1) Modest Pace of Economic Growth in 2017, Supported by Domestic Demand
After a year of consolidation and adjustment, Malaysia’s real GDP growth is expected to improve from an estimated 4.1% this year to 4.2% year-on-year in 2017. The pick-up in growth is likely to be supported by domestic demand.
Consumers have been under tremendous pressure in 2016, with the government cutting subsidies and job market softening. Despite that, consumer spending has been recovering steadily. We are cautiously optimistic that consumer spending will continue its recovery path in 2017, underpinned by government stimulus and minimum wage hike back in July. Consumers are also believed to have acclimatized with the new GST system implemented more than a year ago. In 2017, there is also possibility for the government to introduce more stimulus measures to bolster consumer sentiment prior to an election, which is due on 2018. However, the pace of recovery is expected to be gradual as high household debt will continue to cap on the upside.
Government revenue is expected to improve from higher collection from direct taxation and oil related revenue, assuming improvement in consumption and investment activities and firmer oil prices ahead. This should allow the government to expand spending without putting a strain on its fiscal position.
Government’s pump primping agenda will likely persist moving into 2017. MRT 2 and Pan Borneo Highway are few of many large scale infrastructure projects which expected to kickstart next year. Upcoming projects in the pipeline include the high-profile Bandar Malaysia and KL-Singapore High Speed Rail (HSR), which will create new infrastructure jobs that could set the stage for election play in 2017/18. These high multiplier projects may create positive spill-over effect, which in turn support the domestic investment activities moving into 2017.
Despite a gradual pick up in consumer spending, consumers are likely to be cautious and selective with their spending as a full bound recovery has yet to be seen. As a result, Consumer Discretionary sector is not expected to see a meaningful recovery at this juncture given that spending for big ticket items could remain lacklustre amid cautious consumer sentiment. On the other hand, Consumer Staples sector, may more or less see stable earnings growth ahead due to its resilient nature.
Big scale infrastructure projects in Malaysia have created numerous infrastructure jobs for those construction players, which could keep them busy moving into 2017. Successful tenders for those upcoming government projects in the pipeline would also improve earnings visibility for the coming years.
As economic growth is projected to pick up, the outlook for corporate earnings looks brighter ahead. Our expectation is that corporate profit to regain positive momentum and grow at a moderate pace in 2017, ending the two-year earning recession in 2015 and 2016.
A turnaround in corporate earnings should support local equities trending higher next year.
2) Limited Downside For Ringgit, With Possibility Of Strengthening
Ringgit has been volatile in 2016, no thanks to bobbing oil price movements, jittery on US Fed rate hike, fear of further Yuan depreciation and resurface of the 1MDB issue. However, with stabilizing oil prices and Bank Negara Malaysia (BNM)’s new FX policy to support the Ringgit, it is likely that the worst for Ringgit is behind us now.
Moving forward, we see limited downside for Ringgit, considering how much it has already fallen. According to Bank for International Settlements, the real effective exchange rate for Ringgit is standing at 86.75 as of end Oct 2016. This indicates Ringgit could be undervalued by 13.25%.
That said, the trend could be volatile along the way as there are still many uncertainties ahead, including the Trump’s unpredictability in foreign and trade policy and a possible sharper-than-expected US Federal Reserve interest rates hike.
As we have expected in 2016 Malaysia Outlook, export-oriented companies that source inputs domestically, such as glove manufacturers, semiconductors and electronics producers, and furniture makers have benefited from the weak Ringgit in 2016 due to overseas’ contribution. Weak Ringgit has helped to boost earnings growth as a result. However, strong earnings momentum is unlikely to persist into 2017 as FX gains fade amid stabilization of Ringgit.
From a foreign investor perspective, the oversold Ringgit may appear to be attractive enough to induce inflow back into the equity market, serving as a positive factor that could support equity market performance in 2017.
For domestic investors who are looking for offshore investment opportunities, one of the key risks that concerns investors right now is the rebound in Ringgit. As such, it is important for investors to be selective when investing oversea as a possible rebound in Ringgit may detract returns. Investors could consider investing into equity markets that are expected offer attractive returns (e.g. Asia ex Japan, China H-share and Hong Kong) in the coming 1 or 2 years, where the projected equity returns from these markets are big enough to cover marginal rebound in Ringgit (see Asian And Emerging Markets To Return 40% Over Next Two Years! and Hang Seng Index Will Hit 32,000 By End 2018). For bond investment, investors can consider to trim down bond funds with foreign currency exposures and park it under local bond funds.
3) Monetary Policy To Remain Accommodative, Room For Easing On The Cards
In 2016, BNM has cut its policy rate by 25 basis points in July as a measure to alleviate downside risk to growth for the economy.
We expect the central bank to take a neutral stance throughout 2017 but do not rule out a possible rate cut in the year ahead as growth is still gradual and fragile, with risks to growth remain tilted to the downside, especially on the external front amid rising risk of protectionism.
While possible easing by BNM favours longer duration play, we opined that its positive effect could be mitigated by further rate hike in US. On top of that, the current yield differential between long-duration bond and short-duration bond is not wide enough to justify a buy. Hence, we prefer staying neutral on duration for now.
Instead of taking on duration risk for higher potential return, investors with a higher risk appetite could consider allocating a larger portion of the portfolio towards riskier corporate bond segment as the spread remains reasonable for a better yield pick-up.
4) Headwinds remain, But Most Sectors See Recovery Ahead
As the closest proxy of the broader economy, outlook for banking sector should improve as economy picks up steam. Loan growth will start to stabilize and more contained expenses including reduced labor cost, abating funding cost pressures and lower loan loss provision may flow through earnings in 2017.
Plantation sector could see a better year in 2017. Tight CPO supplies, low inventory and a widening soybean-CPO premium are bullish factors that will help to sustain the current high CPO prices into 1H17 before momentum eases off in 2H17. However, ample forecasted supplies for soybean next year-the key substitute for palm oil suggests that further upside in CPO prices looks to be less possible moving forward.
Sentiment for oil & gas sector is expected to improve amid the recent OPEC’s and non-OPEC’s agreement on production cut. This adds optimistic for a higher oil prices ahead. However, we see a significant surge in oil prices being an unlikely scenario for now, as upsides would be capped by a pick-up in activities in the shale oil industry-if exploration and production projects become feasible at higher oil prices.
Telecommunications sector is undergoing a structural change. With government’s commitment in liberalizing the sector, some spectrums were reallocated recently and there could be more ahead. This coupled with an increase in the number of players (eg. Webe) and a matured telco market should fuel stiffer competition in the coming year.
Banking sector is expected to do most of the heavy lifting for the KLCI Index next year as it recovers with better earnings growth, estimated at 7.8%. Positively, the sector as represented by Bursa Finance Index saw its PB valuation fall from their peak of 2.34X to the current level of 1.24X. The PB current valuation is attractive compared to historical average of 1.72X. Upgrade our neutral call to overweight for the banking sector.
In absence of one off factor (easing losses on FX translation due to a more stable Ringgit) that have lifted planters’ earnings sharply in 2016, earnings should come in at a lower but still respectable double digit rate of 12.9%. Earnings growth is likely to be strong in 1H17 but subsequently taper off in the 2H17. Near term growth outlook looks promising but valuations are somewhat demanding at forward PE of 22.0X, pricing in much of the positives. Hence, we are neutral for the plantation sector.
Topline growth should remain uninspiring, as oil and gas activities may not pick up significantly as industry players are waiting for more clarity before embarking any CAPEX spending. However, earnings for oil & gas sector are set to improve ahead, artificially boosted by lower impairment losses as oil prices stabilize. Valuations are cheap given how much they have fallen since late-2014 but long term growth outlook remains uncertain for now. Maintain our neutral call for the oil & gas sector.
Constrained topline growth and weak margin will continue to haunt telco players, which should translate into a lacklustre bottomline in 2017. The market is expecting 5.1% earnings growth in 2017, but we believe that the risks to the earnings growth are on the downside and earnings downgrades are still possible next year. Valuations are stretched at 25.6X forward PE despite a tepid earnings outlook. Retain our underweight call for the telecommunications sector.
5) Modest Return Expectation For Big Cap KLCI Index
Despite the fact that Malaysia market has underperformed many other markets under our coverage in 2016, valuation for KLCI Index is still trading at a slight premium compared to what we deemed as fair.
With valuation is at a slight premium now, equity return for KLCI is likely to be modest at best, considering earnings growth should be the major contributor to equity return, which we expect to come in at mid-single digit next year.
As of 12 December 2016, Malaysian big caps are expected to produce an estimated annualized return of 7.5% by the end of 2018, lagging behind many markets under our coverage.
While the Malaysian equity market is only expected to provide a modest rate of return, investors should not shy away completely from the Malaysian equity market given its important role in portfolio diversification (from the perspective of a Malaysian investor). As such, we advise investors to consider an allocation of 15% to 20% in Malaysian equities within one’s equity portfolio.
For domestic exposure, given the muted return expectation for the big cap segment, investors should consider underweighting index-tracking passively managed funds as their performance tends to track closely the performance of large cap stocks. In this regard, actively managed fund is preferable as the fund managers will be able to generate alpha through their superior stock picking skills.
Other than that, investors who are looking for stronger growth opportunities in the local bourse could also opt for small cap segment as the valuation is now looking more attractive compared to the large cap segment. As of 12 December 2016, the FBM Small Cap Index is trading at a forward PE of 10.5X compared to KLCI Index’s 16.5X. That said, since small cap segment is more volatile in nature, investors who favour this segment should only include it into their supplementary portfolios, confining their allocation in these segments to no more than 10% weightage of their entire portfolios.
The Research Team is part of iFAST Capital Sdn Bhd
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