This article first appeared in Capital, The Edge Malaysia Weekly on December 25, 2017 - December 31, 2017
By Vincent Khoo
Head of research, UOB Kay Hian Malaysia
LOCAL equities kick-started the year with an upswing, as hoped, led by a steady influx of foreign inflows from 4Q2016, followed by expectations of an imminent general election; commencement of the Bandar Malaysia project; and Jack Ma’s visit to launch AlibabaGroup Holding Ltd’s regional distribution hub. There were also high expectations that China’s President Xi Jinping would visit Malaysia to promote its One Belt One Road project.
Investors saw small-cap Iskandar Waterfront City Bhd go double limit-up, which helped jump-start a feverish run and subsequent limit-ups of many small and mid caps. Such animal spirits have not been seen for years.
At the peak on March 20, daily trading volume on Bursa Malaysia spiked at six billion shares (1H2017 average: 2.8 billion), a three-year high. However, sentiment soured by May, after Ministry of Finance-owned 1Malaysia Development Bhd abruptly cancelled (at the eleventh hour) its Bandar Malaysia joint venture with China Railway Engineering (M) Sdn Bhd and Iskandar Waterfront Holdings Sdn Bhd.
Trading volumes have been much more subdued since then, and the FBM KLCI, FBM70 and FBM Small Caps traded sideways until November. Foreign equity inflow has been largely flattish since then. Sentiment has also been affected by a boardroom scuffle at Felda Global Ventures Holdings Bhd, the Inland Revenue Board’s tax collection overdrive — which could discourage business formation and growth — and Xi’s visit that did not materialise.
Malaysian equities should outperform in 1Q2018, but prospects will be less positive after the 14th general election (GE14), which is widely expected to be held in March or April. After bucking the global equity markets’ upward trend for over half a year, we expect the market to trend upward in 1Q2018, reacting to the ringgit’s 2H2017 outperformance and growing ringgit-based bank deposits since August. However, the upside may be limited by a combination of domestic and external headwinds. Domestically, apart from an uncertain post-GE14 policy landscape, the firm headline economic indicators are still not translating into strong domestic consumption and corporate earnings growth. Externally, equity investor risk aversion should rise in 2H2018 to reflect the cumulative effect of the withdrawal of liquidity in the US (the US Federal Reserve’s interest rate hikes and reverse-quantitative easing effect).
End-2018 FBM KLCI target of 1,860
While we peg an above-historical mean price-earnings multiple of 1.6 times to our target market, we assume that the premium will ease next year (+0.6 standard deviation versus 2017’s expected +0.7 SD). Our bottom-up FBM KLCI target is 1,860 points. We also expect market volatility to rise.
It is worth noting that at the time of the last general election, mid-caps (as proxied by the FBM70) performed in line with the FBM KLCI in the months running up to polling day and outperformed the index in the months after polling day.
Strategy and investment themes
We advocate a trading-oriented and mid-to-large cap-biased investment strategy for 1Q2018, before turning defensive thereafter. Market conditions still generally favour mid-caps, which continue to sustain superior earnings growth.
Investment themes include (a) the multi-year: (i) mega infrastructure (benefiting the construction and building material sectors); (ii) electronics and electrical (E&E) that benefit the outsourced assembly and test (OSAT) and electronics manufacturing services (EMS) sub-sectors; and (b) the situational: (iii) GE14 tactical picks; and (iv) tourism-related thematics.
Key events to watch out for next year are: (i) contract awards for the East Coast Rail Link and Kuala Lumpur-Singapore High-Speed Rail (project delivery partner); (ii) Genting’s opening of the 20th Century Fox theme park; (iii) Yong Tai Bhd’s opening of the Impression Melaka Theatr; and (iv) in the banking sector, the impact of the implementation of MFRS9. Malaysia is getting more entrenched in the global supply chain of the E&E sector, in OSAT and EMS, due to the rising competence of local test equipment makers and precision metal manufacturers.
Within the mega infrastructure theme, we predict some recovery of the large-cap construction counters’ stark underperformance in 2017, and continuing momentum from Urban China Blue Sky programme (benefiting steel companies).
Our top picks for next year are Bumi Armada Bhd, CIMB Group Holdings Bhd, Genting Malaysia Bhd and Tenaga Nasional Bhd for large caps. Mid-cap gems are Ann Joo Resources Bhd, Gabungan AQRS Bhd, Globetronics Technology Bhd, Hume Industries Bhd, Serba Dinamik Holdings Bhd, VS Industry Bhd and Yong Tai. Noteworthy defensive stocks include YTL Power International Bhd and Magnum Corp Bhd.
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