• With the Covid-19 effects being felt across the sectors, we lowered our end-2020E KLCI target to 1,200 (from 1,540) based on a 15-year mean PER of 14x applied to our 2020E EPS.
• In tandem, we also lower our fair value to RM1.18 from RM1.66 for the FBM KLCI ETF. Due to the -13.2% downside, downgrade to SELL from HOLD.
• We expect a weaker market should the Covid-19 threat and political uncertainties prolong.

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.

Heightened Market Volatility

The Covid-19 has taken a toll on the global equity markets which is starting to feel the sting of production supply disruptions, lost man-hours and weaker consumption spending, especially now that the virus outbreak has turned into a pandemic. The Covid-19 coupled with the recent oil price crisis contributed to the heightened equity market risk premium in the recent weeks. Therefore, we have made downward revision in our 2020 GDP estimates to 3.3% from previous 4% while also cutting our corporate earnings growth from 1.3% to -4.7%. We expect further downside to this view should the Covid-19 pandemic prolong.

KLCI to Take a Cue From Falling GDP

Our Economics team is currently forecasting 1Q20 GDP growth to decelerate to 2.5% from 3.6% in 4Q19. We found that even though the long-term correlation between GDP and KLCI Index is low at 0.25, in times of economic slowdown, the correlation spikes to 0.7-0.8. We believe the GDP could be the precursor for a further de-rating of the market. Any further selldown in the global equity markets, as it digests a global slowdown, will likely worsen the performance of the KLCI.

Malaysia Movement Control Order, Good for Health Not Business

On 16th March 2020, Prime Minister Tan Sri Muhyiddin Yassin declared a movement control order for the entire country starting from the 18th to 31st March 2020 to deal with the rise in Covid-19 cases. Though a necessary course of action, we note that the restriction will possibly cause consumers to be more prudent on their spending while companies categorized as “non-essential services” will be negatively affected by the 14-day period business closure. We believe sectors like gaming, retail REITs, consumer retailers, property and automotive sellers will be most impacted by the business closure. Hence, there is further downside risk to company’s earnings.

2020 KLCI Target Lowered to 1,200

We lower our KLCI 2020 year-end target to 1,200 based on 14x PE multiple (based on -1SD to the KLCI’s long term 15-year mean PE, from 17x previously) as we cut our KLCI EPS growth forecast to -4.7%, reflecting our GDP growth cut to 3.3% from 4% previously. In a worst case bear scenario, we believe the KLCI could retest -2SD, which could bring it down to the 962 levels. In tandem, we lower our ETF KLCI fair value to RM1.18.

Upside/Downside Risks

Key downside risks include: (i) Worse than expected impact from Covid- 19 and oil price crisis; (ii) burgeoning trade tensions between the US and China, any easing of the trade tension is an upside risk; (iii) a sovereign rating downgrade; (iv) A pick-up in inflation levels in the US and a hawkish Fed which could lead to outflows from the emerging market; (v) KLCI corporate earnings disappointments; (vi) New taxes that could curb spending (vii) 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; (viii) Geopolitical tension from North Korea or the Middle East disrupting the financial markets; and (ix) Malaysia falling off the FTSE World Global Bond Index and other related indices.

Source: Affin Hwang Research - 20 Mar 2020