Our end-2014 FBMKLCI target is pegged at 1,890, implying 17.5x FY14 PER or 16.0x FY15 PER, backed by earnings growth rates of 1.4% and 11.5% for FY13 and FY14, respectively. Coupled with an estimated FY14 dividend yield of 3.2%, the local equity market offers c4.4% total return from here. While this prospect appears unexciting, it will offer up to >8% upside to 2,020, representing 17.3x FY15 PER, should we roll over our valuation base year to 2015. In terms of sector view, we are BULLISH on (i) Construction, (ii) Gaming, (iii) Gloves, (iv) Oil & Gas, (v) Plantations, (vi) Property Developers and (vii) Power. However, we are BEARISH on (i) Consumer Sin, (ii) Education, (iii) Hospital, (iv) Media and (v) MREITs. Our favourite Top 10 Stocks are: (i) GENTING (TP: RM12.55), (ii) IJM (TP: RM6.60), (iii) IOI (TP: RM4.95), (iv) MATRIX (TP: RM4.80), (v) RHBCAP (TP: RM8.75), (vi) SKPETRO (TP: RM5.81), (vii) SUPERMX (TP: RM3.06), (viii) TENAGA (TP: RM12.07), (ix) TM (TP: RM5.94) and (x) TSH (TP: RM3.38).

Decent upside for 2014 & greater upside for 2015? Our end-2014 FBMKLCI target is pegged at 1,890, implying 17.5x FY14 PER or 16.0x FY15 PER. The targets are backed by earnings growth rates of 1.4% and 11.5% for FY13 and FY14, respectively. Coupled with an estimated FY14 dividend yield of 3.2%, the local equity market offers c4.4% total return from here. While the upside appears unexciting, it will offer up to >8% upside to 2,020, representing 17.3x FY15 PER, should we roll over our valuation base year to 2015.

Short-term risks. Having said that, we still expect possible hiccups in early-2014 from external uncertainties such as: (i) Fed’s QE decision and (ii) U.S. debt ceiling. Besides, both FBMKLCI and DJIA have been trading under a low volatility environment. However, we believe this is not sustainable with both indices due for spikes in trading volatilities and hence corrections. Furthermore, the discount between FBMKLCI and its consensus target has narrowed <3%, which is not a sustainable level judging from its track records and we expect the discount rate to expand soon. At the same time, FBMKLCI is also traded >17x FY13 PER. This valuation seems stretched as per historical trading band.

1H14 is likely to be positive. Apart from the potential hiccups in early-2014, we still believe that 1H14, or at least 1Q14, could be relatively better compared with 2H14. This is because we expect interest rates for both Malaysia and U.S. to remain unchanged at least in 1H14. Besides, consensus could have discounted USD10b-USD15b reduction in bond purchase. As such, as long as the monetary base continues to expand in U.S. by virtue of low interest rate, liquidity will remain ample. On the back of this assumption, we expect RM to strengthen to RM3.09 by end-2014 (as opposed to consensus estimate of RM3.25) on capital inflows back to the region. Besides, the implementation of GST should further strengthen Malaysia’s sovereign rating. Moreover, the underlying bullish trending momentum of FBMKLCI could spill into 1H14. Technically speaking, we do not rule out the possibility of FBMKLCI testing the Major Wave-5 target objective of 1,930-1935 in the near-term as our Elliot Wave count.

2H14 is at risk, nonetheless. 2H14 could be more challenging in our view. Firstly, consensus is looking for a potential domestic rate hike. Furthermore, market participants also expect a certain degree of capital outflow in anticipation for higher U.S. interest rate in 2015. As such, these uncertainties could possibly cause a knee-jerk reaction to the equity market. Nonetheless, market recovery should be swift if and when the market starts to factor in the improving economic condition. This is because we believe the interest rate will only be raised should economy recovery is sustainable, which will be good for equity investment in the long-run. However, as the monthly RSI is fast approaching the overbought territory and time-cycle direction is in the midst of turning down, we reckon that index corrections are highly probable.

All in all, we are still optimistic on the local equity market outlook after taking other tactical factors into considerations. For instance, FBMKLCI could potentially rally before implementation of GST judging from the historical trends in Australia and Singapore. In addition, our Simulation Study also suggests that reward-to-risk ratio favours the upside (>40% to >1880) for now.

In terms of investment timing, we believe 1H14 should be relatively better and more stable in contrast to 2H14. Therefore, for 1H2014, we believe a B.O.W. strategy, say <1,825, is preferred. For 2H14, we could adopt a S.O.S. strategy, say >1,960. Stock picking wise, apart from sector calls, we have also blended in some other tactical considerations such as: (i) Consistent Performers, (ii) Value Stocks & Laggards, and (iii) winners/losers due to changes in the Syariah Compliance List.

Decent upside for 2014 & greater upside for 2015?

Fundamentally Speaking …

Potential 4.4% Total Return. Our end-2014 Index Target is pegged at 1,890 c.1.2% upside. At

1,880, it implied a 17.5x FY14 PER or 16.0x FY15 PER. Our index target is derived from a combination of: (i) Top-Down approach: 1,840 @ 17x FY14 PER and (ii) Bottom-Up methodology: 1,940 @ 18x FY14 PER. Coupled with the estimated FY14 net dividend yield of 3.2%, the local equity market offers approximately 4.4% Total Return (see Figure 1 for details).

Our index target is backed by FY13 & FY14 core earnings growth rates of 1.4% and 11.5%, respectively, or CY13 and CY14 earnings growth rates of 1.2% and 10.8%. Note that these core earnings growth rates were lower after IOICORP spun off its property division. Should we include this division, the growth would be restated to 2.8% and 11.8%, respectively. These growth rates are also supported by our 2014 real GDP growth assumption of 5.0%-5.5%.

Our forecasts are not far off vis-a-vis consensus earnings estimates and index target. Based on Bloomberg data, the investment community is expecting FBMKLCI’s net earnings to grow 10.8% and the index target pegged at 1,905, representing ≈2% from here (see Figure 2 for details).

However, we do notice there are some inconsistencies among analysts and strategists. Based on consensus target prices for all FBMKLCI component stocks, the index target is supposed to be registered at 1,905 but we notice quite a number of strategists pegging their index levels at the higher end of 1900s or low 2000s. As such, we believe such higher-end target could only materialise if and when the expectation gap converged with our FY15 numbers.

Looking into 2015, FBMKLCI may hit 2,020, implying ≈17.3x to FY15 earnings estimates despite a slower core earnings growth estimate of 7.3%. This higher index target is derived from the combination of Top-Down index target of 1,990 at 17.0x FY15 PER and index target of 2,050, implying 17.6x FY15 PER as per Bottom-Up approach.

Our Macro View Assumptions

Apart from the uncertainties over (i) Fed’s decision on QE programme and (ii) U.S. debt ceiling hearing in early 2014, we remains optimistic on the local equity market outlook.

We are taking the view that

- Interest rate of U.S. and Malaysia will remain unchanged at least until 1H14,

- Market could have discounted USD10b-USD15b cut in bond purchase.

- Monetary base of U.S. will continue to expand as interest rate is “near zero”.

-Hence, Ringgit will continue to strengthen RM3.09 by end-2014 (from RM3.17 end-2013) and foreign capital will flow back into this region, including Malaysia.

-  We also believe the implementation of GST will help strengthen the sovereign rating of Malaysia, thus positive for foreign inflows.

- Furthermore, we also believe uncertainties in interest rate outlook could benefit equity market at the expense of tougher investment environment in fixed income / bond market.

Source: Kenanga