28 July 2010

KLCI back on a high, what now?

Malaysia Strategy
Back on a high, what now?

Malaysia appears to be a safe refuge for foreign investors for now given its strong domestic economy outlook (7.7% 2010E GDP growth JPM forecast) and relatively defensive characteristics, i.e., low volatility and weak correlation with major indices, during this bout of increased volatility in regional markets. In our view, short term uncertainties surrounding the US bank bill, Chinese growth, EU bank stress tests, and European sovereign funding have caused the KLCI to get squeezed upwards alongside other ASEAN markets, with the index now standing above 1350 (which is a 2010 as well as a 29-month high). We see evidence of foreign monies trickling in based on foreign incremental buying and ownership levels.

Looking for the positives. We recap the Malaysia-specific positive drivers we see over the coming months:-
  1. 2Q10 reported results which are likely to remain relatively robust (current earnings growth of 23% in 2010 and 16% for 2011);
  2. Unveiling of Part 2 of the New Economic Model document (expected in August) which will provide greater granularity on the structural reform policies needed to put Malaysia on a higher growth trajectory;
  3. More evidence of greater Malaysia-Singapore cooperation especially in Iskandar, South Johor; 
  4. More new IPOs to put Malaysia back on foreign investors’ radar screens 
  5. Positive sound bites on the 2011 Budget (14 October) and proposed pump priming agenda as the possibility of a snap general election may emerge in 2011 (although the elections need to only be held by March 2013).

The key risks:
  1. policy flip flops by the administration as reforms prove difficult to implement
  2. relatively high valuations with market PE of 14.3x and a 15.5% premium to MSCI APxJ which to some extent reflects the optionality of structural reform already.
Thus, despite the apparent low expectations of reform, the question is whether the market can further rerate without being accompanied by strong upward earnings revisions.
Our current end 2010 KLCI target of 1,400 based on a 14x forward PE target stands unchanged. Tactically, we remain positioned in cyclical sectors with our top picks being AMMB, Public Bank, Tenaga, Genting and IJM.

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