May 22, 2013

Malaysia GE13 Aftermath Market Strategy

Increased 2013 Year-end Target: 1,800 (from 1,750)
•  Political scenario post-GE13 is expected to remain stable
•  Post-GE13 ‘relief rally’ is not unexpected but must be anchored to fundamental considerations
•  FBM KLCI already re-tracked earlier lost ground relative to regional counterparts
•  Only rapidly rising expectations or sheer liquidity can sustain FBM KLCI well beyond current levels
•  Anticipate reduced political risks and slight upward-bias to earnings expectations
•  Hence adjust our FBM KLCI 2013 year-end target to 1,800 points

Election outcome is  not unanticipated. On  page 13  of our “2Q13 Outlook: A Nation Decides” dated 1 April 2013, we forewarned of the following outcome to the GE13:

Potential  unintended  consequence  of  the  GE13.  The  main  unintended  consequence  of  the  GE13  if  the  incumbent retains power, as implied by the opinion polls, is that the federal government would be meaningfully represented by only 2 ethnicities. In this instance, the Sarawak 2011 state election scenario may be repeated at the national level. It seems  that,  by  accident,  the  nation  might  be  heading  towards  a  two-race  system  as  opposed  to  the  intended  twoparty system. The possible impact on the people’s nation building will not likely be positive over the long term.
National reconciliation to counter possible negative impact. But we are thankful that the returning government promptly  takes  full  cognizant  that  efforts  should  be  made  towards  national  reconciliation  to  counter  the  possible negative impact of GE13 voting trends on the people’s nation building.

Expect  PM  Najib  Razak’s  party  position  to  be  safe... We  reckon  the  position  of  PM  Najib  Razak  as  the  head  of UMNO  (the  backbone  of  the  ruling  coalition)  will  be  secured  pursuant  to  the  just  concluded  election.  His  party managed to (i) improve on its parliamentary seat counts (GE13: 88 seats; GE12: 79 seats), (ii) wrest control of the state of Kedah, and (iii) single-handedly (UMNO won more than half of total state seats) retain control of the state of Perak.

…hence broad political scenario should remain relatively stable.
Hence the broad political scenario post-GE13 is expected  to  remain  stable.  This  is  despite  the  ruling  coalition  having  secured  fresh  federal  mandate  with  a  lesser overall  parliamentary  majority  (GE13:  133  seats)  as  compared  to  earlier  election  (GE12:  140  seats)  in  2008.  It  is important to note that for as long as the internal  cohesion within UMNO  remains intact, the stability  of the ruling coalition government can be highly assured.

FBM  KLCI  earlier  suffered  from  ‘pre-election  discount’...
Recall  that,  in  mid-January,  the  FBM  KLC  was  bashed down by  bouts of selling  likely triggered by jittery investors who were worried  the GE13 would  unfavourably alter the  political  status  quo.  Consequently,  the  local  benchmark  decoupled  with  the  rest  of  the  regional  markets attested by its gaping ‘pre-election discount’.

…but  already  re-tracked  lost  ground  relative  to  regional  counterparts,  and  more.
  Nonetheless  in  our  strategy report  dated  22  January  2013,  we  alluded  to  the  empirical  market  behaviour  that,  “While  the  local  market performance may temporarily decouple from the rest of the region, it would soon re-track the broad regional trend direction.”  In  its  true  fashion,  by  early  May,  the  FBM  KLCI  successfully  re-tracked  the  broad  regional  trend direction. Furthermore, the post-GE13 ‘relief rally’ has more than erased earlier lost ground relative to its regional counterparts.

Taming  the  undercurrent  is  a  priority.
On  the  surface,  the  just  concluded  GE13  has  resulted  in  only  slight alterations  to  the  political  status  quo.  But  beneath  the  seat  counts,  the  voting  trends  arguably  portend  to  a weakening  in  societal  cohesion.  Nonetheless  we  believe  the  overall  political  scenario  to  remain  calm  as  we  doubt not the government’s resolve and ingenuity to tame the undercurrent.

Status  quo  helps  to  keep  government  initiatives  on  track. On  the  economic  front,  the  maintenance  of  political status  quo  would  help  to  keep  on  track  the  multitude  of  on-going  as  well  as  planned  ETP  and  related  projects. Besides, the much clearer political visibility post-GE13 would also help private businesses to execute their plans as well  as  to  continue  on  planning  ahead.  Thus,  while  it  is  too  early  to  quantify,  we  are  foreseeing  a  slight  upwardbias  to  the  prevailing  consensus  of  corporate  earnings  expectations.  This  would  help  to  potentially  raise  the valuation-based ceiling of 1,790 points for the FBM KLCI in 2013.

Slight improvement in earnings may commensurately be reflected in market performance. Nonetheless a slight upward revision to earnings expectations alone may not be adequate to propel the FBM KLCI into an extended cycle during the remainder of this year. We are inclined to believe that the local benchmark would conform to a normal cyclical path hence ending the year circa 1,800 points at best.

Liquidity equation is a wild-card. Having said that, an abrupt change to the liquidity equation is a wild-card that may  upset  even  the  best  laid  out  fundamental  arguments.  At  this  moment  however,  we  are  assuming  that  the market liquidity situation is going to remain (i) supportive in quantity, but (ii) measured in intensity.

Investment  strategy. So  far  this  year,  it  has  been  a  rather  fruitful  2013  to  the  world’s  equity  market.  But  at  the same time, we are also wary of possible short-term cyclical correction after the roaring start to the year. Hence we continue to recommend a portfolio with combination of stocks with:
(i) inherent earnings quality,
(ii) good earnings growth potential, and/or
(iii) attractive valuation. On sectorial basis, we continue to like Construction, Oil & Gas, Healthcare, Power and Semiconductor.

Adjust FBM KLCI year-end target to 1,800 points.
An adjustment to our market target is warranted post-GE13 due to 
(i)  reduced  political  uncertainties,  and 
(ii)  slight  upward-bias  to  corporate  earnings expectations.  We  thereby adjust  our  FBM  KLCI  2013  year-end  target  to  1,800  points.  This reflects  a  PER13  of  circa  16.4x,  which  is  1.0 standard deviation above the 6-year average, starting from pre-Financial Crisis days. Earnings growth (adjusted) for 2013 is expected at 3.5%.