In the summer months when the KLCI has traditionally been at its weakest, this June has been a rather good month, with a MTD gain of 1.57%. Hence, YTD losses on the KLCI have narrowed from -5.46% earlier in May to -0.83%, largely led by expectations of the US Fed easing and a potential resolution of global trade tensions. However, corporate earnings revisions remain negative, and this trend could sustain should trade tensions persist, leaving limited ground for the KLCI to trade above its current PE multiple of 18x (its historical mean). We favour a shift into defensive names with sustainable yields given that the interest-rate upcycle has passed, while we steer away from cyclicals. We upgrade MREITS to Overweight and downgrade Autos to Neutral. We also cut Gaming and Rubber Products to Neutral as risk-reward looks fair. We remain NEUTRAL on the KLCI with a year-end target of 1,679 (set at 18x 2019E EPS).

RM and KLCI Have Recovered From Their Lows…

The KLCI has recovered from its 2019 lows and YTD losses have narrowed to 0.83%, largely on the back of the US Fed’s more dovish stance on interest rates and potentially a resolution of the trade tensions. Strong equity fund outflows in the early part of the year have also subsequently tapered off in recent weeks while the RM has recovered by 1.19% from its lows.

… But Current Rally May Not Have Legs

While the risk-on trade seems to be in favour, we are of the view that market valuations are fair for now. Moreover, we see an increased risk of earnings downgrades because of the trade tensions and hence any sharp spike in the KLCI may not be sustainable. Moreover, current weak crude-oil prices would likely put pressure on the RM and raise concerns on the fiscal-deficit front. Also, the KLCI still has 2 major overhangs ahead of it – a further reduced weighting with the upcoming MSCI rebalancing and the risk of Malaysia falling out of the FTSE World Bond Index in the September review.

MREITs Raised to Overweight; Axis, ELK, AQRS Added to Our BUY List

Given our cautious stance on the KLCI, we favour defensive and upgrade the MREIT sector to Overweight, joining the Healthcare and Insurance sectors. We downgrade the Auto, Gaming and Rubber Product sectors to Neutral. We make several revisions to our Top Buy calls for 2019, adding: Axis Reit (AXRB MK, RM1.75) for its solid asset base and attractive yields; micro-financier ELK Desa (ELK MK, RM1.49), which is an attractive niche play in the mass-market auto-financing business; and AQRS (AQRS MK, RM1.35) for exposure to the construction sector on better prospects following the revival of major infrastructure projects. We remove from our list Gamuda (GAM MK, RM3.62, BUY) and Telekom (T MK, RM4.15, HOLD) after their recent strong share performance, and Globetronics (GTB MK, RM1.67, BUY) on poor sentiment.

3 Potential Catalysts for the Market

However, we see 3 catalyst for the market that could positively surprise: 1) a sharper-than-expected cut in Fed rates leading to fund inflows back to the region; 2) heightened M&A activity spurring investor focus, particularly in depressed sectors; and 3) GDP upside surprise as infrastructure spending accelerates. Although from a corporate earnings and valuation angle this may not warrant funds to re-visit Malaysia, we believe that the sharp fall in stock prices over the past 2 years, low foreign holdings and the potential thematic ideas (particularly points 2 & 3) could spark some selective interest.

Source: Affin Hwang Research - 28 Jun 2019