AFTER peaking at 1,862 points in late April, the FBM KLCI plunged 10% to a six-month low of 1,691 points last Monday. However, the market correction seems to have improved fundamental valuations, which experts say may entice bargain-buying activity over the next few months.

On July 1, Fitch Ratings affirmed Malaysia’s long-term foreign currency Issuer Default Rating (IDR) at “A-” and local currency IDR at “A”, despite previously hinting that a downgrade was likely. This sparked a strong rally in equities on the same day, with the FBM KLCI gaining as much as 2% in intraday trading.

However, as the recent decline and subsequent strong rebound could also indicate greater volatility, investors may be well advised to pick sectors and stocks that are less directly correlated with the broader market. This is because they are largely immune to short-term fluctuations in the market, which is typically driven by sentiment.

In a recent note, Credit Suisse highlighted low-beta sectors as a guidance for making investments. Beta is a measure of the asset’s risk in relation to broader market movements. Low-beta picks, or sectors that are largely uncorrelated with the market, include plantations, industrial, consumer, telecoms and real estate investment trusts (REITs) (see chart).

Opportunities abound in mid-cap and blue-chip stocks now that prices have normalised, says the head of equities for Malaysia at a foreign investment bank. “Look for high-yield stocks that are above the FBM KLCI’s average. While those with low earnings multiples and consistent dividend commitments are better picks, companies with high capex requirements are set to be under pressure to maintain generous payouts if profits start to dwindle.”

While the FBM KLCI recorded a 6.8% quarter-on-quarter decline in 2Q2015, or one of the worst quarterly performances in years, a few stocks have stood out for their market-beating performance. In a July 2 note, Kenanga Research head Chan Ken Yew says downside risks remain intact going forward, necessitating the need for investors to choose defensive stocks.

“We prefer to look for high-yield stocks. Apart from traditional generous paymasters like REITs and the gaming companies, we also like stocks that are likely to pay final dividends in 3Q15. Berjaya Sports Toto Bhd (fundamental: 1.30; valuation: 2.10) is a good example,” he says.

In terms of capital gains, glovemakers as well as technology and consumer staples are clear standouts (see table). Utility stocks are also largely immune to the market’s decline, thanks to their resilient balance sheet and steady cash flow expectations.

The aforementioned sectors reported average gains of up to 50% over the first six months of the year, outperforming the FBM KLCI’s 2% gain in the same period. In terms of dividend yields and share price gains, top picks include Pharmaniaga Bhd (fundamental: 0.75; valuation: 1.70), Top Glove Bhd (fundamental: 2.50; valuation: 1.70), Malaysian Pacific Industries Bhd (fundamental: 1.80; valuation: 2.0) and YTL Power International Bhd (fundamental: 1.20; valuation: 2.40).

According to MIDF Research, foreign capital outflows from the stock market reached RM8.5 billion in 1H2015, compared with RM6.9 billion for the whole of last year. As at June 26, foreign investors had been net sellers for nine consecutive weeks, the longest stretch in two years.

“The short-term pressure will likely be neutralised as foreign liquidity outflows subside. We are already seeing a strong bullish reversal and would not be surprised to see the market perform even more positively in the weeks to come,” says MIDF Research head Syed Muhammed Kifni.  

Amid the negative sentiment and sustained selldown, the FBM KLCI is now priced at more reasonable levels compared with any point over the past two years. According to Bloomberg data, the index carries a forward earnings multiple of 16 times for the full 2015 financial year, which is well within historical averages.

The recent price correction has also ensured that yields remain respectable. The FBM KLCI’s current dividend yield stands at 3.24%, or unchanged on a year-on-year basis despite the worsening investor sentiment now. This is partly explained by the FBM KLCI constituents with fixed dividend commitments this year, as well as the federal government’s push to extract more dividends out of government-linked companies as part of its 2015 budget initiatives.

Moving forward, key concerns remain similar. A weakening ringgit and low commodity prices continue to hang over the Malaysian stock market, which remains the worst performer among Asean bourses.

However, with the FBM KLCI’s valuation having narrowed compared with its regional peers, there is still hope for a reversal of capital back into the stock market.

“We do not rule out a temporary bottom in the market as the recent price decline was steep in nature. We also believe that the decline in foreign shareholding in the FBM KLCI could be tapering off. Trading activity over the past few months points to an oversold condition, so a swift market recovery is still possible,” says Kenanga’s Chan.

This article first appeared in Capital, The Edge Malaysia Weekly, on July 6 - 12, 2015.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.