Despite the underlying external uncertainties and domestic issues, we remain cautiously optimistic over the next two quarters as 4Q and 1Q are seasonally stronger quarters. Furthermore, we still see decent upside c.5% to our end-2014 Index Target of 1,855 (vs. consensus estimate of 1,845). Nonetheless, we reckon that there may not be a broad-based rally, judging from our less bullish sector calls. As such, we are selective and prefer to adopt a Bottom-Up approach in selecting Top Picks. To capitalise on stronger 4Q and 1Q, we believe blue-chip laggards and small-and-mid-cap stocks are worth considering. Our Top 10 Picks for the quarter are AIRASIA (OP; TP: RM3.51), CBIP (OP; TP: RM3.18), KOSSAN (OP; TP: RM7.86), GAMUDA (OP; TP: RM5.30), RHBCAP (OP; TP: RM8.35), SKPETRO (OP; TP: RM4.72), TENAGA (OP; TP: RM10.48), TM (OP; TP: RM5.94), UEMS (OP; TP: RM3.70) and ZHULIAN (OP; TP: RM4.30). 

Recall that in our 3Q13 Investment Strategy, we had spelled out clearly that 3Q is normally a weak quarter, especially in the months of August and September and highlighted that the risk of a market correction in 3Q13 is relatively high due to: (i) heightened volatility, (ii) global and domestic monetary policies, (iii) aggressive foreign outflow, and (iv) stretched valuations. 

Decent Upside. While the performance in early 3Q13 was uninspiring, we still believe there is still decent upside to be  capitalised  in the  coming two quarters. Based on our  FBMKLCI  Earnings Universe, we  estimated that corporate core earnings would grow by 9.7% in FY14 (vs. FY13 estimated growth of 3.8%). The stronger FY14 growth is due to the low base effect in FY13 and strong earnings growth in selective sectors such as Construction (+19.0% YoY in FY14), Gaming (+16.7% YoY), Oil & Gas (+27.9% YoY) and Property (+22.4% YoY). Our FY13 and FY14 earnings growth estimates are pretty much in line with consensus estimates of 2.4% and 10.0%. 

We pegged our end-2014 Index Target at 1,855 based on the average valuation between Bottom-Up and Top-Down Approaches. (Bottom-Up: 1,880, representing 17.5x FY14 PER; Top-Down: 1,825, representing 17.0x FY14 PER). Our year-end Target, on the other hand, is fine-tuned to 1,800 (from 1,810) as per our Simulation Study. 

Zooming in 4Q2013. Despite our cautious optimism, we still see potential game-changing  factors arising from the upcoming Budget 2014. It is widely expected that the market could see a series of subsidy cuts in the 1st Budget after the recent 13th General Election. Besides, to improve the country fiscal position, it is would not be surprising to see the government introducing Goods and Services Tax (“GST”) as an effort to broaden the tax revenue apart from trying to reduce operating cost by cutting subsidies. Clear-cut losers are consumer (especially high-end retailers), property (but affordable housing players may benefit from strong demand) and to a certain extent, the sin sector. Power and Telco sectors, on the other hand, may see neutral-to-positive impact from GST implementation.  

As for market, we believe the forthcoming budget announcement could be muted for the market, unless we see more  market  friendly  announcement such  as  corporate  tax  cut.  Furthermore,  based  on  foreign  countries’ experience, we believe the implementation of GST may not be entirely bad for our equity market. The respective benchmark  indices  of  Australia,  Thailand  and  Singapore  enjoyed  good runs  before the  actual  dates  of GST implementation before posting corrections subsequently. 

4Q2013 Investment Strategy. All told, we are cautiously optimistic on the local equity market for the current and next quarters despite facing domestic and external uncertainties. This is because we believe these uncertainties could have already been factored into the market in the previous quarter when FBMKLCI recorded its recent low of c.1,660. Nonetheless, due to a decent but limited upside from here, we prefer to adopt a “Buy On Weakness” (B.O.W.) strategy, preferably below 1,745. While aggressive investors may take some profits (“Sell On Strength”, S.O.S.) if and when FBMKLCI surpasses the 1,820-level, we still prefer B.O.W. strategy based on the favourable seasonal study and post-GE performance study. 

Nonetheless, we also believe that the rally, if any, may not be broad-based in nature, judging from our sector calls. Thus far, we only have OVERWEIGHT calls on (i) Construction, (ii) Gaming, (iii) Oil & Gas, (iv) Property and (v) Utilities. As such, we are selective and prefer to adopt a Bottom-Up approach in selecting Top Picks. Also, it is worthwhile to note that our sector calls are subject to revision after Budget 2014.

Tactically speaking, we also believe that blue-hip  laggards; such as TM (OP, TP: RM5.94), RHBCAP (OP; TP: RM8.35), etc, could stage catch-up plays in the event of year-end window dressing activities. Moreover, we also believe small-and-mid-cap stocks could outperform the benchmark index in the coming quarter as we normally see more active retail participations in 1Q, hence greater interest in lower liner stocks.               

Source: Kenanga