In our last strategy piece – Rain or Shine, the Market Goes On (Jul 2019) – we highlighted that we expected the market to register a turning point sometime during the period between Dec 2018 and Sep 2019. Indeed, we may be finally closing in on a bottom after several quarters of earnings downgrades. And, an expected sequential earnings recovery (albeit mild) in the 2H19 should serve to lift the KLCI in a seasonally strong quarter. We see 7% earnings growth next year on the back of modest commodity price recovery, a pick-up in loan demand post NIM compression at the banks and potentially, a resolution on the US-China trade war. However, anxieties over earnings disappointments, the continuous reduction in Malaysia’s weight in major global bond and equity indices and falling interest rates globally, will likely see defensive yield seeking to be the dominant investment style in the near term. We see a mild upside in the year-end target to 1,642 points in the FBMKLCI. Our 4Q19 top picks are ABMB (OP; TP: RM3.45), BAUTO (OP; TP: RM2.75), CARLSBG (OP; TP: RM27.15), CIMB (OP; TP: RM6.45), HARTA (OP, TP: RM5.85), KOSSAN (OP, TP: RM5.25), MISC (OP, TP: RM8.80), MPI (OP; TP: RM12.10), PWROOT (OP; TP: RM2.30), and TAKAFUL (OP, TP: RM6.85).

Forward earnings gaining momentum: The 2Q19 earnings report which concluded at the end of August led us to adjust our FY19E/FY20E earnings growth rates to - 3.1%/+6.5% from -2.6%/+4.6% in the previous quarter (and compared to current consensus +3.6%/+6.6%). Our earnings expectations are slightly below consensus’ 2019 and 2020 estimates by 1.2% each. We expect 2H19 to be better than 1H19 with a sequential earnings growth of 5% driven by among others, higher CPO price of fRM2,100 versus RM1,950 achieved in 1H and higher sequential earnings at some of the larger banks, Given that our earnings expectations are just moderately below that of consensus, we do not expect adverse market impact if earnings track our expectations in the next 3Q reporting season in November.

4Q Market Outlook – Remember, 4Q is a seasonally strong quarter: History shows quite convincingly that 4Q returns tend to be positive. In the past 20 fourth quarters, 14 turned out to be positive quarters versus just 6 negative ones. And, in a generally downbeat year dogged so much by bad news - from concerns over foreign funds outflows due to Malaysia’s continually diminishing weighting in major global indices, moribund commodity prices on which Malaysia is dependent, heightened risk of global recession with a resolution to the US-China trade tension seemingly so distant, government debt levels, down to fears of persistently weak corporate earnings, it may not take much to get the market going again. Indeed, the insidious nature of such fears has led the market back down to its 5-year historic mean valuation PE of 15.8x (on 12-month forward earnings) alongside recent earnings downgrades. Based on our individual stocks target prices, our bottom-up constructed target level for the FBMKLCI of 1,687 points sits at 2SD above mean which admittedly, looks rich. Taking the average between current mean value levels of 1,597 and 1,687, we arrive at 1,642 – our year-end target. This level represents 16.3x, or 0.8SD above mean. On consensus earnings, this would be 16.1x. See table below:

Source: Kenanga Research - 2 Oct 2019