Brokers Write

VINCENT Khoo

Head of research, UOB Kay Hian Malaysia

Favouring a large or mid cap-centric strategy in 2020

Having earned the reputation of being probably the only unloved Asian equity market in 2019, we expect the FBM KLCI to end the year with a whimper and enter 2020 with high caution. Sentiment remains eclipsed by concerns of domestic political uncertainty and poor policy implementation and domestic consumption is slowing in reaction to inadequate pro-growth policy actions and amid the effects of a protracted US-China trade war. Most of the expected tangible benefits from the promised pro-growth government policy shift in 1H2019 did not materialise and market sentiment has been particularly damaged by the snail’s pace follow-through on various reaffirmed and revived mega and e-government projects, mixed signals from the delayed takeover of Gamuda Bhd’s toll roads by the Ministry of Finance and slow thawing of the foreign worker hiring policy/process. The proposed Axiata-Telenor merger, which was much celebrated by the investment community, was derailed, presumably partly attributed to political intervention. Adding insult to investors’ injury towards end-2019, Tenaga Nasional Bhd was served with a shocking tax claim by the Inland Revenue Board of RM3.98 billion (eclipsing an earlier tax claim that TNB has been contesting) and Magnum Bhd was served with a RM182.8 million assessment (recall that Magnum earlier in the year settled a tax dispute of IRB’s RM476 million claim by paying a RM100 million penalty). Naturally, domestic-oriented businesses have further choked down their reinvestments in the country, which further retarded domestic consumption.

We brace for a more volatile year in 2020 as myriad domestic political concerns affect sentiment — the power handover within the ruling Pakatan Harapan coalition, friction within the coalition and within PKR and growing concerns that PH would likely be a one-term government. The unhappiness of the people was reflected in the recent landslide by-election loss of a PH-held parliamentary seat. As we expect investor risk aversion to Malaysia to further elevate in 1H2020, the FBM KLCI could touch a year trough in 1H2020 in its theoretical trading range of 1,535 to 1,660 points (-0.5 standard deviation to +0.6SD of mean price-earnings ratio). Nevertheless, we expect the FBM KLCI to trend upward in 2H2020 to end the year at the 1,650 level (based on +0.5SD of mean PER valuation) as, by then, mega projects would achieve some level of activation and US-China trade tensions would have eased.

Positively, the country’s macroeconomic fundamentals remain stable and there is also better visibility for large caps to deliver positive returns after four years of earnings doldrums, led by better earnings visibility in the plantation sector (following the spike in crude palm oil prices), stability of the banking sector (at worst, one last policy rate cut) and an adequately high crude oil price. We expect the FBM KLCI to eke out 6% growth in 2020, led by the plantation, gaming, healthcare and oil and gas sectors.

Accordingly, we advocate a strategy that embraces both defensive stocks and promising growth sectors or companies that are not beholden to government policies or actions. We expect 2020 to favour a large/mid cap-centric strategy.

Thematically, we continue to ride major investment themes such as the CPO price recovery and trade diversion themes, followed by the many O&G-related themes (strong global demand for floating production storage and offloading and LNG vessels, moderate rise in Petroliam Nasional Bhd’s upstream capital expenditure and regional decommissioning) and niche alpha plays within the e-government, environmental, social and governance and mega infrastructure sectors.

We are “overweight” on the plantation, gaming, healthcare and technology (electronics manufacturing services) sectors, as well as quality yield stocks (for example, real estate investment trusts) and selected stocks in the O&G and building material sectors. However, we are tactically “underweight” on the structurally challenged cyclical stocks that are indirectly impacted by the US-China trade war.

Andrew San

Head of equities, Amundi Malaysia

Challenges aplenty but there are opportunities for long-term returns

We see the local bourse entering into a low growth phase over the next few years as our base case, given that several outstanding issues need to be dealt with before sustainable higher growth potential can be achieved.

Market participants

That government-linked investment companies (GLICs) have a heavy representation within the domestic equities space is an issue that has been well known for some time. While they have provided relative price stability for the markets, especially during uncertain times, there are longer-term impacts — liquidity is sapped out of the system, discouraging other domestic and foreign investors from participating in the markets.

While the government acknowledges this issue and looks intent on scaling back GLIC market ownership for the long-term health of the market, any overhang in sentiment from a potential stake selldown would naturally dampen any potential price gains for key market constituents over the shorter term. The pace at which such reforms takes place would determine how soon the market improves its liquidity structure and the diversity of participants within the market. It is worth noting that increasing the free float within market constituents would lead to increased representation in regional and global indices, hence, a greater attraction of foreign fund flows.

Market constituents

In addition to increasing market liquidity, how corporate earnings are to grow over the next few years needs to be considered. This is particularly pertinent given that current market valuations are not cheap at 17 times 2020 price-earnings ratio (PER20) consensus, with corporate earnings growth needed to avoid further market declines. Representative of the Malaysian economy, the domestic equity market consists of largely “old economy” companies with earnings that generally tend to be driven by commodity prices (palm oil, crude oil) and asset-heavy investments (construction, property development, telecommunications, utilities). The IT sector represents only 2% of the market while many industrial manufacturing companies tend to survive on low-cost manufacturing rather than research and development innovation. Therefore, until there is a shift in focus towards higher growth, human capital-intensive businesses within the economy, market earnings growth should generally remain low for the foreseeable future (with commodity prices providing some volatility) — the quality of education is the key enabler for this shift.

Policy and implementation

The level and quality of growth in the stock market, we believe, are dictated by whether there will be an improvement in liquidity and corporate earnings over the longer term. Both factors are dependent on the strength of the policies initiated and implemented by the current government. This is especially the case, given that Pakatan Harapan was voted into power under the premise of change. However, given the current circumstances, our base case of a low market growth trajectory over the next few years remains for now. The next two years will be key in determining whether any reforms take place as we approach GE15, which may or may not warrant us revisiting our base case.

Given our market structure, in which liquidity is tightly held domestically, we find that wider macroeconomic themes resulting in foreign fund flows have dictated market movements over the 10-year period. These factors consist of:

1.     Global economic recovery post the global financial crisis 2008 (dictating the domestic market recovery from 2010 to 1H2011);

2.     Heightened oil prices and subsequent correction 2012 to 2014 (which saw the beginning and end of the bull run in the Malaysian market);

3.     US rate hike, ringgit weakening and the 1MDB scandal in 2015/16 (as the US increased interest rates toward the end of 2015, this coincided with news of the 1MDB scandal, resulting in the dramatic weakening of the ringgit and an exodus of foreign investors, culminating in tepid market returns during the two years);

4.     Oil price recovery 2016 to 1H2018 (this provided a welcome recovery to the markets after the tumultuous years that preceded it);

5.     GE14 and post-election 2H2018 to the present (a largely unexpected event, perceived political risk is now increased with greater concerns coming from policies that this new government has generally yet to announce and implement across many of the ministries. This uncertainty has led to a consistent outflow of foreign funds, and with it a general decline in the index since mid-2018).

Despite such challenging market dynamics, we believe the domestic equity market provides many attractive opportunities to earn good returns over the longer term. As witnessed by our approach to investing, we are able to generate attractive returns through being disciplined, selective and benchmark-agnostic with our investments, preferring to maintain a balanced exposure between dividend yield and growth stocks. It is also important to avoid sectors and names that are facing structural headwinds, just as we have done. As it stands, we have a longer-term favourable outlook towards the real estate investment trust sector, along with niche banks, consumer staples and fibre telco players while we look to avoid wireless telco players, consumer discretionary and property development companies.

Dr Tan Chong Koay

Founder, Pheim Asset Management

A better year ahead

Malaysia was one of the worst-performing markets with a year-to-November return of -8% due to a slowdown in earnings growth that made the equity market less attractive to foreign investors. However, small-cap stocks have done well — particularly those in the technology, energy and construction sectors, showing a return of 18% for the same period.

The key event that affected performance was definitely the US-China trade war. The market had a good run-up in 1H2019, as investors anticipated a major trade deal in May. When the deal failed to materialise and tensions increased, the market corrected significantly. As we head toward the year end, the market is again anticipating some sort of trade deal, at least before the US election in 2020. Both the US and China have indicated desire to strike a “Phase 1” agreement. We expect the market to be supported by the hope of a trade deal and a low interest rate environment.

Since the trade war started in March 2018, until Nov 30, the Hang Seng has declined 16%. In comparison, the US was doing much better with Dow Jones up 10% during the period.

Protests began in Hong Kong on March 22, when an extradition bill was tabled in the legislature. These escalated following the second reading of the bill on June 12. The bill was later withdrawn but the protests have continued, though the intensity appears to have moderated following local council elections in late November. From June 12 to Nov 30, the Hang Seng has shed 5%. Property stocks in Hong Kong were hit particularly hard. Swire Pacific dropped 27% and Wharf Real Estate Investment, 19%. Offsetting these losses, however, were gains made by some big Chinese companies on the Hang Seng Index, such as Sunny Optical (74%) and CSPC Pharmaceutical Group (51%). Overall, while the Hong Kong protests have exacted a fairly heavy toll on the Hong Kong economy, they have not had a significant impact on the markets of other countries in the region.

The market is expected to be supported by expectations that a US-China trade deal of some sort will be reached before the US election. However, the trade war has caused protectionism to grow across the globe, from the US and China to Europe and India. Unilateralism and a reversal of globalisation will be a risk to economic growth.

As 5G becomes more widely adopted, the areas that concern Industry 4.0, which include technologies such as 5G, artificial intelligence (AI), Internet of Things (Iot), cloud computing and automation — which will push industries and businesses to greater efficiency, productivity and capability — will offer opportunities for stock picking.

We also think that with greater connectivity, the proliferation of data sharing and increased usage of technologies in our daily lives and, better yet, in an industrial and business context, there will also be increasing need for cybersecurity. Technology users — be they individuals, governmental entities or business enterprises, large or small — will require cybersecurity products, services or systems that will enable them to secure their data and systems and ensure their operational safety, reliability and continuity.

Another area we cannot ignore is renewable energy, be it solar, wind, hydro, geothermal or any other energy that reduces the dependency on cheap fossil fuels. What is critical is how the cost of generating and storing sustainable energy can be lowered so it becomes viable for economies and businesses to apply. And battery technology is also expected to grow with the increased adoption of batteries in electric vehicles. Adopting renewable energy is also a step towards Impact Investing.

On the other hand, we think Malaysia’s plantation sector may experience earnings growth following the recovery of the crude palm oil price. CPO hit the lowest level of around RM1,800 per tonne in November 2018 and rose to RM2,800 in December 2019. We think that if the CPO price maintains at the current level, plantation companies will post better year-on-year growth in the first nine months of 2020, so, a rerating of the sector is likely.

Oil and gas service providers are expected to show further improvement moving into 2020, as a result of an increase in Petroliam Nasional Bhd’s upstream spending. According to Petronas’ outlook for 2020, jack-up rigs are expected to increase to 17 to 19 from 16 or 17 in 2019. However, a significant rally this year may cap further upside potential in 2020, unless earnings continue to surprise on the upside.

As the global economy continues to face downward pressure, central banks across the globe are expected to maintain or reduce interest rates to boost the economy. In the context of an economic slowdown, bank shares may continue to face downward pressure in anticipation of slower growth, despite the interest rate cut.

In terms of stocks to avoid, we would definitely avoid companies with high gearing, negative earnings growth and poor management.

Generally, I think 2020 may be better than 2019. If global interest rates remain low, asset prices, including stock markets, will likely stay high. As the US presidential election draws nearer, the possibility of more good news to boost the US economy, including a US-China trade deal, would be positive for the market.

Ray Choy

Regional head of treasury, CIMB Bank

The transitional year

Growth will likely sustain in 2020, but it will be marginally weaker. This assumption is supported by the declining probability of a US recession (Cleveland Fed model), which declined from 46% in August to about 30%, suggesting that the risk of a major economic slowdown is less than even. Furthermore, this underlines the fact that the recession risk, which was often discussed since mid-2019, was largely overblown. US employment continues to improve and this attests to the strength of the underlying economy. Generally, followers of the Consumer Price Index argument believe that this suggests there is much left to be desired, although technological changes, supply-side reconfigurations and competitive pressures suggest a need to avoid over-interpreting growth through inflation indicators.

The other argument for a greater slowdown in global growth stems from proponents of the economic cycle theory. However, the cycle appears to have extended and the prolonged flattening of global yield curves appear to corroborate this idea. In the past, peak-to-trough term structure spreads used to suggest a lifespan of about half of the full economic cycle, in the ballpark figure of six years. Today, not only has the flattening of the yield curve extended to more than twice that, but the flattening towards negative term structure spreads are not indicating recession risk as they used to. Part of this distortion is attributable to a glut of investable liquidity, central bank repurchases of bonds and risk-averse sentiment. The final point remains nebulous and a policy panacea to that remains elusive amid the ageing demographic of the investing world.

The narrative in 2019 was one of dovishness but, increasingly, 2020 will likely be a narrative of “transition”. This refers to the transition of whether interest rates need to be cut further or remain the same. There is also the transition as to whether exporting economies, particularly China and other Asian economies, have been severely affected by the Trump-induced trade war. At this point, activity levels (for example Purchasing Managers Indices and trade surpluses) appear to be in a phase of bottoming out and have coped pretty well, and it appears that trade regionalism has led to a transfer of China’s current account balance surplus to the other Asian economies. There is the risk that naysayers are proven wrong and have missed the contribution of creative destruction as an upshot of Trump’s trade disruption.

On the trade war, the disconnect between imputations in economic growth and sentiment from rhetoric will imply see-sawing markets within a reasonably palatable range. This is because trade negotiations tend to be back and forth and there is little incentive for Trump to give up his bargaining chip by coming to terms with a comprehensive and complete resolution. Trump is also unlikely to damage markets to the extent that it would impact results of the 2020 US election. Hence, trade wars will remain embedded not just in US economic policy, but also co-opt foreign policy, such as the manifestation of the Hong Kong Human Rights and Democracy Act 2019. This war for hegemony will see other variants, such as through non-tariff barriers or sanctions on banks that facilitate transactions with US enemies.

Based on my reading of global and domestic growth forecasts (excluding countries plagued by civil strife and country-specific risks), it seems that most forecasts are pointing to a very slight slowdown in 2020 and, hence, most forecasters have changed their tune, expecting no changes in US interest rates by 2020. As the pendulum swings the other way, a major theme of transition would reflect on interest rates as markets shake off the dust of dovish monetary policy towards more neutral positions at central banks.

Therefore, should it even happen, a further rate cut in the US or elsewhere (including Asia) is likely to be an insurance, loaded with the “one and done” language. This would also lead to the abovementioned shift from “dovish to neutral”, hence, the 10-year US Treasury yield will likely exceed 2% in 2020, and local currency bond markets will likely follow this cue. However, due to the expectation of a mild move in the global interest rate policy setting, financial markets are likely to move within a range without a strong direction in either way. Tactically, markets will then focus on adopting some credit risk for higher yields, taking into account this “transition”. A rise in yields due to risk-on sentiment will be capped by markets’ disappointment over the progress of trade talks and the partial nature of economic improvement. On the other hand, a decline in yields due to risk-off sentiment will be limited by pressure for improved trade talks alongside US pre-election cheer. On currencies, this would translate into potentially some US dollar strength as the dovish narrative dilutes, which presents some very mild risks for non-US currencies. Due to the potential stability of interest rates in 2020, the carry trade will be important, and this may see an adoption of both credit risk as well as investing in higher yielding currencies. However, to clarify, it is likely investors will seek yield but avoid being “overweight” on the non-investment grade space and, across asset classes, there will be caution investing in the aggressive, high beta space as risk sentiment continues to meander near current levels.

Due to limited directional drivers from the global front, domestic developments will remain pertinent. These country-specific risk factors are likely to include: (i) views from private supranational agencies such as rating agencies and index providers; (ii) political succession planning and cabinet reshuffling; (iii) the size and use of fiscal policy amid a gentle growth slowdown; and (iv) central bank policies outside the realm of interest rates.

Ray Choy is regional head of Treasury and markets research at CIMB’s Treasury and Markets division. The views expressed in this article are entirely those of the author and do not necessarily reflect the views of the CIMB Group or its subsidiaries.