We still believe that the market is still stuck in a sideways or range-bound mode at best. Therefore, our range-bound TRADING-oriented strategy remains unchanged. Our preferred “Buy on Weakness” (B.O.W.) range is pegged at 1,570/1,610 while “Sell on Strength” (S .O.S.) range is targeted at 1,680/1,720. While we see: (i) no immediate re-rating catalysts, (ii) continuous foreign outflow, (iii) draining domestic liquidity, and (v) bearish technical picture, we do not rule out that these obvious negative observations could have already been priced in. This is because we notice that investment sentiment gradually improves as per the PER multiple discount between FBMSC and FBMKLCI. Coupled with the revival of ValueCap and the fact that the discount between FBMKLCI and its consensus target has reversed, the market could have seen a bottom when it tested 1,503.68, at least for the short-term. Moreover, should we see more market-friendly measures being announced in the coming Budget Day, say corporate tax cut, these could reinforce the expectations of the market bottoming out. Out of the 19 sectors under our coverage, we only have OVERWEIGHT call on: (i) Construction, (ii) Gaming, (iii) Gloves, (iv) Plastic Packaging, and (v) Telco. We are NEUTRAL on: (i) Auto, (ii) Aviation, (iii) Banks & Non-Bank Financials, (iv) Building Materials, (v) Consumer, (vi) Media, (vii) MREIT, (viii) Oil & Gas, (ix) Plantation, (x) Power Utility, (xi) Property (xii) Shipping & Ports, and (xiii) Technology. Healthcare (mainly for Hospital operators due to rich valuations) is rated as UNDERWEIGHT. We select ARMADA (OP, TP: RM1.17), KIMLUN (OP, TP: RM1.63), MPI (OP; TP: RM8.28), PESTECH (OP, TP: RM6.49), PHARMA (OP, TP: RM6.95), PWROOT (TB; TP: RM2.58), SLP (OP; TP: RM1.87), TAANN (OP; TP: RM4.80), TM (OP, TP: RM7.33) and TOPGLV (OP, TP: RM9.16) as our 4Q15 Top Picks. We also like two non-Syariah compliant counters - BJTOTO (OP; TP: RM3.72) and MAYBANK (OP; TP: RM9.74) - for their decent dividend yield offerings.

Thus far, the challenging market conditions and investment environment have not changed. Against our earlier expectations that market could be bottoming out after a sharp decline of ~7% in 2Q15, the FBMKLCI declined further by another 5% vs. mild the decline of 1.2% in 3Q14. YTD, the benchmark index dipped 7.5%, under-performing regional peers (ex-Japan) by a mere 0.04% on average. However, the local currency has underperformed its regional peers (ex-Japan) by a wide margin of ~12%, on average. This could be inline with the weaker Brent (-16.0% YTD) and light (-14.5% YTD) crude oil prices.

Liquidity is shrinking ... Thus far, we saw RM9.3b of net foreign outflows from the domestic equity market in 3Q15 (vs. RM5.5b in 2Q15), with YTD total foreign outflow hitting ~RM18.0b. Based on our Modern Portfolio Theory Study, we can expect foreign selling to continue as FBMKLCI has lost its shine as a "low-beta" market. We may only start to see foreign inflow if and when the monthly performance of FBMKLCI turns positive (in USD term), which is less probable given the weak Ringgit outlook. Besides, on the domestic front, the excess liquidity in the banking system has been declining. As at end-Sep 15, the excess liquidity in the banking system only stood at RM215.8b, accounting for 22.8% of FBMKLCI's market cap. This excess liquidity condition represented a decline of RM91.8b from the peak of RM307.6b in May 15.

… ValueCap to the rescue along with Budget 2016 probably. The revival of ValueCap could be a positive measure to the local equity market as it provides additional liquidity of RM20b, or ~2% of FBMKLCI market cap, which should be able to cushion the incessant foreign outflows that we have seen so far. Besides, based on the outperformance of 4% (FBMKLCI vs. DJIA) back in 2013, we can expect the additional 2% capital to potentially generate up to 4% of return in FBMKLCI. As for Budget 2016, should the government decide to lower the current corporate tax by 1 percentage point, this should instantly translate into 1% of additional upside to the market.

Nonetheless, upside is likely to be capped, fundamentally speaking. It was clearly seen that the recent results season failed to provide any strong rerating catalyst to the local equity market. Out of the 134 stocks under our coverage, 52 of them, or 38.8%, still reported lower-than-expected results. Post results reporting season, we have revised our FY15E/FY16E core net profit growth rates to 1.4%/6.0% from 2.5%/7.8% previously. As for FY17E, our earnings growth is estimated at 7.7%. Even with such downgrades, the FBMKLCI is still traded >17.5x PER over our conservative FY16E earnings estimate. Based on the historical Fwd. PER Band, this PER multiple seems to be at the higher end of the range, as the Fwd. PER of FBMKLCI normally peaks near 17.5x-18.0x.

End-2015 @ 1,680 & end-2016 @ 1,740. As we have adopted a lower PER-multiple in our Top-Down Approach and revised target prices for constituents in our earnings universal post results, we maintain our end-2015 index target at 1,680 (vs. 1,810 in the previous quarter). This index target represents 19.4x and 18.1x over our FY15E and FY16E earnings estimates, respectively. For end-2016, our index target is ~4% higher at 1,740, representing 18.8x FY16 PER. The higher target PER is due to our higher growth estimate of 7.7% in FY17E.

The challenging market condition and investment environment have not changed thus far. Against our earlier expectations that market could be bottoming out after a sharp decline of ~7% in 2Q15, the FBMKLCI declined further by another 5% vs. mild decline of 1.2% in 3Q14 (see Figure 1). YTD, the benchmark index dipped 7.5% underperforming regional peers (ex-Japan) by a mere 0.04% on average. However, the local currency has underperformed its regional peers (ex-Japan) by a wide margin of ~12%, on average. This could be inline with the weaker Brent (-16.0% YTD) and light (-14.5% YTD) crude oil prices (see Figure 2).

Besides, continuous foreign outflow from both domestic equity and debt markets is still the key concern. In 3Q15, we saw a total of RM9.3b net foreign outflow from the equity market while we also saw RM14.0b outflow from the debt market in the months of July 15 and August 15. These led to a whopping reduction of RM64.7b in banking system’s excess liquidity in the said 2-month period (see Figure 3-4), shrinking the excess liquidity condition to RM215.8b (or a decline of RM91.8b from the peak of RM307.6b in May 15).

Remarkable market developments that took place in 3Q were as follows.

• In mid-August 15, China carried out the biggest devaluation of the renminbi in two decades to boost its slowing economy, marking an escalation of international “currency wars”, surprising global market. The 1.9 percentage points downward move by the Chinese central bank was its biggest one-day change since 1993 and since China abandoned its tight currency peg for a managed float in 2005.
• 2QCY15 results reporting season: The recently concluded corporate results season was somewhat still weaker than expected. Out of 134 stocks under our coverage, 52 of them, or 38.8% (vs. 24.6% in the previous quarter), reported lower-than-expected results (see Figure 5). In general, most of the sectors were either mostly within expectations or mixed in nature but (i) Automotive, (ii) Building Materials, (iii) Consumer Retail, (iv) Gaming (or Casino in particular), (v) Oil & Gas, and (vi) Plantations sectors performed weaker than expected. The glove sector was probably the biggest winner as we saw market consensus revising their earnings estimates higher. Please refer to following section for more details in our earnings revision.
• Bank Negara Malaysia (BNM), on the other hand, maintained an accommodative monetary policy stance and left the Overnight Policy Rate (OPR) unchanged at 3.25% for the seventh (7th) straight session during the Monetary Policy Committee (MPC) meeting in September 2015.
• In Sep15, Prime Minister Datuk Seri Najib Tun Abdul Razak (PM) announced a slew of measures to support the domestic economy, stabilize the capital market, and in due process restore investor confidence and ringgit’s strength. At the same time, PM reassured that there is no need to re-introduce capital controls and re-peg the ringgit, adding that the current economic conditions are far better than during the Asian Financial Crisis of 1997/98. Besides, one of the measures that excite the local equity market could be the revival of ValueCap. To recap, the federal government has brought back the defunct equity fund - ValueCap - to help boost underperforming shares and stabilise the financial market. For this purpose, it was announced that RM20b would be injected into this equity fund. Please refer to following section for more in-depth analysis in impact of ValueCap.
• The US Federal Reserve also decided to keep federal funds rate at its record low with a target range of 0.00%-0.25%. That decision ended weeks of feverish speculation over whether Fed would raise rates for the first time since the previous global financial crisis. The decision was made as there is a concern about an increasingly weak global economy which could have overshadowed evidence of a resilient US recovery. Nonetheless, based on Fed funds futures, it is widely expected that US interest rate to be lifted by 2016 while some economists are looking at December 2015.
• On end-September 2015, the domestic investment sentiment was also affected by a report which cited that six (6) developing nations, including Malaysia (and South Africa) are perceived to follow Brazil as “junk”-status as per a credit-default-swaps (CDS) model, raising concerns over a potential downgrade in the country’s sovereign rating.

Source: Kenanga Research - 5 Oct 2015