“Average Joe” should see a boost in his 2019 income and is the backbone to economic resiliency, given his high marginal propensity to consume. Tax refunds of RM37bn also leave room for potential uplift to GDP growth, possibly by c.2pp. We also remain positive on the ongoing revamp for Malaysia, which should benefit from productivity gains, while managed by a more efficient and transparent government. Near term however, the fiscal discipline that Malaysia is undergoing due to it mending its inherited fiscal mess and bringing its house back in order should cap growth. Against a backdrop of slower global GDP growth and weak corporate earnings, we lower our PE valuation for the KLCI to its past-5-year mean (from +1SD). Downgrading to NEUTRAL.

External Headwinds Outweighing Domestic Strength

“Average Joe” is the typical Malaysian that will likely spend more as his income improves going into 2019. With supportive government measures to boost consumption spending and stable employment, he will therefore be Malaysia’s economic pillar of strength. We also see potential for GDP growth upside if the: 1) RM37bn in tax refunds flow back into the economy; 2) tax-amnesty program is successful, and 3) private sector participation increases via a reduction in crowding out by the government. However, this impact is only likely to be felt longer term and just be sufficient to weather the impact of slowing global economic growth, rather than be a booster to the economy. Without a resolution on the prolonged US-China trade tensions and given Malaysia’s open economy, this will have a greater negative bearing, in our view.

Lower KLCI Valuation on Disappointing Earnings, Cautious Outlook

Reflecting the above, our outlook calls for much weaker corporate earnings growth of 3.2% in 2019E, vs. 4.8% we had forecast last year in 2018. Except for Banks and O&G, most sector heavyweights (Plantation, Telcos, Utilities) should only see EPS growth in 2019E due to contractions in 2018. With disappointing corporate earnings delivery and a cautious economic outlook, we now argue for a lower KLCI PE multiple, reverting to a mean PE multiple (from +1SD).

Downgrading to Neutral; rolling out our end-2019E index target of 1,810

With that in mind we downgrade our market view to NEUTRAL from Positive and roll out our end-2019E target of 1,810 (based on past-5-year mean PE of 18x on our 2019E EPS). On a more positive note, we remain firm believers that the RM remains undervalued based on REER and positively reinforcing sticky capital outflows from Malaysia. With foreign equity holdings on the KLCI appearing to hit a trough, downside to the market seems limited.

Downgrade Banks (N); Upgrade Gaming (OW), Building Materials (N)

As a key investment theme, we stay focused on consumer-centric sectors and Overweight the Auto, Healthcare and Insurance sectors. Other Overweights are Utilities and Gaming, which we upgrade as the negatives from additional gaming taxes and delays in the theme park seem priced in. We upgrade Building Materials to Neutral after our recent Lafarge upgrade. We continue to seek alpha in the Rubber Product and O&G sectors. We downgrade Banks to Neutral (from Overweight) on weak earnings growth prospects. Our top BUYs remain: Maybank (MAY MK, RM9.42), Serba (SDH MK, RM3.68), UMW (UMWH MK, RM5.57), Tenaga (TNB MK, RM13.92), Kossan (KRI MK, RM4.29), KPJ (KPJ MK, RM1.07), Aeon Credit (ACSM MK, RM15.38), QL Resources (QLG MK, RM7.04), Globetronics (GTB MK, RM2.0) and Supermax (SUCB MK, RM3.56).

Source: Affin Hwang Research - 7 Dec 2018