This article first appeared in The Edge Financial Daily on April 21, 2017

KUALA LUMPUR: Affin Hwang Asset Management Bhd (Affin Hwang AM) has advised investors to focus on “selective and judicious” stock picking in the small-cap space as the market is likely to enter into a period of consolidation.

“As we move into the second quarter of this year, our view is that the market will probably have to go through a period of consolidation. Don’t perceive it negatively because the market after having risen so quickly in such a short span of time, will typically need to go through a period of consolidation where markets will have to digest the outlook and earnings prospects of companies,” Affin Hwang AM chief investment officer David Ng said during a market outlook presentation yesterday.

Year to date, the FBM Small Cap Index is the top performer in Asia and emerging markets, rising 17.4% to close at 17,279.95 points yesterday, while the benchmark FBM KLCI Index has also performed well with a 6.1% growth to 1,741.61 points.

Ng said it is unlikely for the small-cap stocks to keep performing at such a rapid pace, advocating selective and judicious stock picking — to focus on fundamentals, cash flow and earnings.

While he opined that the global market remains volatile in the near future, Ng said pockets of opportunity continue to present themselves in Asia given the improved macro data in Asia including Malaysia.

“Corporate earnings growth is being revised up by analysts, the first rerating in the past five years,” he said, highlighting Affin Hwang AM’s three investment themes of reflation, domestic Asia and infrastructure.

The story of reflation would benefit the banking sector, insurance, industrials and commodity, while domestic Asia is good for consumer goods and tourism. The infrastructure spending story would put both infrastructure and construction companies in the limelight.

Specifically on Malaysia, Ng said from a relative standpoint, international investors will have strong arguments to increase their exposure to Malaysia based on the current stock valuations and the cheap ringgit.

He said the Malaysian market has typically traded at a premium to its regional counterparts, but that premium has either disappeared or been compressed, deeming the valuation of Malaysian stocks as “fair”.

“There is a high level of bullishness in Malaysia based on those arguments. It’s very important that the market has to digest the performance in the first quarter and for the corporates to deliver,” he said.

This was reflected in the cumulative foreign purchase on Bursa Malaysia up to RM6.63 billion year to date.

In line with Ng’s view, RHB Research Institute Sdn Bhd director and head of Malaysia Research Alexander Chia said the time for index-investing has past, and it is crucial for investors to pay attention to smaller-cap companies with good management and strong earnings track record in order to provide superior returns.

He was speaking during the launch of the 13th edition of the RHB Top Malaysia Small Cap Companies 25 Jewels 2017 book yesterday.

Chia believes now is a good time for investors to take a look at small-cap stocks in the market despite the strong rally seen in the first quarter of this year. However, he stressed that it is important to focus on the fundamentals of the companies rather than purely on sentiment.

Chia cited potential market risks include external factors such as the uncertainty in US President Donald Trump’s policies, potential US-China trade dispute, rising geopolitical tension, as well as upcoming elections in Europe.

Earlier at the book launch, RHB Investment Bank Bhd said it has a sterling track record with over 56% of the counters featured in the 2016 edition of the book recording positive returns, as well as outperforming the FBM KLCI by an average gain of 50%. The 2017 edition of the book shows companies with an average price-earnings of 17.8 times and an average return on equity of 16.9%.

The book is part of a larger RHB Asean Small Cap Compendium that annually lists stock investment ideas from the bank’s research houses in Malaysia, Indonesia, Singapore and Thailand.