – potentially saving RM20-25bn (1.1-1.3% of GDP). In this regard, the government will leverage on its PADU database (ready in Jan-24) which will be used as a central reference for assistance targeting. Though a “necessary pain”, we reckon GST is unlikely to feature in Budget 2024 given cost of living concerns. Nevertheless, an expansion in revenue collection in 2024 is still expected via the capital gains tax (on unlisted shares) and digitalisation to enhance tax compliance (IRB is targeting 4k businesses with revenue of >RM100m for its new e-invoicing, expected in Jun-24).

Sector expectations. Although broad based positives are likely in Budget 2024, its market impact could be relatively muted, judging from past experience. Higher cash handouts would be positive for the Consumer sector – names that come to mind are MrDIY (low ticket items) and Aeon (mass market target). Construction (traditionally a Budget favourite) should benefit from elevated DE allocation and the reiteration of pipeline mega projects. To encourage greater EV adoption, more incentives could be rolled out along with expansion/extension of existing ones. Healthcare allocation (to MoH) will likely be higher to gradually attain its 5% of GDP target (2021: 2.9%). In view of higher operating cost for Plantation, a review of the windfall tax is plausible – either (i) raising the CPO price threshold and/or (ii) lowering the tax rate. For Property, we envisage: (i) easing of restrictions under MM2H, (ii) Johor focus (e.g. Forest City special financial zone and Special Economic Zone (SEZ) with Singapore) and (iii) continued emphasis on affordable housing and first home buyers. The RE space should see reiteration of NETR initiatives with more granularity (e.g. project timelines). On Tech, we envision more incentives for the semiconductor supply chain, especially for D&D and front-end. Not forgetting the sins, we believe a tax/excise hike can be averted for Casinos (last hike in 2019 and still recovering from the pandemic), Brewers, NFOs and Tobacco (all still face a sizable black market).

Foreign shareholding at record low. Foreign shareholding in Malaysian equities declined to yet another record low of 19.6% in Aug-23. However, this should recover in the next reading (end-Sep), considering that foreigners have recently been net buyers (Jul-to-date: +RM1.8bn). Our regression model estimates that foreigner’s current underweight position on Malaysia (relative to weight in the MSCI-EM index) is the lowest in the past decade (Figure #12).

End-2023 KLCI target at 1,530. We project CY23/24 KLCI earnings growth to chalk in at +2.0%/+7.5%. Our end-2023 KLCI target is at 1,530 based on mid-CY24 EPS tagged to 15.3x PE (-0.75SD 5Y). We also introduce our preliminary 2024 KLCI target of 1,650 derived from 16x PE (-0.5SD 5Y) on CY24 EPS – the higher multiple ascribed reflects easing of the Fed’s tightening cycle externally, diminishing political risk premium domestically and the UG’s strategic plans gaining traction. As a sanity check, our KLCI target for 2023/2024 implies PB of -1.3SD/-0.5SD 5Y which isn’t excessive. In our view, the market could regain traction in Nov-Dec when the Fed signals that its rate upcycle is over (remaining two FOMC meetings), alongside the traditional year-end window dressing effect (92% positive KLCI hit rate in Dec since the GFC). Our top picks are Public, Tenaga, YTLP, MAHB, Gamuda, Inari, Sunway, Armada, OSK, ITMAX, Aeon and FocusP.

Source: Hong Leong Investment Bank Research - 27 Sept 2023