Kenanga Research & Investment

3Q14 Investment Strategy - Calm Before The Storm?

kiasutrader
Publish date: Tue, 01 Jul 2014, 10:52 AM

Although we believe it is still a liquidity driven market supported by the ample underlying financial liquidity, a few negative factors are capping market upside. These negative factors include: (i) indecisive interest direction, (ii) less attractive regional valuations, (iii) historical low volatility, (vi) stretched valuation (as per the historical PER Band and discount between FBMKLCI and its consensus), (vii) weaker seasonal quarter, and (viii) lack of earnings catalysts & lower economic growth in 2H. While we have revised our FBMKLCI target to 1,960 (from 1,930 previously), we are cautious/neutral for 3Q14. We do not rule out a short-term pullback which could probably offer good buying opportunities. In general, we prefer to adopt a Buy On Weakness (B.O.W.) strategy to capitalise on: (i) the broad liquidity and (ii) potentially prolonged low interest rate environment. The ideal B.O.W. level is < 1,835.

Post results & our house-keeping after recent changes in index constituents, our FY14E & FY15F core net profit growth rates for FBMKLCI are now 13.0% and 10.5% (vs. 13.3% & 8.7% previously), respectively. Our earnings estimates are higher than consensus estimates of 6.2% & 9.6%.

Our end-2014 Index Target is also fine-tuned to 1,960 @ 18.2x FY15 PER, implying 3.7% upside from here. This index target is backed by (i) Top-Down Target at 1,890 @ 17.6x FY15 PER (vs. 1,885 previously), and (ii) Bottom-Up Estimate of ~2,030 @ 18.8x FY15 PER (vs. 1,970 previously).

Of late, we have upgraded our sector rating for (i) Building Material, (ii) MREIT, (iii) Transports & Logistics as well as (iv) Water. On the contrary, we downgraded (i) Oil & Gas as well as (ii) Property Developers. In all, we are now OVERWEIGHT on (i) Building Material, (ii) Construction, (iii) Gaming, (iv) Gloves, (v) MREIT, (vi) Plantations, (vi) Power Utility, (vii) Water Utility, and (viii) Transports & Logistics. At the same time, we UNDERWEIGHT Media sector and are NEUTRAL on (i)Auto, (ii) Aviation, (iii) Banking & Non-bank Financial, (iv) Consumer, (v) Healthcare, (vi) Oil & Gas, (vii)Property Developers, (viii) Technology, and (ix) Telco.

Apart from B.O.W. investment strategy, we believe the strategy of Sell On Strength (S.O.S.) could be workable for aggressive traders in 3Q14 due to the emerging signs of “market toppishness” coupled with the weaker seasonal factor. The ideal S.O.S. level for the quarter would be >1,890 (or 3% discount to 1,950). Besides, as most companies will declare interim/final dividends post results reporting month in August, we believe DIVIDEND play could also be a wise move.

As for Top Picks, we are recommending GAMUDA (OP, TP: RM5.50) and SUNWAY (OP, TP: RM3.70) to capitalise on construction and water sectors which could be hot sectors especially approaching Budget time. We have HARTA (OP, TP: RM7.48) and MAYBULK (OP, TP: RM2.53) as proxies to export driven sector. While we have downgraded Oil & Gas sector, we still like SKPETRO (OP, TP: RM5.57). We also include KLCC (OP, TP: RM6.90) into our list of Top Picks as we have just upgraded the sector. We also like AFG (OP, TP: RM5.25), TM (OP, TP: RM6.74) and TENAGA (OP, TP: RM13.58). At the same time, we position NESTLE (OP, TP: RM76.10) as a laggard and dividend play.

Apart from these bigger cap stocks, we feature a few smaller cap alternative picks such as AEONCR (OP, TP: RM17.80), COASTAL (OP, TP: RM5.94), INARI (TB, TP: RM3.15), HARBOUR (OP, TP: RM 2.20), LONBICS (TB, TP: RM1.18), MITRA (TB, TP: RM1.13), PADINI (OP, TP: RM2.13), PESTECH (OP, TP: RM7.27), REDTONE (OP, TP: RM0.81) and TSH (OP, TP: RM4.10).

 

3Q14 / 2H14 Market Outlooks

Trend is your friend?

Favourable Liquidity Position

The Malaysian equity market has been well supported and just recently marked a new all-time high of 1891.64. While this move is merely tracking the similarly bullish move of the Dow Jones industrial Average, which has just recorded an all-time high of c.17,000, we believe such bullish tone is due to the underlying ample liquidity condition.

From Figure 1, it is clearly seen that excess liquidity position of the domestic banking system remains near its all-time high at RM300bn as at end-Mar14. While it has retraced approximately RM20bn from the peak of RM320bn, this should not be a major concern as this only represents 0.2% of the total market capitalisation of FBMKLCI of c.RM1.0tn. Based on our study, the excess liquidity is required to contract by >10% to the market of FBMKLCI before seeing any meaningful selling pressure.

           

Foreign Investors Have Turned Buyers

Besides, foreign investors have also turned net buyers since late-Mar14 (see Figure 2) with total inflow of c.RM6bn. As such, we expect the excess liquidity position to further strengthen and to continue supporting the market.

 

Technically & Quantitatively Looking Good

Apart from the consideration of liquidity position, the FBMKLCI’s outlook seems to favour the upside as per both our technical and quantitative studies.

Technically speaking, FBMKLCI is trending up within a well-established uptrend channel (see Figure 3). Based on our Elliot Wave count, FBMKLCI could potentially trend up to at least 1,930/35 before the underlying uptrend ends. Nonetheless, this uptrend may not be sustainable as RSI is fast approaching overbought territory.

Our Monte Carlo Simulation (see Figure 4) also reinforced this bullish view with favourable reward-torisk odds on the upside. Based on the 95% confidence interval, FBMKLCI is expected to fluctuate between 1,800 and 2,000 throughout the remainder of 2014.

 

Until It Ends!

The Wild Card: Indecisive Interest Rate Directions

Note that all the above-mentioned factors are either tactical or technical in nature. We reckon these arguments could be fragile and is highly dependent on the movement of both domestic and US interest rate directions. We would not be surprised to see a sudden change in market sentiment and a much stronger outflow of foreign capital, which could probably be triggered by a hike in U.S. interest rate and stronger U.S. Dollar.

Thus far, the interest rate differential between 10-Year MGS and 10-Year US Treasury Bond is fast approaching the +1SD-level (148bps) above its long-term average (of 60bps) (see Figure 5). While this differential is likely to stay high for sometimes judging from past experience (early-2012 to Mid-2013), it will eventually contract given time. It is proven that the differential normally sustain near or above the +1SD-level and tends to revert back to its long-term mean or even swing to test -1SD-level.

The implication of such contraction in interest differential could be negative. This is because it tends to imply that US interest rate is rising faster than our domestic interest rate, leading to a weaker ringgit against US dollar and eventually outflow of capital. From Figure 6, it is clearly demonstrated that narrower interest differential often leads to reduction in excess liquidity, which will eventually have a negative impact on local equity market.

 

Less Attractive Regional Valuations and Much Higher Premium

Apart from indecisive monetary policy decisions, the less exciting market valuation could potential lead to weaker foreign inflow and upside. Since early-2013, the PER valuation of FBMKLCI has been on a rising trend and is traded higher than regional peers, especially North-East Asia markets (see Figure 7). While we understand that FBMKLCI has always been trading at a premium to its peers, as global investors tend to view the country as a “defensive” bet that holds up well in market downturns, the current premium could be at the higher end of its historical range. From Figure 8, it is clearly seen that North-East markets are now trading at historical discount (since 2011) against FBMKLCI. Such high discount could probably limit FBMKLCI’s upside, we believe.

 

Historical Low Volatility - Calm Before The Storm?

Recall that we mentioned (in our earlier Quarterly Investment Strategy report) that volatilities in the Malaysian and U.S. equity markets were likely to spike given that their respective historical volatilities register at the lower end of their historical ranges (see Figure 9 & 10) although we were not able to pin-point the timing of such spike in volatilities.

Source: Kenanga

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