• FBM KLCI has gained 7.1% in the first two months of 3Q18, reversing the 5.9% decline in 1H18.
• Our in-house projection of the FBM KLCI maintained at 1,845 at end-2018, based on 18.4x 2018E KLCI EPS, while positive outcome from structural reforms and sustaining economic growth will be a medium to long-term positive
• Downside risks are arising from trade tensions between US and China, faster pace of US rate hikes, disappointing corporate earnings and EM contagion

The Fund and Its Objective

The Net Asset Value (NAV) per Unit was RM1.8782 as of 5th September 2018, up by 1.4% year-to-date and an improvement of 0.4% since our initiation on 6th June 2018. The FBMKLCI had declined by 0.1% year-todate but has increased by 1.0% growth since our initiation. The Fund’s NAV was RM3.1404m as of 5th September 2018 which is 2.5% higher compared to the start of the year compared to a 1.9% increase over the same period for the benchmark.

For the quarter ending 30 June 2018, the NAV of the fund decreased by 8.96% from RM3.245m to RM2.954m, while the NAV per unit fell from RM1.9407 to RM1.7668. During the financial period under review, the KLCI ETF registered a negative return of 8.70% (+3.89% in 1Q18) which had underperformed the FBM KLCI return of 8.43% (+4.39% in 1Q18). The size of the Fund remained at 1,672,000 units. A gross distribution of 0.50 per unit income distribution was announced (unchanged from last year) while the management’s expense ratio was 1.07%, similar to the previous quarter. There were no significant changes to sector weights during the quarter with trading/services and finance comprising the largest portions at 38.65% and 33.31%, respectively.

KLCI Has Rebounded Since Its 1H18 Tumble

In 2Q18, market earnings growth slowed to 0.1% yoy compared to 1.4% yoy registered in 1Q18. While on a quarterly basis, earnings declined by 2.3%, following a fall of 0.7% in the previous quarter weighed down by the Utilities sector. Two months into the 3Q18, the FBMKLCI had rebounded by 7.1% to a three-month high of 1811.60. This had managed to erase the 5.9% decline seen in the first half of the year. Aside from bargain hunting, the improvement in the KLCI was also aided by the taper in net capital outflows. Although net capital flows continued to register outflows since May to August amounting to RM12.4bn, we noticed a tapering of outflows in August of RM97.4m compared to the RM1.7bn outflow in July.

On the external front, the performance of the FBMKLCI held up despite headwinds such as the continuing strengthening of the US Dollar Index by 3.6% year-to-date, selldown of emerging market currencies, concerns of a slowdown in China’s economic growth and rising trade tensions between US and China. Regionally, the year-to-date performance of the FBMKLCI held up well. It was the second strongest performer despite declining by 0.1% coming behind Taiwan’s TWSE which rose by 3.3%.

Upside to the Outlook

Going forward, the zerorisation of the 6% Goods and Services Tax (GST) from June to August 2018 will boost domestic demand in 3Q18 where with front-loading purchases by consumers and businesses. Sectors which are likely to benefit include auto & autoparts where zerorated GST car prices will give a temporary boost to the sector’s 3Q18 earnings. The consumer sector will also see an improvement in 2H18 on the back of higher consumer spending and improving consumer sentiment. In 2Q18, private consumption expanded to 8.0% yoy, its highest reading since 1Q15 (6.9% in 1Q18) while MIER’s consumer sentiment index surged to a 21-year high of 132.9 in 2Q18.

Structural reforms conducted by the new government will also be a longterm positive. This is reflected in Malaysia’s sovereign credit ratings, which have been affirmed following the recent change in government. Fitch Ratings affirmed Malaysia’s long-term foreign-currency issuer default rating at A- with a stable outlook. Meanwhile, S&P has also reaffirmed Malaysia’s ‘A-/A-2’ foreign currency and ‘A/A-1’ local currency ratings with a stable outlook. Moody’s credit rating has been unchanged at A3 with a stable outlook.

Downside Risks

Amid abounding headwinds and lower-than-expected 2Q18 GDP growth of 4.5% yoy, Malaysia’s economic growth in 2H18 is expected to be around 5% compared to 4.9% in 1H18 (6.1% in 2H17) due to the high base effect in the corresponding period in the previous year. Export growth as well as manufacturing production are also anticipated to moderate in 2H18, driven by the slower exports to China and EU countries as well as concerns on the oncoming global trade tensions especially between US and China.

Another potential downside risk to the KLCI outlook is the US Fed’s ongoing monetary policy tightening which could lift the greenback higher against the Ringgit. The Fed’s recent policy tightening has been attributed partly to rising inflationary pressure, which accelerated to a six and a half year high of 2.9% yoy in July 2018 (2.8% in June), while the core-personal consumption expenditure (PCE), which is the Fed’s preferred gauge of inflation reached the Fed’s target inflation rate of 2.0% in July (1.9% in June). The USD Index which has appreciated by 3.6% since the start of the year was boosted by the depreciation of emerging market (EM) currencies especially the Turkish Lira and robust US GDP growth which expanded for the eighth consecutive quarter to its fastest growth in three years of 2.9% yoy in 2Q18. Also backing the Dollar’s uptick is the divergence of monetary policies between US Fed and ECB and BNM where both central banks’ policy rates are anticipated to remain unchanged for the rest of 2018.

Furthermore, EM currencies have yet to recover. The MSCI emerging markets currency index, which declined 5.8% since the start of the year, is still hovering near its one-year low. Anticipated US Fed rate hikes will continue to keep EM currencies under pressure which could cause a spillover effect onto Malaysia. Besides that, escalating trade tensions between the US and China will continue to pose as a risk to the KLCI outlook. Hence, the in-house KLCI 2018 year-end target is maintained at 1,845 based on 18.4x 2018E earnings.

Source: Affin Hwang Research - 6 Sept 2018