The 1,096 point pullback in the Dow over the past 5 days warrants genuine concern. This was sparked by positive datapoints emanating from the US economy through steady job creation (an addition of 200k jobs), low unemployment levels (which are at their 17-year lows) and better than expected US wage growth of 2.9% yoy in January, also the largest gain in over a decade. Combined, these are stoking inflation fears, and hence the possibility of additional rate hikes required. We are however sticking to our view for 3 rate hikes by the US Fed. The correction thus offers an opportunity to accumulate ahead of further strengthening of the RM and an election rally. Maintain Overweight on the FBMKLCI.

Dow Dives 665 Points, Down 1,096 Points Over Past 5 Trading Days

The Dow declined a sharp 665.75 points last Friday and a fell a total of 1,096 points just over the past 5 days. Last Friday’s selloff was also the single largest decline since June 2016, sparked largely by concerns that the Fed will raise rates by more than the three times guided for this year in tandem with improved macro datapoints from the US. The rout in the equity market was also accompanied by US 10-year treasury yields rising to a 4-year high of 2.84%, up 44bps ytd.

Strong US Job Creation and Rising Wages

The US non-farm payrolls rose from a revised 160k in December to 200k in January, higher than market expectations of 180k, as well as above the 12- month average of 176k. Despite adverse weather condition during the month, the higher-than-expected increase in non-farm payrolls was attributed mainly to stronger hiring of 196k workers by the private sector, as compared to 146k jobs in December, as market observers raised concern that rising optimism among businesses in hiring may lead to job growth and rising wage. This may then point to the Federal Reserve accelerating its interest rate hike (from the current three times) to prevent potential inflation from rising sharply.

Other Macro Datapoints Also Positive

We believe other economic indicators are also pointing to stronger US economy, such as the ISM for the manufacturing sector, which expanded by 59.1 in January, due to higher new export orders and production, suggesting that employment growth will pick up pace from January onwards.

…suggesting the Possibility of Additional Rate Hikes

As a result, on the monetary policy front, with signs of stronger series of economic indicators (such as ISM manufacturing and non-farm payrolls), the market is concerned that there is a likelihood of the US Fed raising policy rates (on track to raise rates at least three times in 2018), in view of the state of the economy. However, in our opinion, we believe the US Fed is likely to be committed to the timeframe on when it would raise the Fed Funds rate, in view of strains in the global financial markets leading the global economic uncertainty.

But, US Fed Seems Committed to Their Target Range

Last week, the US Federal Reserve (US Fed) kept its target range for the federal funds rate (FFR) unchanged at 1.25% to 1.5%, but guided that the current economic conditions may warrant further gradual increases in the federal funds rate, which market expects another 25bps hike in the March FOMC meeting. Currently, while market players have shifted up their expectations for the pace of rate hikes in 2018, in the recent FOMC meeting, the US Fed continues to see the risks to the outlook for economic activity as roughly balanced. We also believe the new Fed Governor Jerome Powell will likely adopt the same policy or guidance from Janet Yellen, with the process of balance sheet normalization and interest rate hikes on a gradualbut-steady process in monetary policy tightening.

FBMKLCI…brace for Volatility Ahead

Back to the FBMKLCI, we nevertheless expect market sentiments on the FBMKLCI to be volatile amidst the Dow pullback. The VIX index is already suggesting so, having reached its highest level since November 2016. We are nevertheless of the view that any correction offers an opportunity to accumulate, despite the FBMKLCI having surpassed our 2018 year end target of 1,854.

…. We Suggest Accumulating

Ytd, the market performance has far exceeded our expectations, driven by the strong rally in the Ringgit and capital inflows. This has been premised on an undervalued Ringgit and hence the strong Ringgit trade driving foreign inflows. We believe that the Ringgit has further room for appreciation, based on a fair real effective exchange rate of RM3.80/US$. Likewise, we would also want to position our portfolios for a possible GE14 rally and believe that these two drivers could possibly take market PE valuations to up to +1SD historical mean PE or 18x, pushing our FBMKLCI target to 1,940 points, over the near term.

Remain Market Overweight

We maintain our Overweight stance on the market and remain positive on the Banks, Construction & Infrastructure, Insurance, Gaming, Oil & Gas, Rubber Products and Utilities sectors. Our top picks include Maybank and Hong Leong Bank in the banking space and Serba Dinamik for exposure to the O&G sector. HSS Engineers is our preferred pick in the construction sector while Tenaga is still favoured for its attractive valuations and liquidity. For rubber glove exposure, Top Glove is our pick. Despite the negative newsflow from Apple, we are selectively positive on tech names such as Inari and Globe. Our other small cap picks are Hai-O for a consumer play and Apex Healthcare for an attractively price pharmaceutical play.

Source: Affin Hwang Research - 5 Feb 2018