The local equity market is expected to remain choppy and volatile for the time being. As such, we are selective and would probably be more trading-oriented in our stock picks. However, as the benchmark index is traded at c.9% discount to the consensus’ index target of 1,900 which is fairly close to the -1SD-level, we believe a temporary bottom could form should oil prices stabilise above USD60/barrel. After rounds of revision, our end-2015 Index Target is now pegged at 1,905, implying 17.7x FY16 PER on the back of 1.3%/4.7%/7.4% earnings growth for 2014/15/16. For the short-andmedium term, we like BJAUTO (OP; TP: RM4.29), CIMB (OP; TP: RM6.27), GAMUDA (OP; TP:RM5.29), HARTA (OP; TP: RM7.36), MBSB (AO; TP: RM2.82), MMCCORP (OP; TP: RM3.21), MPI (OP; TP: RM6.80), PHARMA (OP; TP: RM5.03), QL (OP; TP: RM3.86), SKPETRO (OP;TP: RM3.03), SIME (OP; TP: RM9.92), SPSETIA (OP; TP: RM3.95), SUNREIT (OP; TP: RM1.68) and TENAGA (OP; TP: RM14.65). These stocks are picked based on various focused themes such as (i) bottom-fishing, (ii) GST beneficiaries or sectors/stocks those are less sensitive to GST, (iii) optimism over construction sector and (iv) back to basic and other (v) alpha stock selections.

Worst 4Q in the past 5 years. As at 19 December 2014, the YoY and QoQ performances of FBMLKCI were recorded at -7.1% and -7.2%, respectively (see Figure 1). Contrary to our earlier expectation of stronger 4Q as per our seasonal study, the disappointing YoY/QoQ performances were the lowest or the only negative performance in the past 5 years. Apart from the great disappointment in the recent results season, the plunge in crude oil prices coupled with the weakening ringgit (which implies outflow of foreign funds) have seen considerable strong selling pressure in local equity market. Vis-à-vis our selective regional and global equity markets, Malaysia is one of the few worst performing countries (see Figure 2).

Against wind and tide. Of late, Brent Crude prices have fallen by c.50% to USD60.5/barrel from its peak at USD115.7/barrel on 19 June 2014. While this could be a piece of good news for net importers, Malaysia’s economy and equity market could face headwinds due to its heavy reliance on Petroliam Nasional Bhd’s (Petronas) contributions and capex. As such, these developments have led to expectations of potential downgrade in the country sovereign rating due to lower-than-expected government revenue despite having GST to cushion such short-fall; hence, we saw further weakening in ringgit (see Figure 3-4). To make thing worse, the U.S. dollar has been in an up-trending mode probably due to an expectation of rising interest rate in U.S. after the end of QE in September 2014 (see Figure 5-6). Such strong U.S. dollar has been putting pressure on foreign outflows (see Figure 7). Nonetheless, we still believe there is sufficient liquidity to support the local market as per the underlying excess liquidity condition (see Figure 8).

Not cheap, even after downgrading? Having said that, the underlying investment/market sentiment is weak. While it is approaching the lower-end of its historical range, we have yet to see a climax in selling as per our sentiment analysis (see Figure 9). Part of the reasons for such conclusion could be the market valuation.

Recall that we saw more disappointments in the recently announced corporate results. These results were much weakerthan-expected despite few rounds of downgrades earlier. 40.0% of stocks under our coverage performed weaker-thanexpected, resulting in the “disappointment ratio” deteriorating to the “highest” point for the past few quarters (vs. 37.4% in 2QCY14, 32.0% in 1QCY14 and 34.4% in 4QCY13). As such, our FY14E-FY15E core net profit growth estimates for FBMKLCI were revised to 1.3%-4.7% (from 4.9%-11.3%, previously) while our FY16F earnings growth rate was almost unchanged at 7.4% (see Figure 10). Thus, our end-2015 Index Target has also been revised lower to 1,905 (from 1,980/50 previously), implying 17.7x FY16 PER. This Index Target is derived from the blended Top-Down Approach (1,880 @ 17.5x FY16 PER) and Bottom-Up Approach (of 1,930). The target price multiple is still relatively high as per historical PER Band (see Figure 11). As such, we would not be surprised to see further downgrades (by us or consensus) should the Forward PER gradually revert back to its mean level (at ~16x) or even lower (~15x @ -1SD) in view of the weak underlying sentiment.

The above expectation is also reinforced by the widening in discount between FBMKLCI and its consensus target price (The Discount). While consensus target of FBMKLCI has been revised down from the high of 1,955 in end-August14 to ~1,900 recently (see Figure 12), the Discount has widened from 4.5% to 9% for the similar period of time (see Figure 13). We believe this could be partly owed to heightened market volatility (see Figure 14). In the meantime, valuation of FBMKLCI is not as attractive as per its regional peers even after its recent sell down (see Figure 2) and the fact that ringgit has also been relatively weaker vis-à-vis its regional peers (see Figure 15).

Tough going, technically speaking. As such, with the weak underlying sentiment, FBMKLCI could persistently trade at a wide discount, say minimum 5.5%, to its consensus target, in the near future. Technically speaking, long-term up-trend of most of the benchmark indices (i.e. FBMKLCI, FBM70 & FBMSC) have been broken down convincingly. Apart from their respective oversold technical condition, they have yet to show any concrete turnaround sign (see Figure 16-18). Based on our Monte Carlo Simulation (see Figure 19), the FBMKLCI is expected to trade at 1,855 on average in 2015. This represents 3.6% discount to our end-2015 index target. At the same time, within the 1 standard deviation or 68% confidence interval, FBMKLCI could fluctuate between 1,765 and 1,947. Taking this finding into consideration, FBMKLCI may worsen before turning better in later part of 2015.

Risk of further downgrading? Therefore, it is our interest to search for the bottom in the near-term. Nonetheless, such effort is very much dependent on crude oil prices movement. Brent crude oil spot month futures contract (CO1) closed at USD60.5/barrel as of 22/12/14. Based on our simulation study (see Figure 20), CO1 is likely to trade at an average of c.USD70/barrel in 2015. At 68% confident interval, CO1 could oscillate between USD60/barrel and USD79/barrel. Judging from this confidence interval, CO1 is likely to test USD60/barrel before reverting back to the mean again. However, we downplay the probability of CO1 trading below USD50/barrel as this probability is as low as 2.3%. Based on these findings, we can now assess if there is potential further downside risk in Oil & Gas stocks. From 19 June 2014 (USD115.7/barrel) to 16 December 2014 (USD58.5/barrel), CO1 declined approximately 50% (or 70% on annualised basis) (see Figure 21). Consensus target prices for Oil & Gas stocks under our coverage were cut by c.21% for the similar time period (see Figure 22). Is this sufficient? Recall during the period of July08-Dec08, CO1 fell 76% (or annualised at 95%). Target prices for the similar poll of stocks were cut by ~40%. Applying similar ratio, target prices for these Oil & Gas stocks should be cut by ~26% on average. Hence, we could be in the tail-end of this round of Oil & Gas sector downgrade, otherwise we believe there would be another 5% additional downside in a worst-case scenario. Nonetheless, should CO1 dip further to USD60/barrel, the market may expect further cut in target prices up to 25%, implying another 5% in downside from here.

The similar trend could be applied to banking stocks as well. With the expectation of lower oil revenue hence prime priming activities, coupled with weaker consumer sentiment ahead of GST implementation, the market is expecting flatter top-lines growth for all the domestic banks i.e. lower loans growth, narrower net interest margin (↓interest earnings yield, ↑cost of funding) and lower non-interest income due to tougher capital market condition. At the same time, bottom-lines were underpressured as well.

Recall that most of the banks’ results have been driven by linear cost and lower provisioning in the last few years. However, these privileges could be diminished with sticky or higher cost-to-income ratio CIR and higher credit cost especially for those banks have higher exposure in O&G i.e. AFFIN (~4.5% of total loans), CIMB (~3.5%) and MAYBANK (~2.5%). While we believe it is still too preliminary to price in such negative factors as we have factored in more conservative assumptions in our earlier earnings forecasts, we cannot rule out this possibility if both domestic and external market conditions turn more hostile than expected. Should we further price in the above-mentioned assumptions, our FY14E/FY15F/FY16F core net profit growth estimates for FBMKLCI would be revised down to 1.1%/2.1%/7.3% from (1.3%/4.7%/7.4% earlier). Our end-2015 Target is likely to be cut by another 35 index points (to 1,870 from 1,905). However, even with this lower index target, it still implies ~19x and 18x to our FY15F and FY16F earnings estimates.

1Q15/2015 Investment Strategy - Be Selective. All told, the local equity market is expected to remain choppy and volatile for the time being. As such, we have to be very selective and probably be more trading-oriented in our stock picks.

Timing-wise, the benchmark index is traded at c.9% discount to the consensus index target of 1,900. This is fairly close to its 6-Year -1SD-level of 8.5%. In fact, at the recent low of 1,730.77, it was traded at c.10% discount; hence a temporary bottom could have been seen. Coupled with the favourable seasonal factor (stronger 4Q & 1Q), the downside could be limited from here. Of course, this anticipation is premised on stable oil price above USD60/barrel. As such, we would advocate a Buy On Weakness (B.O.W.) strategy.

Focused Theme Plays.

· Bottom-fishing. Under the assumption of a stable oil price above USD60/barrel, we would like to bottom-fish stocks especially those heavily sold down stocks i.e. index-linked as well as Oil & Gas stocks in 1Q15 to capitalise on any possible rebounds due to the recent oversold technical condition. Figure 23 clearly list these OUTPERFORM calls that YTD, have way underperformed the FBMKLCI including Oil & Gas stocks. Within this list, we notice SKPETRO (OP, TP: RM3.03), BARAKAH (OP, TP: RM1.62), UZMA (OP, TP: RM2.02), PERDANA (OP, TP: RM1.61) and CIMB (OP, TP: RM6.27) were the Top few laggards even after the recent downgrades.

· Natural hedge against oil price weakness. On the contrary, we believe AIRASIA (OP, TP: RM3.27) as well as Plastic Packaging players i.e. TGUAN (OP, TP: RM3.70) are likely to get a boost from the lower oil prices. Nonetheless, the recent tragedy of AirAsia Indonesia Flight went missing could be a share price dampener for AIRASIA, at least in the short-term.

· GST beneficiaries or sectors/stocks those are less sensitive to GST. As GST will be implemented starting 1 April 2015, consumption driven sectors could turn weaker. Based on other countries’ experience, we believe a weaker tone could set in for the next two consecutive quarters after the implementation of this new tax regime. As such, for middle-term investment horizon, we would emphasis on GST beneficiaries, such as MYEG (TB, TP: RM4.73), or sectors/stocks that are less affected by GST such as export-driven sectors i.e. E&E players, OEM and Gloves manufacturers. Coupled with the trend of weaker ringgit and new products launching, we believe HARTA (OP, TP: RM7.36), MPI (OP, TP: RM6.80) and VS (TB, TP: RM3.56) should act as good proxies under this investment thesis.

· Construction, the next major engine of growth apart from export. While some market observers are sceptical over the job flows continuity as: (i) Petronas is likely to cut capex by 15%-20% in 2015, and (ii) lower government revenue arising from lower oil prices, hence, the need of government to cut development expenditure to meet its fiscal deficit target; we beg to differ. We opine that the cut in Petronas capex could translate into an effort to maintain Petronas’ dividend to the government. Besides, most of the sizeable projects are under PPP (Public Private Partnership) or PFI (Private Funding Initiative) arrangements. As such, we reckon that the concerns over government fiscal position may be overly magnified. Furthermore, we believe government could still re-prioritise some of the projects instead of cancelling them. Recall that in Budget 2015, the government is expected to focus on transportation infrastructure and affordable housing projects namely: (i) KVMRT2, (ii) urban highways, (iii) TRX, and (iv) PR1MA housing. Our preferred stocks to benefit from news/contract flows in the near-term is GAMUDA (OP, TP: RM5.29) (one of the major beneficiaries from KVMRT2 news flows and M&A activities in water).

· Back to the basic. In view of the higher market volatility going forth, investors may also consider resilient sectors such as Telco, Sin, REIT, Power, Pharmaceutical and Consumer Staple Food sectors. Within these sectors we like TENAGA (TP: RM14.65), SUNREIT (OP, TP: RM1.56), PHARMA (OP, TP: RM5.03) and QL (OP, TP: RM3.86). Any More Alpha Stocks? We also like stocks/sectors surrounded by corporate exercise newsflow (i.e. M&A, privatization, IPO, restructuring). For instance, …

· We like MBSB (AO, TP: RM2.82) as we believe the VGO is likely to go through due to attractive valuation. Hence, at this price level, it offers arbitrage opportunity.

· SIME (OP, TP: RM10.10) is likely to be a beneficiary of high corporate newsflow in view of frequent media highlights. It is widely expected that the Group could embark in corporate restructuring exercises that include spinning off its automotive or property business segment.

· We also may see potential corporate exercise in SPSETIA (OP, TP: RM3.95). Besides, the stock has been trading sideways after rebounded from its multi-year low of RM2.95. As such, tactically speaking, any potential news flow in corporate exercise could act as re-rating catalysts.

· Listing of MALAKOFF should benefit MMCCORP (OP, TP: RM3.21) as our SOP valuation only factor in 12.3x FY15 PER for MALAKOFF (vs. TENAGA’s 14x FY15 PER).

· BJAUTO (OP, TP: RM4.29) is a clear beneficiary of weaker Japanese Yen. 1Q15 Top Picks. All told, after taking the above-mentioned thoughts into consideration, we propose the following stocks as our Top Picks. Brief comments for these picks are listed down in Figure 24. While various sector outlooks are featured in Figure 25-27.

Source: Kenanga