Market Review 2017

• A year of two halves. The local bourse was in an uptrend in 1H17 with the FBM KLCI rising almost 9% from 1642 points in Dec 2016 to as high as 1792 points in June 2017 before retreating to 1720-1760 level for most of the time in 2H17. Following window dressing activities in the last month of the year, the local benchmark index managed to break the deadlock and chalked up 9.4% return for the whole year of 2017.

• Net inflow of foreign funds into local bourse. In 2017, net inflow of foreign funds into the Malaysian equity market stood at RM10.3b, reversing from a net outflow of RM2.5b in 2016. The vigorous net buying by foreign investors as compared to the previous year was evident especially during 1H17 as a result of improved global market sentiment and strong GDP growth amid external headwinds such as US rate hikes in 1H17 and geopolitical risks in North Korea. However, the positive momentum tapered off in 2H17 with mild profit taking by foreign investors as market sentiment was affected by uninspiring corporate earnings.

• All sub-sector indexes registered positive returns with Technology counters standing out from the crowd. In 2017, the Technology sector posted a stellar performance with a gain of 89.7%, benefiting from the tech boom in Wall Street, launch of Apple’s new smartphone models and better corporate results. On the flip side, the Plantation sector was the worst performer with a return of merely +2.0%, no thanks to its lacklustre financial results and rich valuation.

• The FBM KLCI underperformed most of regional peers. The Malaysian bourse was the among the worst performers in the region with a positive return of 9.4%, just ahead of Shanghai market’s +6.6% and significantly lagged behind other Asian bourses which registered double-digit growths.

• Value emerging. As of to-date, the local bourse is now trading at 16.3x 2018 PE, the fourth highest PER after the Philippines Composite Index (19.1x), Jakarta Composite Index (16.5x) and Thailand SET Index (16.5x), as contrast to a year ago whereby the local benchmark index traded with the second highest PER. This also indicates that the FBM KLCI is trading at 11.7% premium to other major Asian indices with its 2018 PE. Having said that, the local equity market has always traded at a premium to regional peers due to its defensive nature as ownership of government linked investment funds is relatively high in KLCI component stocks.

Market Outlook & Investment Strategy 2018

• A strong start for 2018. The local bourse, thus far, has been trending upwards, being in line with the strong rallies in Ringgit and crude oil prices. The positive performance of the FBM KLCI was mainly lifted by inflow of foreign funds as we believe the local market is playing ‘catch up’ to regional bourses since its returns for last year lagged behind other regional peers.

• Sustainability in doubt. However, we expect the current positive momentum to be shortlived, as there will probably be some profit taking as we approach the General Election 14 (GE14) which is widely anticipated to be held in March or April this year. We believe the market has factored in the positive factor of which BN will continue to be given another mandate to rule the nation with continuation of major policies amid divided opposition front. Thus, investors may not wish to hold their equity assets during the polling period with unfavourable risk-reward whilst market reaction after the GE14 is highly dependent on the outcome.

• A volatile year. We expect the market to be choppy this year mainly affected by a slew of uncertainties in local and external fronts which include: 1) outcome of GE14, 2) GDP growth for this year is likely to slow down following surprisingly strong economic growth recorded in 2017; 3) downside risks on corporate earnings growth - concerns on escalating costs with the implementation of few policies and rulings starting this year; 4) prelude of normalisation of interest rate from developed markets to emerging markets; 5) possibility of financial crisis happening in China, 6) jittery over the curse of ’10-year downcycle’ especially the Wall Street hitting all-time highs; and 7) flattening of yield curve signalling economic recession ahead.? Based on our study, we found that pre- and post-election movement in the stock market is inconclusive in contrast to general perception that market would trend upwards ahead of the election. However, we might see some thematic plays on certain GLCs or politically-linked stocks prior to election as the market anticipates policy continuation with BN to be given another mandate in the upcoming general election amid a divided opposition front. As mentioned earlier, we expect some profit taking to happen when approaching the polling date whilst stock movement post-GE14 is highly dependent on the outcome. Should BN win back the 2/3 majority, the market will resume its rally or the opposite might happen if situation remains status quo or the opposition party manages to form a government.

• GDP growth expected to taper off for this year. We expect Malaysia to record an economic growth rate of 5.0% for 2018, declining from our estimated GDP growth of 5.8% for 2017 (actual 9M17: 5.9%) mainly due to high base in 2017 (the country recorded 4.2% growth rate in 2016) thanks to unexpected strong surge in exports pursuant to strong global recovery in advanced economies as well as China coupled with recovery in commodity prices. Moving forward, we expect the domestic consumption and private investment to cool down on the backdrop of higher interest expenses (potential rate hike as hinted by Bank Negara Malaysia), rising operating costs in relation to higher gas and fuel prices (increase in power tariffs), labour costs (increase in minimum wages begins mid-18 and Employment Insurance Scheme starting early this year).

• Downside risks to corporate earnings. With the abovementioned policies and rulings coming into picture, corporates especially the manufacturing companies may face headwinds of rising costs of doing business locally. This is detrimental to corporates especially smalland mid- cap stocks whilst market earnings of the KLCI-linked counters are relatively less affected.

• Tightening monetary policies around the world. We believe that we are in the end cycle of low interest rate judging from the market prediction that Federal Reserve aims for 3 rate hikes in this year, whilst ECB indicated earlier that it would halve its bond-buying programme from 60b euros to 30b euros a month starting from January this year and eventually stop the quantity easing in end-Sept 2018. Back to the region, we have witnessed South Korea and China raising their interest rates which prompt speculations that Malaysia, the Philippines, Thailand and Taiwan will also raise their benchmark policy interest rates over the coming months.

• Lingering concerns on China’s cooling economy and mounting corporate debt. The market now expects China's economic growth to slow down in 2018 after a surprised strong showing last year, as its top leaders flag tighter monetary policy and further curbs to clamp down on asset price bubbles, especially in the property market. We believe China could still achieve satisfactorily growth, within its target of 6.5% for 2018, whilst manage to curb its high corporate debt (169% of GDP) by taking multi-pronged approaches to cut company debt such as M&A, bankruptcies, debt-to-equity swaps, and securitisation.
• Curse of ‘10-year downcycle’. Whilst we are still cautiously optimistic on the market outlook for 2018 underpinned by resilient economic growth, we are mindful that the ‘10-year downcycle’ (i.e. Black Monday in US in 1987, 1997/98 Asian Financial Crisis, 2008/09 Global Financial Crisis) could haunt the market as investors would trade cautiously with reluctance of taking ‘long-term investment horizon’ in the market. However, the market usually exhibits a strong rally ahead of any perceived market crash that could happen. Hence, we shall see a tumultuous year in 2018.
• Flattening of yield curve signalling economic recession ahead? Recessions in the US have always been preceded by an inversion in the yield curve, but not every inversion has been followed by a recession, though it does generally signal economic risk. The shallow slope of the yield curve, i.e. the spread between 2 and 10-year Treasury notes is currently 50 basis points, near the flattest in a decade, have triggered doubts in financial markets over the Federal Reserve’s rate hike plans. Investors now believe the Fed’s actions will cause the economy to slow and yields to fall, and hence buying more longer-dated paper to lock in current yields, rather than take the risk of continually rolling over shorter-dated debt where the yields they earn are declining. A flattening yield curve can have a negative effect to the US banking stocks as they are typically borrow short and lend long.

• Fundamental analysis wise, current market valuation is fairly priced with the FBM KLCI currently trading at 16-17x 2018 PE, which is at the range of +0.5~+1.0 standard deviation above its historical mean PE of 15.2x. At this junction, we deem the current valuation as fully valued in the absence of any strong positive catalyst whilst immediate market outlook remains uncertain.

• On a technical outlook, our study shows that the recent rally stemming from the year-end window dressing could face a downward correction. However, the uptrend can be sustained if the immediate support at 1800 points manages to hold.

• Maintain NEUTRAL on the local bourse with our 2018 KLCI year-end target of 1860 points. Our 2018 KLCI target is based on our respective market EPS growth forecast of +5.9% for 2017 and 2018 with target PER of 16.9x 2018 PE (+1 standard deviation above mean). Whilst we maintain our neutral with positive bias view on the market outlook for this year, we are mindful that the ‘10-year cycle’ as mentioned above could haunt the market, especially with the current all-time highs in Wall Street. We could see another volatile year in 2018 under prevailing mature bull market.
• Our top picks under coverage are: IJM (Target Price: RM3.47), Gadang (Target Price: RM1.50), Hai-O (Target Price: RM6.41), Padini (Target Price: RM5.76) and Tasco (Target Price: RM2.69).
• Investors should adopt a combination of defensive and active investment strategies by investing in: a) Value stocks which are trading at lower price relative to their BV, earnings; b) Growth stocks which yield brighter earnings prospects; and c) High-yielding stocks with resilient business models, i.e. stable earnings coupled with positive operating cash flow which are unfazed by the sudden slowdown in economic growth.

• Our picks on value stocks are: Maybank, Tenaga, Genting Berhad; growth stocks include: Pestech, GHL, OCK, Press Metal, Inari; high-yielding stocks such as: Magnum, IGB REIT, SunREIT, Heineken; and other small-and-mid cap stocks such as: Tiong Nam, SCGM, Sasbadi, Scientex, Lii-Hen, OKA, Aeon Credit, Syarikat Takaful, Yinson, HeveaBoard (Target Price: RM1.58), Oriental Food (Target Price: RM1.61), Engtex (Target Price: RM1.36), Titijaya (Target Price: RM1.03), Kim Loong (Target Price: RM4.59) and C.I. Holdings (Target Price: RM2.61).

Source: JF Apex Securities Research - 11 Jan 2018