We believe the domestic market is still stuck in a fairly tight trading range of 1,630-1,670 while awaiting fresh catalysts before a more meaningful/tradable range of 1,585-1,715 can be seen. Fundamentally speaking, we strongly believe that a broad-based earnings growth story is still missing and market valuation remains less than exciting. However, the downside risk seems well protected/cushioned as; (i) FBMKLCI could have traced a "double-bottom" reversal pattern at ~1,610 with a make-or-break neckline resistance at ~1,665, (ii) foreign equity outflow is expected to taper off should Ringgit and crude oil prices stabilise, and (iii) downgrades by market could be nearing the tail-end as the consensus index target has remained relatively stable for the last two months. Nonetheless, while the downside risk seems well protected/cushioned, we are also mindful of a potential weaker quarter, as the 3Q is normally the weakest quarter. Besides, the excess liquidity in the domestic banking system remains lacklustre. In addition, with the relatively low market volatility, we also expect a big move to unfold soon.

Not so bad after all! Surprisingly, the domestic and global markets seem resilient despite all the uncertainties. The recent Brexit has proven to be a storm in a teacup. In fact, contrary to our earlier expectation of a potential "volatility breakout" following Brexit decision, the local market volatility remains relatively low. We also believe that the stronger-than-expected market condition could partially be due to the expectation of Fed likely to revise US interest rate in a less aggressive manner given the uncertainties over Euro-zone and US Presidential Election, which is fast approaching as well.

However, we believe a broad-based earnings growth story is still missing and market valuation remains a major deterrent. We are only looking at net earnings growth rates of 2.3%/7.8% for FY16E/FY17E (see Figure 5), which are in line with consensus estimates of 2.2%/9.2%. While both market and our house view have estimated higher growth for FY17E, we believe this is mainly due to the low-base effect in FY16E. Besides, even if the FY17E growth rates are achievable, valuation of FBMKLCI is still less exciting as it is traded at 18.8x/17.5x to our FY16E/FY17E earnings forecasts (and 18.9x/17.2x to consensus estimates). Recall that FBMKLCI has historically peaked at ≈17.5x/18.0x Forward PER.

We lower our end-2016 Index target marginally to 1,715 (from 1,725 previously), implying <5% upside from here. Based on the blended Top-Down and Bottom-Up approaches, we peg our end-2016 index target at 1,715, implying FY16E/FY17E PER of 19.6x/18.2x. For Top-Down approach, we assign a target FY17E PER of 17.5x, hence 1,660. Bottom-Up approach values FBMKLCI at 1,770 based on our analysts’ inputs. Our index target is not far from consensus index target of 1,705/10.

3Q16 Investment Strategy. Timing-wise, to account for potential spike in volatility, we have widened our Buy On Weakness (B.O.W.) zone to 1,630/1,585. On the other hand, ideal Sell On Strength (S.O.S) levels should be >1,715. As for preference in sector allocations, we have assigned OVERWEIGHT calls for: (i) Construction, (ii) Gloves, (iii) Plastic Packaging, and (iv) Power Utility. At the same time, we label: (i) Automotive, (ii) Healthcare (Hospital), and (iii) Property as UNDERWEIGHT. The other sectors are rated as NEUTRAL. On tactical front, we also like stocks with defensive nature and preferably offering decent-to-high dividend yields. At the same time, we also like those companies that have delivered QoQ and YoY growth in the recently concluded reporting season. We also believe exporters may return to investors' radar should the USD appreciate and when investors look for safe-haven stocks as externalities turn more hostile.

3Q16 Top Picks. For Shariah selection, we have selected: (i) DLADY (OP; TP: RM62.36), (ii) KIMLUN (OP, TP: RM2.10), (iii) KOSSAN (OP; TP: RM8.00), (iv) SCIENTX (OP; TP: RM15.13), (v) SLP (OP; TP: RM3.11), (vi) TENAGA (OP; TP: RM17.50), (vii) VITROX (TB; TP: RM4.23), and (viii) YOCB (TB; TP: RM1.50). Non-Shariah compliant picks are: (i) AEONCR (OP; TP: RM15.12), (ii) AIRASIA (OP; TP: RM3.41), (iii) BJTOTO (OP, TP: RM3.40), (iv) HEIM (OP; TP: RM16.90), (v) SUNCON (OP, TP: RM1.81,) and (vi) SUNREIT (OP; TP: RM1.79).

Source: Kenanga Research - 11 Jul 2016