While the local equity market could be supported by favourable seasonal factors (i.e. strong 4Q & 1Q) and strong domestic liquidity, its upside could be capped by a series of negative developments such as: (i) foreign outflow due to strengthening of US dollar and (ii) lack of price catalysts (i.e. unexciting earnings growth & rich market valuation). However, as FBMKLCI is traded at c.5.1% discount to the consensus index target of 1,945 (which is near the 6-year average of 5.6%) and coupled with the favourable seasonal factor, we believe the downside from here could be limited. Hence, we prefer to adopt a Buy On Weakness (B.O.W.) strategy. Our end-2014 and end-2015 index targets are pegged at 1,910 and 1,980, respectively. These index targets are backed by our FY14, FY15 and FY16 earnings growth forecasts of 4.9%, 11.3% and 8.1%, respectively. For the quarter, our selected Top Picks are BARAKAH (OP, TP: RM1.74), COASTAL (OP, TP: RM5.94), GAMUDA (OP, TP: RM5.52), KSL (TB, TP: RM6.63), MBSB (OP, TP: RM2.65), MUHIBAH (OP, TP: RM3.55), RHBCAP (OP, TP: RM10.00), SIME (OP, TP: RM10.10), SUPERMX (OP, TP: RM3.23) and VS (TB, TP: RM3.16).

Earlier expectations materialised. Recall that in our 3Q Investment Strategy dated 1st July 2014, we highlighted that FBMKLCI might stage a short-term pullback inline with the weaker seasonal 3Q (please refer to Figure 1), the unsustainable low market volatility (Figure 2) and stretched valuation as per our findings from (i) historical PER Band (Figure 3), (ii) discount between FBMKLCI and its consensus (Figure 4) as well as (iii) regional perspective. Even in early part of the year, we also highlighted that there is risk in seeing outflow of foreign funds from local equity and debt markets should U.S. indicate to start its Quantitative easing (QE) exiting programme earlier and more aggressive than expected. The aggressive outflow of foreign capital and uncertainties over QE direction could cause market volatility to spike and hence causing a correction. While we have no intention to blow our trumpet, the fact is that, all of these expectations have materialised. Quarter-to-date (QTD), the FBMKLCI declined 1.34% and had tested the 1,840/30-area, which is our recommended ideal buying level, for a number of times during the quarter (Figure 5). Besides, we also notice convergence between our market valuation and other regional countries especial North-East Asia could have started (Figure 6).

Losing steam? In the forthcoming quarters (i.e. 4Q14 & 1Q15), while we believe the local equity market could still be supported by favourable seasonal factors (Figure 1) and strong domestic liquidity albeit slight weakening (Figure 7), the above-mentioned concerns remain intact. The risk of foreign outflow heightening due to exist of QE as evidenced by (i) RM1.64b net outflow of foreign funds QTD (Figure 8) and (ii) the fast strengthening in USD or weakening in ringgit despite the recent 25bps hike in our Overnight Policy Rate (“OPR”) in early-July14. QTD, ringgit has depreciated by 2.2% against U.S. dollar while the dollar index has also strengthened in a faster pace at c.8.0% (Figure 9). Although we do not rule out such situation was the result of heightened geopolitical risk, uncertainties in U.S. interest rate direction could be a vital root cause as well, in our view.

Moreover, similarly to previous quarter, we see no immediate rerating or price catalysts emerging. The recently concluded corporate results season was uninspiring. During the quarter, 37.4% (vs. 32.0% in 1QCY14 and 34.4% in 4QCY13) of companies under our coverage delivered set of results which were below expectations. Consequently, our FY14E core net profit growth estimate for FBMKLCI was revised to 4.9% (from 11.8% previously). In tandem with the weaker results and less bullish earnings growth prospect, our Index Target has also been revised lower to 1,910 (from 1,960 previously). These earnings and index target cuts were also inline with consensus. Recall that consensus has also cut current year earnings growth from 6.2% in late-2Q14 to 3.8% recently while the year-end index target has also lowered to by 10 points to 1,945 (from 1,955) (Figure 10). In addition, with the implementation of Goods & Services Tax (“GST”) in April15, corporate earnings may see risk of slower top-line growth due to lower demand or lower profit margins owing to higher operating expenses.

The saving grace. Having said that we still believe that the downside will be well-supported judging from the: (i) strong domestic liquidity despite weakening (Figure 7) and (ii) favourable seasonal factor i.e. strong 4Q & 1Q (Figure 1). To recap, the recent reduction of RM40.0b excess liquidity in the banking system is manageable judging from the historical track record. Besides, apart from potential window dressing activities in year-end, 2nd and 3rd liners are usually quite actively traded during these 2 quarters as per our observations, reflecting better investment/trading sentiment vis-à-vis 3Q14. On external front, European and Japanese governments are still having some sort of QE programmes and China is expected to follow suits as well. As such, these collective efforts are expected to support the regional economies. Should China start to pump-prime in an aggressive way, this may be good for commodities, including Crude Palm Oil (CPO), as well.

More indications in early-4Q14? Apart from the FOMC & MPC meetings, at the start of the quarter, (i) the announcement of Malaysia’s 2014 Budget and (ii) the tabling of China’s next 5-year Plan by National People's Congress (NPC) could provide more indications to market direction going forward.

Nonetheless, we believe the 2014 Budget could be muted to equity market unless there is major cut in corporate income tax ahead of GST implementation. However, any pleasant surprises to targeted/selective sectors could act as rerating catalysts to those particular sectors. For instance, construction sector especially mid-to-small cap players could benefit from more exciting projects announcement. Staple food companies i.e. NESTLE (OP, TP: RM76.10) and non-bank money lenders i.e. AEONCR (OP, TP: RM17.80), MBSB (OP, TP: RM2.65) could be benefitted in the event that more “free money”, such as BR1M (Bantuan Rakyat 1 Malaysia), is dished out. Likewise, as expectations in property sector are low, any revisions in DIBS (Developer Interest Bearing Scheme) and RPGT (Real Property Gain Tax) could act as rerating catalysts to the sector as well.

4Q14 Investment strategy - B.O.W. stance remains unchanged with more emphasis on Stock Picking. Based on our FBMKLCI (or big cap) earnings universe, we estimate market core net profit to grow at 4.9% and 11.3% in FY14E andFY15F respectively (see Figure 11). Our earnings estimates are inline with consensus’ current year and next year earnings estimates of 3.8% & 9.9%. Our end-2014 Index Target is also fine-tuned to 1,910 @ 18.3 FY15 PER, implying 3.4% upside from here and seems to be more conservative vis-à-vis consensus target of 1,945. This index target is backed by (i) Top-Down Target at 1,835 @ 17.5x FY15 PER (vs. 1,890 previously), and (ii) Bottom-Up Estimate of c. 1,980 @ 18.9x FY15 PER (vs. 2,030 previously). Our initial end-2015 index target is pegged at 1,980 implying 17.5x FY16 PER with a projected earnings growth of 8.1%, which is also inline with our Bottom-Up’s Fair Value as well.

While the upside from here seems uninspiring, the benchmark index is traded at c.5.1% discount to the consensus index target. Coupled with the favourable seasonal factor, we believe the downside from here could be limited. As such, we prefer to adopt a Buy On Weakness (B.O.W.) strategy at this juncture. The easiest way to capitalise on the favourable 4Q season performance is to indentify Year-to-Date underperformers for a potential brief rebound due to window dressing (Figure 12) such as SKPETRO (OP, TP: RM5.57) and PCHEM (OP, TP: RM7.19). Nonetheless, as the valuation of most FBMKLCI component stocks seem stressed, we reckon that investors should pay more emphasis on stock picking. Apart from Outperform-rated stocks in selective sectors that we are bullish on (Figure 17), …

- investors may also consider GST beneficiaries or sectors/stocks that are less affected by GST such as exportdriven sectors i.e. E&E players, OEM and Gloves manufacturers. Coupled with the trend of weaker ringgit and new products launching, we believe stocks like MPI (OP, TP: RM6.72) and VS (TB, TP: RM3.16) should act as good proxies under this investment thesis.

- We also like stocks/sectors that surrounded by corporate exercise newsflow (i.e. M&A, privatisation, etc). For instance, we pick MBSB (OP, TP: RM2.65) and RHBCAP (OP, TP: RM10.00) as our Top Picks under the CIMBRHBCAP-MBSB merger talks. Besides, there are also a number of media reported that SIME (OP, TP: RM10.10) could embark on some corporate restructuring exercises including spinning off its auto business segment. We believe this newsflow is potentially positive to its share price.

- We also selectively cherry-pick property stocks as alpha stock despite the fact that we are less optimistic over the sector. In general, we still like affordable housing developers such as HUAYANG (OP, TP: RM3.52) and MATRIX (OP, TP: RM4.35). Besides, we still view the sector as an important sector as most of the stocks under this sector are Syariah compliance. It is worth noting that property, REIT as well as construction and building material sector accounts for approximately 14.0% in FBM Syariah Index. It is the heaviest sector after Plantations & Resources (21.6%), Telco (20.3%) as well as Oil & Gas (19.5%) sectors (Figure13). Moreover, we also notice that RNAV or revaluation play on non-main stream property stocks have also been outperforming FBMKLCI as per KL Property Index (KLPRP). KLPRP outperformed FBMKLCI by 6.21%. This property sector benchmark index also outperformed FBMS (FTSE Syariah Emas Index) by c.60bps. (Figure 14). To capitalise on this observation, we select KSL (TB, TP: RM6.63) as one of our Top Picks.

4Q14 Top picks. For this quarter, the research team has listed down 10 stocks (combining big-, mid- and small-cap stocks) for the considerations of our readers. These stocks are BARAKAH (OP, TP: RM1.74), COASTAL (OP, TP: RM5.94), GAMUDA (OP, TP: RM5.52), KSL (TB, TP: RM6.63), MBSB (OP, TP: RM2.65), MUHIBAH (OP, TP: RM3.55), RHBCAP (OP, TP: RM10.00), SIME, (OP, TP: RM10.10), SUPERMX (OP, TP: RM3.23) and VS (TB, TP: RM3.16). The short comments and financial highlights of these Top Picks are shown in Figure 15.

Source: Kenanga