We presented our 3QCY22 market outlook and strategy to 16 pension, unit trust and insurance funds over two weeks from 4 to 15 July 2022. Our virtual sessions were attended by more than 100 fund managers and buy-side analysts. The gist of our market strategy and the feedback from our audience are as follows:

Inflation Fears vs. Recession Fears

Our thesis: While the key focus of our 3QCY22 market strategy is how and what to invest in amidst high inflation, there has been a shift in investors’ focus from inflation to recession in recent weeks (manifested in the US 10-year Treasury yield falling rapidly to as low as about 2.8% at one point from the recent peak of about 3.5% as investors sought refuge in the safety of the US Treasury bonds).

However, we are not prepared to go there, i.e. recession, as yet. Our rationale is two-fold:

1. Under a recession scenario, we find it difficult to make ourselves useful as a broker, as the only way investors could possibly beat the market is to hold cash. While conventional wisdom points to seeking refuge in consumer staples, utilities and healthcare services, we have limited listed companies in these segments (and some of them, especially the ones in the utility space, do not quite offer the required defensiveness given their company-specific issues); and

2. We believe it is equally risky to position one’s portfolio for recession as the recession may be averted, and even if it does happen, it could be shallow and brief. Investors could be caught short in those situations.

Client feedback: We sensed that most of our clients are largely in the “wait-out-the-storm” mode, with only a handful showing interest in our buy call for plantation and tech names, while our buy call for telco stocks garnered little interest (we hold the view that telco stocks - currently trading at historically low depressed valuations—are poised for a rebound when the dust finally settles on the 5G rollout).

Questions were raised if the market and most stocks are already trading at bottom valuations, and hence one should start nibbling or accumulating for an eventual recovery. We believe it is pre-mature to “buy the market” (vs. sector picking and stock picking) as the market could still go another leg down if a global recession does play out. In other words, we think the market has yet to fully price in a recession.

Global Market Selloff Not Unjustified

Our thesis: The global market selloff is consistent with the steep monetary tightening paths laid down by policy makers globally, especially the Fed. We take cognizance of the significantly more aggressive rate hikes by the Fed - both in terms of quantum and pace - during the current cycle (i.e. 375 bps from 0.25% to an assumed terminal rate of 4.00% over 12 months, vs. only 225 bps from 0.25% to 2.50% over 37 months during the previous cycle) and a massive balance sheet reduction (i.e. by an assumed USD3t from USD9t to USD6t, vs. only USD650b from USD4.5t to USD3.8t during the previous cycle).

Client feedback: Lamenting over the dent inflicted on their portfolios by the market selloff, our clients nonetheless do not disagree with our view above (apparently, funds that are tracking the FBM KLCI closely have suffered less vs. those that are not). Questions were raised if our market has bottomed with the FBM KLCI currently trading at 13-14x its CY22 earnings. Our response was: historically, the FBM KLCI rarely traded at low teens in terms of PER over a prolonged period of time, as such, putting aside the recession risk (a big caveat though), one can argue strongly that the FBM KLCI has bottomed at the current level. This jives well with our end-2022 FBM KLCI target of 1,610 pts based on 16x 2022 PER, of course, barring a sharp and synchronised deterioration in the global economic outlook in 2H 2022.

We See a Bright Spot in EM

Our thesis: Emerging Markets (EM) assets, especially equities, may not fare too badly despite the rate hike cycle in the US as the current rate hike cycle in the US coincides with a super commodity cycle. While commodity prices in general have came off their recent peaks, they remain elevated by historical standards. This augurs well for the generally commodity export dependent EM. Also, on a relative basis, EM now appear a safer bet vs. Europe given the Russia-Ukraine war situation.

Client feedback: There are concerns that if the global economy does slip into a deep recession; the generally less wealthy EM will be more vulnerable than the generally wealthier Developed Markets (DM). We concur with this view as in a deep recession scenario, commodity prices would plunge (due to significant demand destruction) and as such EM would see their key sources of income being substantially eroded. However, a deep global recession is not our base-case scenario.

Our Top Buys Largely Premised upon Pricing Power

Our thesis: Pricing power enables industries and companies to pass on higher input costs and defend their profit margins amidst high inflation. We are unable to find any companies with pricing power on a global scale (in the likes of Apple, Microsoft, Amazon, etc.) listed on Bursa Malaysia. However, there are no lack of “pricing power near proxies”, which we define as “companies that are able to maintain margins despite rising cost pressures”. We see them in banks and telecommunications players (service-based industries that are able to keep pressures on wages—their largest cost component—at bay), suppliers to multinational companies with pricing power, predominantly in the tech/consumer electronics space (which means there are less cost pressures to be passed on along the supply chain) and providers of private healthcare (a low “price elasticity of demand” for their goods and services). We also like commodity producers, i.e. plantation and oil & gas as we expect CPO and crude oil prices to stay elevated in 2H 2022. We hold the view that construction stocks will do well ahead of the 15th General Election (GE15).

Client feedback: Our clients generally have no qualms about owning banking stocks (the question is probably if they should own more). Our buy calls on the plantation and tech sectors are generally being viewed as contrarian calls. For our bullish call on the plantation sector, the concern that stands out the most is the lack of catalyst amidst weakening CPO prices. Our explanation is simple – we see plantation as a defensive play. Our rationale is three-fold: (1) resilient demand (steady consumption growth coupled with bio-fuel mandates globally) but fragile supply still (labour shortage in Malaysia and multiple downgrades of US soybean acreage); (2) plantation companies being land-rich and cash-rich; and (3) compelling valuations both in terms of PER and P/B.

For tech stocks, some clients are concerned about the supply chain disruption (and hence the potential for earnings disappointments in coming quarters) and potential further valuation compression (on a higher terminal rate).

For construction stocks, the concerns are mainly on the tight fiscal position of the government, given its massive subsidy programme. We believe that this could be mitigated by roping the private sector to provide funding for public infrastructure projects via Public Private Partnership (PPP) or Private Finance Initiative (PFI) but we are mindful that the private sector does not enjoy cheap cost of fund as per the government.

We sensed interest in consumer stocks among some clients. While we acknowledged their defensiveness, particularly for consumer staples, we believe margin compression is inevitable as players exercise restraint in hiking selling prices (in order not to hurt demand and defend their market shares) which means they have to absorb a significant part of higher input cost.

Our Sector Recommendations, Overall Top Picks and Top Shariah Picks are reflected in Exhibits 1 to 3.

Source: Kenanga Research - 18 Jul 2022