This article first appeared in The Edge Financial Daily on May 4, 2018

KUALA LUMPUR: The market, which has priced in a win by the incumbent Barisan Nasional (BN) government in the upcoming 14th general election (GE14), may see a knee-jerk selldown if the opposition emerges the victor instead, according to RHB Research Institute head of Malaysia research Alexander Chia.

“What the market has priced in right now is the incumbent government’s win. You can see from the foreign participation data. Foreign investors have been net buyers in the Malaysian stock market year-to-date (YTD), with [a net acquisition of] close to US$1 billion (RM3.94 billion).

“In the event of an unexpected victory for the opposition, you can expect to see a knee-jerk reaction in the market,” Chia told reporters after the launch of RHB’s Top Malaysia Small Cap Companies 20 Jewels 2018 book, its 14th edition.

An opposition victory will also raise concerns about the continuity of the government’s policy as well as other uncertainties, which will see the country’s risk premium increase, Chia noted.

He said economists have already questioned some of the reforms proposed by the opposition, such as the removal of the goods and services tax (GST) and how the expected collection of RM43.8 billion in the GST in 2018 could be replaced. “All these will lead investors to a ‘sell first, talk later’ perception,” he said.

And unlike an external trigger from global developments like the US election outcome and Brexit, which resulted in just a temporary selldown in the market before a rebound, Chia said the situation in Malaysia could cause an immediate selldown that lasts for at least a week after the election.

“Malaysia will be in unchartered territory if that happens,” he said.

On the severity of the decline, Chia said it will depend largely on the outcome, whether it is an outright opposition win, a hung Parliament, or a scenario where the incumbent retains power but with a simple majority after losing a few more states to the opposition.

With foreign investors and local institutions positioning themselves in a best-case scenario where BN wins with a simple majority, the FBM KLCI — a benchmark index for the Malaysian equity market which consists of the largest 30 companies by market capitalisation — hit its record closing price of 1,895 points recently. It closed at 1,851.8 yesterday, giving it a 4.1% YTD return.

This was in stark contrast to the small- and mid-cap space, which saw a decline of 14.1% YTD. At the same time, retail investors have largely taken a back seat in the overall market, as they see political risks arising from the upcoming GE14.

According to Chia, this has led to a divergence of unprecedented proportions — the FBM KLCI has outperformed the FBM Small Cap Index by over 18% YTD — compared with past periods prior to the general election.

Kong Heng Siong, a senior research analyst at RHB Research, also pointed out that the strong gain in the small-cap space in 2017 led to some profit-taking activities amid uncertainties ahead of the election. “Given the strong gain in the previous year, it makes sense for investors to profit-take before GE14,” Kong said.

However, once GE14 is over, assuming that there are no unexpected results, Chia said investors will return to focusing on fundamentals that are driving the market.

“You will expect investors to look for stocks that have been bashed down, stocks that offer superior earnings growth and typically, you would expect small-cap stocks, with a lower base, to offer greater and bigger earnings growth versus the large-cap names that are trading at high bases currently.

“We believe the small-cap index has retraced to a level that is now looking more attractive. If you look at my PE (price-earnings) band chart, the small-cap index has retraced back to quite close to the post-GST mean for the small-cap index, which is around 10.9 to 11 PE,” Chia added.

However, he believes the rest of the year will remain a trading year, with a lot more volatility in store with concerns remaining over external factors like the potential US-China trade war, as well as the US Federal Reserve’s monetary policy direction.

Nonetheless, with fundamentals of most small- and mid-cap companies remaining strong on the back of good gross domestic product growth while global trade remains robust, Chia believes the time is right for investors to revisit the small- to mid-cap stocks once the election risks subside.

Among the sectors he is positive on include banking, utilities, oil and gas, gaming, healthcare, construction, rubber products, non-bank financial intermediaries, timber and basic materials.

RHB Banking Group managing director Datuk Khairussaleh Ramli, echoed Chia’s sentiments and said small-cap stocks in Malaysia hold good potential with attractive propositions for institutional and retail investors, backed by the country’s strong economic fundamentals, robust global oil prices and a recovery in the ringgit.