• More volatility ahead. The expectation of a more persistent inflationary picture is forcing the US Federal Reserve to double down on its hawkish pivot, leading to rising fears of a policy error, and if the hoped-for soft landing can be achieved. Geopolitical risks are a wildcard that could further fuel the inflation genie. Domestic public finances remain fragile, amid populist priorities forced by an impending general election. Capital preservation is a key priority, centred on a core defensive posture coupled with a nimble trading mentality.

• Murky outlook. With the economic re-opening now fully priced in, the markets’ attempt to digest prospects for 2H22 and beyond are being hampered by limited forward visibility on business and macroeconomic conditions. Sentiment will remain fragile, given the potent cocktail of various external and internal macroeconomic threats, coupled with domestic political and regulatory worries.

• Risks tilted towards downside. With global central banks chomping at the bit to make right their misreading of the global inflation picture being the main course, accompanied by the potential for escalating geopolitical risks as an appetiser, a gloomy meal for risk assets seems to be on the menu. A protracted Ukraine crisis will underpin commodity prices and continue to fuel inflation in 2H22. The expectation of an inflation peak has now moved well into 2H22, even as multiple rate hikes loom. This, with the US Fed’s balance sheet deleveraging (QT) implies, at minimum, below-trend growth for the US and the global economy in 2023. Investors should also keep tabs on the 20th National Congress of the China Communist Party, which is expected to endorse a third term for President Xi Jinping. With consensus earnings yet to meaningfully adjust lower, the apparent valuation de-rating may be a mirage. We see downside risks for consensus earnings, if expectations for business conditions in 2023 continue to deteriorate.

• Strategy. RHB is not yet assuming the worst-case scenario as the base case. But the uncertainty of the severity of the slowdown and absence of clear upside risks will keep investors guarded and reluctant to take big bets, as forward valuations may be unreliable. This suggests that investors will be inclined to hold higher levels of cash and other liquid assets in the interim. Key investment attributes to focus on include companies with robust balance sheets, pricing power, ability to pass through higher costs, captive customer bases, and a strong ESG profile. We advocate a core defensive stance, coupled with a trading mentality. Captive domestic investment funds should seek attractive entry points (nibble on weakness) to build positions. We also see selective opportunities in the small cap space. We are OVERWEIGHT on banks, non-bank financial institutions (NBFI), oil & gas, healthcare, basic materials, gaming and technology. We slash our end- 2022 FBM KLCI target to 1,580pts (from 1,670pts) after ascribing a lower 15x (from 16x) P/E to FY23 EPS to reflect the less favourable operating environment going forward.

Source: RHB Research - 6 Jul 2022