KEY POINTS

• Global Growth Prospects Fading
  • Europe is likely to fall into a mild recession in 2012, with Gross Domestic Consumption (GDP) estimated to contract by 0.6% year-on-year.
  • US economy will grow by 2.2% year-on-year in 2012, after taking into account spillover effects from a probable European recession.
• Malaysia’s GDP to grow 4.0 - 4.5% year-on-year in 2012, lower than the government’s projection of 5.0 - 6.0%.
  • Private Consumption to grow at 6.0 - 6.5%, lower than the government's projection of 7.1% in 2012
  • Exports growth, especially on E&E products (comprising around 35% of total exports), are likely to suffer on account of the slowdown in the global economy.
  • A bright spot would be the export of commodities such as palm oil which we expect to remain stable.
• Bank Negara Malaysia will likely cut the Overnight Policy Rate by 25 – 50 basis points in 2012 if economic conditions worsen significantly.
• the forward PE ratio for FBM KLCI is estimated to be 15.1X and 13.3X respectively (as of 13 January 2012).
• we estimate its upside potential by end-2013 to be around 20.1% (as at 13 January 2012), which is not as exciting as other markets such as the those in North Asia.
• We recommend long-term investors to underweight the Malaysian equity market and consider increasing their exposure to other countries and regions that offer higher upside potential such as Greater China (China, Hong Kong and Taiwan) and Global Emerging Markets (GEMs).

Global Growth Prospects Fading

The European debt crisis, which would inevitably spread to Italy and further weigh on France, will continue to dampen investors’ sentiments. Countries such as Italy and Greece which require bigger help from the European Financial Stability Facility (EFSF) will have to commit to stricter austerity plans and incur government spending cuts. This will significantly reduce government spending in Europe on aggregate. In addition, as business confidence declines in Europe, business expansion and regional exports are likely to decline as well. Putting all these negative factors together, we believe that Europe is likely to fall into a mild recession in 2012, with Gross Domestic Consumption (GDP) estimated to contract by 0.6% year-on-year.

While the European debt crisis continues to hog the headlines, worries of a “double-dip” recession in US have not yet subsided. US unemployment rate remains high with stagnant job creation and generally weak economic results in 2011. As such, we believe that the US economy will grow by 2.2% year-on-year in 2012, after taking into account spillover effects from a probable European recession.

Malaysia Economic Growth is Easing but Remains Resilient

Despite our expectations for Europe and US, Malaysia economic growth is expected to remain resilient, supported by domestic factors such as domestic consumption as well as private and government investments. This is in light of the weak external demand which will likely dampen Malaysia’s exports growth, especially for electrical and electronic (E&E) products.

In Budget 2012, the Malaysian government projected a 7.1% year-on-year growth for private consumption in 2012 (the government estimates 2011 growth at 6.6%), while our in-house view suggests a more conservative 6.0 - 6.5% growth. We believe that a slower growth is inevitable as consumer spending is likely to moderate, with consumers being thriftier in view of an uncertain economic outlook. This is evidenced by the Consumer Sentiment Index (CSI) which has remained flat since 1Q 2011 (see Chart 1). The mitigating factors to our projected decline in private consumption growth are the nation’s relatively high savings rate and the general increase in household income.

Private investment in 2012 will likely be driven by Private-Public Partnership (PPP) Projects under the Economic Transformation Programme (ETP), although this will be partly offset by lower business spending due to economic uncertainty and lower demand coupled with an increase in idle capacity. We believe that the decline in Business Confidence Index in 3Q 2011 is the start of a downward trend (see Chart 1).

CHART 1:

Public investment is likely to remain robust in 2012, driven by PPP Projects as well. Despite risks from a slowing external environment, we do not expect the government to implement pump-priming measures as seen during the global financial crisis in 2008. This is because the government is bogged down by its finances, given the high budget deficit of 5.7% (see Chart 2) and rising government debt-to-GDP ratio of 53.8% in 2011 (see Chart 3). Moreover, we think that it is quite difficult for the government to reduce its current budget deficit, as most of the deficit is contributed by operating expenditure such as emoluments and subsidies (see Chart 4).

CHART 2:

CHART 3:

CHART 4:

Exports growth, especially on E&E products (comprising 34.7% of total exports as of September 2011), are likely to suffer on account of the slowdown in the global economy. A bright spot would be the export of commodities such as palm oil which we expect to remain stable. Overall, we expect Malaysia’s GDP to grow 4.0 - 4.5% year-on-year in 2012, lower than the government’s projection of 5.0 - 6.0%.

Bank Negara Malaysia May Cut Overnight Policy Rate

The slowdown in economic growth and demand will likely lead to lower inflation rates. While the government has said that it plans to reduce subsidies for fuel, power tariff and industrial gas every 6 months, we believe that this would not come to fruition given the impending general election. With lower inflationary pressures, Bank Negara Malaysia (BNM) will likely cut the Overnight Policy Rate (OPR) by 25 – 50 basis points in 2012 if economic conditions worsen significantly (see Chart 5).

CHART 5:

Malaysian Equity Market Outlook in 2012

For the earlier part of 2011, we have utilised consensus earnings forecasts as a basis for our estimates. Our economic outlook now differs from the consensus, and we have changed our forecasts accordingly. Unlike the consensus, we are expecting a mild recession in Europe and slower growth in the US, which has negative implications for corporate earnings in global markets. As such, we have lowered 2012 and 2013 corporate earnings growth forecasts to 8.3% and 12.9% respectively (see Chart 6). Based on these conservative estimates, the forward PE ratio for FBM KLCI is estimated to be 15.1X and 13.3X respectively (as of 13 January 2012). These are lower than its fair PE ratio of 16.0X and indicate that the Malaysian equity market is undervalued.

CHART 6:

Nevertheless, as the Malaysian equity market has been resilient during the global stock market rout in August 2011, we estimate its upside potential by end-2013 to be around 20.1% (as at 13 January 2012), which is not as exciting as other markets such as the those in North Asia. We recommend long-term investors to underweight the Malaysian equity market and consider increasing their exposure to other countries and regions that offer higher upside potential such as Greater China (China, Hong Kong and Taiwan) and Global Emerging Markets (GEMs).