While the equity market for 2018 may not be smooth sailing, it is still reasonable for us to expect a relatively good 1Q. In the short-run, we believe the spill-over effect of the favourable seasonal factor coupled with the improved Buying Interest/Momentum should serve as supportive factors. Besides, the undemanding valuation of FBMKLCI against regional peers is likely to attract more foreign interest on top of the favourable uptrend of Ringgit and Crude Oil. However, with a relatively flat-to-negative earnings growth rate for 2018 (of -0.2% vs. 9.8% for FY17E) before improving to mid-single digit in 2019 (4.9%) as well as <4% upside to our end-2018 Index Target of 1,860, B.O.W. is still our preferred strategy. We believe investors should start nibbling if and when the benchmark index retraces below 1,765. Sector-wise, we stay OVERWEIGHT on Aviation, Gaming, MREITs and Power Utility while Healthcare sector is the only UNDERWEIGHT sector. The others are NEUTRAL. For 1Q18, our Top Picks are AMBANK (OP, TP: RM4.75), AMWAY (OP, TP: RM8.30), ANNJOO (OP, TP: RM4.70), F&N (OP, TP: RM28.85), MITRA (OP, TP: RM1.09), PIE (OP, TP: RM2.65), SERBADK (OP, TP: RM3.65), TAKAFUL (OP, TP: RM4.27), TOPGLOV (OP, TP: RM8.80), WASEONG (OP, TP: RM1.40) and WCT (OP, TP: RM1.95).

What to expect in 2018? 2018 may not be a smooth sailing year. In fact, 2018 could be an eventful year. On the global backdrops, we see challenges in: (i) normalisation in interest rate, and (ii) uncertainties over the new tax reform in US. On the domestic front, concerns over the impacts of pre and post GE14 are raised as well. Besides, (i) the recent run-up in commodities price, (ii) the final phase of RAPID development, (iii) recent corrections in construction sector/stocks, (iv) better luck factor for gaming stocks going forward, (v) potential impact of La Niña over plantations sector, and (vi) the 2018 FIFA World Cup Russia, could probably provide selective investment opportunities for investors.

Sector-wise, we stay OVERWEIGHT on Aviation, Gaming, MREITs and Power Utility while Healthcare sector is the only UNDERWEIGHT sector. The others are NEUTRAL. However, we are also monitoring Aviation and MREITs sectors very closely. The performance of AIRASIA could be affected should crude oil price remains strong over the next few months. As for MREITs, while we believe the movement of MGS yields is less sensitive to US interest rate hike and OPR changes to a lesser extent, higher risk-free rate normally reduces the attractiveness of MREITs (from valuation point of view).

Stock selection wise, we pick AMWAY and F&N as we believe their profitability should improve in line with the stronger Ringgit. We also reckon that MITRA and WCT are ripe for picking as their share prices have corrected sharply while fundamentals remain relative unchanged, hence we see value emerging. SERBADK (OP, TP: RM3.65) and WASEONG (OP, TP: RM1.40) are our picks for the exposure in Oil & Gas, especially to capitalise on the recovery of oil prices as well as to participate in the final leg of RAPID completion. ANNJOO acts as a proxy to capitalise on the rising steel price. AMBANK is more of a tactical play. We believe its valuation is undemanding and its weighting in the FBMKLCI has recorded a 5-year low. As a result, we think this is not justifiable for a decent growing bank, hence our pick for the quarter. TAKAFUL, on the other hand, has also shown good value after recent selldown. As for Gloves and Semicon sectors, we are pretty selective as we are fully aware of the valuation cycles for these sectors. Nonetheless, we still believe PIE and TOPGLOV could potentially offer further upside from here. Besides, these two stocks could stage a catch-up play (in price performance and valuations).

Latest numbers. Due to the recent changes in index constituents (inclusion of NESTLE & PMETAL and exclusion of IJM & WPRTS) as well as the demerger of SIME, we see significant changes in our earnings growth estimates. Our FBMKLCI FY17E/FY18F net earnings growth estimates have been revised from 2.6%/3.6% (vs. 0.4%/4.6% previously) to 9.8%/-0.2%. Changes in constituent aside, 2018 is still likely to see a lower earnings growth as opposed to 2017 due to normalised earnings growth in Banks, Power Utilities and Telcos, which are estimated to grow slower at 4.7%, -10.6% and 3.5%, respectively, as compared to growth rates of 12.6%, 19.9% and 11.6% for 2017. For FY19, our tentative earnings growth is forecasted at 4.9%. Again, our growth estimates appear to be more conservative than consensus numbers. Based on consensus numbers, corporate earnings growth rates are expected at 8.3%, 8.2% and 7.6% for FY17E, FY18F and FY19F, respectively.

End-2018 Index target @ 1,860! Based on the latest numbers and inputs from analysts, we are pegging our end-2018 Index Target at 1,860, implying 16.8x and 16.0x at FY18E and FY19E earnings. Note that our target PER is the 3-year historical average (of 16.8x) as per Bloomberg data. Based on the data, PER of FBMKLCI was traded in the range of 15.1x-18.7x. Meanwhile, our index target is also not far from the consensus index target of 1,850. Moreover, our index target also implies a market cap-to-GDP ratio of 0.94x for 2018 on the back of 2018 real GDP growth of 5%. Note that this ratio is achievable given that the ratio has been oscillating between the low of 0.9x to the high of 1.0x for the past five years. In fact, the ratio had traded higher pre and post GEs, judging from its historical pattern.

As for risks, investors should also realise and be ready to embrace the impact of interest rate hike should it materialised. Banks could see a knee-jerk rally for the short-term expansion in interest margin, but asset quality remains a concern for a longer run. Investors should also stay cautious over Oil & Gas players that have high borrowings for their assets. Property counters may see greater selling pressure before buying/trading opportunities emerging. Plantations sector may not see immediate rerating catalysts judging from the lacklustre price movement. In the meantime, we are also monitoring the Aviation and MREITs sectors very closely. Performance of airlines is highly dependent on crude oil prices, while for MREITs, higher risk-free rate normally reduces the attractiveness of MREITs.

Source: Kenanga Research - 2 Jan 2018