It is without a doubt that the market sentiment has turned weak. However, we believe the sell-down should serve as a good opportunity to buy on weakness as per our 3Q13 Investment Strategy. While we would review our investment strategy and index target after this on-going result reporting season, at this juncture, we believe that: (i) the strong liquidity position in the local financial system should provide reasonably good support; and (ii) the oversold technical condition should at least provide short-term trading opportunity. The Top 10 picks to capitalise on are DIALOG (OP, TP: RM3.28), GAMUDA (OP, TP: RM5.30), MAYBANK (OP, TP: RM11.00), GENTING (OP, TP: RM12.28) HARTA (OP, TP: RM7.32), KOSSAN (OP, TP: RM6.88), SUPERMX (OP, TP: RM2.39), TENAGA (OP, TP: RM10.48), DIGI (OP, TP: RM5.24) & TM (OP, TP: RM5.91).

Thus far, the global market has been haunted by the fear over Fed’s decision in tapering off its quantitative easing program. Earlier on, the global market was also affected by concerns over China’s liquidity crunch and shadow banking issues and of late, the emerging markets have been hit by a gradual but persistent bout of bad news. For instance, Thailand has fallen into a recession after the economy shrank unexpectedly in 2Q13 (contracted by 0.3%) while Indonesia is faced with slowing growth, quickening inflation and its current-account deficit widened to a record last quarter. India, on the other hand, has also been facing concerns over its twin deficits, increasingly weak currency and potential stagnation in infrastructure projects because of forthcoming elections.

Foreign outflow and weaker local currency. These issues have caused a series of foreign funds outflow (see Figure 1 & 2) and the local currency has depreciated to near its multi-year low (see Figure 3). Since 25 July 2013, foreign investors have been net sellers. Accumulatively, they had sold approximately RM4.0b, representing 27% of the total net buying position of RM15b between 2 January and 24 July 2013, of Malaysian equities. This amount of outflow is still manageable in our view. However, the fall in ringgit is somewhat steeper than expected. Recall that our economist has recently revised the year-end RM/USD target to 3.17 from 3.05 previously. Apart from the trengthening of the U.S. dollar, we reckon that the downgrade of credit rating by Fitch coupled with the lower balance of payments (“BOP”) have escalated the depreciation of ringgit. Going forward, we believe the movement of ringgit will depend on the country’s fiscal reform such as subsidy rationalisation, GST implementation, etc.

3Q is proven weak. Recall that in our 3Q13 Investment Strategy, we highlighted that the risk of a market correction in 3Q13 is relatively high despite the fact that the market is well-supported by ample liquidity. We have spelled out clearly that 3Q is normally a weak quarter, especially in the months of August and September (see Figure 4). It seems that this seasonal pattern had materialised again when the FBMKLCI staged a sharp pullback from 1,800-level to 1,710, representing a 5% retracement, in the last 2 weeks.

Other studies are proven workable as well. Apart from our seasonal pattern study, it is also proven that our earlier studies such on other parameters such as: (i) volatility; and (ii) reversion toward the mean (for both PER valuation and discount to Index Target) seem workable. To recap, i. Increase in volatility could also imply a change in trend and this seems validated (see Figure 5). A similar situation could be seen for the Dow Jones Industrial Average (“DJIA”) as well (see Figure 6). ii. We also believed that the local market was due for a correction from a valuation standpoint. Based on Bloomberg data, the Forward PER valuation of the FBMKLCI has surpassed the 1-standard deviation level (“+1SD”) above its 6-year mean and normally, based on our observations, this was not sustainable. True enough, the Forward PER of FBMKLCI start reverting back to the mean from +1SD (see Figure 7). iii. We also highlighted that the discount between FBMKLCI and the consensus target tends to peak and widen when it hit the +1SD or 2.9%. Again, this discount widened from the recent high of 2.3% to 7.4% as of 22 August 2013 (see Figure 8).

It’s time... Now, it is the time to act. Recall that we have advised aggressive traders to adopt a “Sell on Strength” (S.O.S.) Strategy above 1,810 and long-term investors to employ a “Buying on Weakness” (B.O.W.) strategy below 1,720. While market condition is still uncertain, we reckon that the heavily sold down blue chips (as per their oversold technical condition and 1-month % changes) coupled with OUTPERFORM ratings should provide good value plays (such as DIALOG, GAMUDA, MAYBANK & GENTING). Otherwise, investors should capitalise on the trend of weak ringgit through exposure via glove making stocks (HARTA, KOSSAN & SUPERMX). We also believe that the subsidy rationalisation programme is inevitable, especially after the 2014 Budget announcement; hence TENAGA could be a perfect candidate to leverage on this expectation even though its earnings could be affected by weak ringgit due to its high foreigncurrency debts. We also reckon that Telco stocks (DIGI & TM) are also good investing targets for their defensive nature and given that they were also laggards in the recent rally.

Source: Kenanga