New Year Hiccups

• We lowered our end-2020E KLCI target to 1540 (from 1,660) based on a 5-year mean PER of 17x applied to our 2020E EPS.
• In tandem, we also lower our fair value to RM1.66 from RM1.75 for the FBM KLCI ETF. Maintain HOLD on the ETF.
• We remain cautious on the market amidst the Covid-19 threat and political uncertainties.

The Fund and Its Objective

FBM KLCI ETF aims to achieve a price and yield performance, before fees, expenses and tax, that is similar to that of the FTSE Bursa Malaysia Large 30 Index. The Fund manager, AmFunds Management Berhad, aims to achieve performance, over time, with a correlation of 95% or better between the Fund’s Net Asset Value (NAV) and the Benchmark. It will have an asset allocation of at least 95% in Index Shares and options and warrants referencing the Index Shares and no more than 5% in cash or cash equivalents. Income distribution is expected to be made semi-annually.

The NAV per unit was RM1.5195 as of 2nd March 2020, a decline of 7.8% ytd. This is in line with the KLCI index which declined 7.7% ytd. As such, the benchmark outperformed the fund by 0.1 ppt. With a 3-year tracking error of 0.90%, we believe the fund is tracking the benchmark sufficiently. In 2019, the fund recorded a negative return of 4.12%, comprising of 6.00% capital growth and 1.88% income distribution. Meanwhile, the benchmark recorded a lower negative return of 2.89%, larger than our expected 1.6% decline. The KLCI however outperformed the fund by 1.23 ppt. Sequentially, the ETF recorded a net investment loss of RM119,480, lower than the RM138,893 loss in 2018.

Stronger 4Q19, Unlikely to Continue

The 4Q19 corporate earnings under our coverage grew 1.8% yoy, which broke the negative growth trend over the past 6 quarters. The better performance was attributable to the Telecoms (accelerated depreciation in Axiata in 4Q18), Plantations (higher ASPs) and Banks (higher noninterest income), more than offset weaker performance in the Oil & Gas, Gaming and Utility sectors. Key companies that resulted in the earnings drag were Petronas Chemicals, Tenaga and Genting. However, we believe the stronger performance is unlikely to continue in 1Q20 given the onset of Covid-19 and also partially due to the higher base in 1Q19.

Covid-19 Poses a Threat to Economic Growth

We have taken a more cautious stance on corporate earnings post the Covid-19 outbreak. Our Economics team has also downgraded 2020E GDP growth to 4% from 4.5% previously in tandem with this. We believe the Covid-19 may cause a disruption in supply chain, weaker consumer sentiment, lower number of tourist arrivals and hence affect consumption spending in the long-term. We have also taken into account a possible 50 bps cut in OPR for the full year of 2020, an additional 25 bps to the January cut for our banks’ earnings.

A New Government…again

Malaysia received its 8th prime minister, Tan Sri Muhyiddin Yassin, the president of Parti Pribumi Bersatu Malaysia on 29th February 2020. PM Muhyiddin represents the coalition Perikatan Nasional, which is a national cooperation comprising political parties including Barisan Nasional and PAS. The PM is expected to take a confidence vote to determine if he will remain in office after forming his own cabinet. The next Parliamentary sitting falls on March 9th .

Construction Sector and Sin Stocks May Suffer the Consequence

We believe the implication of a new government formation may lead to a period of political uncertainty and may negatively effect the construction sector and sin counters. The construction sector will be depressed due to uncertainty surrounding the seamless continuity of the public-sector projects open tender system under the new government. The change in the Minister of Works could also further delay roll out of public-sector projects depending on the level of experience of the new Minister in this area and lead to possible review of projects. There is also a high chance of projects stalling including those revolving around the Penang Transport Master Plan. Further, we believe sin stocks, the likes of Genting, would be most impacted given the inclusion of PAS into the new coalition government.

…but Quick Bold Steps May Help

However, we believe, in the near term, it is crucial for the new Government to act quickly and take bold measures to boost public and investors’ confidence by ensuring the sustainability of economic growth, raise income of the people and reduce cost of living. Nevertheless, if the political uncertainty prolongs and combined with the global economic uncertainties and Covid-19 outbreak, many investors, be it local and foreign (both long-term and portfolio investors), may hold back their investments pending further clarity on the political environment.

Maintain Neutral on KLCI and 12-month KLCI Target of 1,540

Based on 17x 2020 market EPS, or -1SD below its 5-year mean, we lower our 2020 KLCI target to 1,540. This is in tandem with our cut in GDP growth. With the recent change in government and appointment of the 8th Prime Minister, political uncertainty will likely remain a major overhang on the market over the near term. Further, the KLCI is also weighed down by the impact of Covid-19 as the outbreak spreads beyond its origin of China. We remain cautious on the market.

Upside/Downside Risks

Key downside risks include: (i) burgeoning trade tensions between the US and China, any easing of the trade tension is an upside risk; (ii) a sovereign rating downgrade; (iii) A pick-up in inflation levels in the US and a hawkish Fed which could lead to outflows from the emerging market; (iv) KLCI corporate earnings disappointments; (v) New taxes that could curb spending (vi) Government successfully executing reforms that significantly improve its fiscal position, enhancing its investment attractiveness and thus encouraging foreign equity inflows. Conversely, any further reduction of MSCI weighting will have negative implications; (vii) Geopolitical tension from North Korea or the Middle East disrupting the financial markets; and (viii) Malaysia falling off the FTSE World Global Bond Index and other related indices

Source: Affin Hwang Research - 6 Mar 2020