Unexciting 3Q for local equity market

By iFAST Capital / Pic By ISMAIL CHE RUS (TMR)

After a strong kick-off in 2017, Bursa Malaysia-listed companies have posted unexciting returns since the beginning of the third quarter (3Q), leading some investors to worry about the sustainability of the market rally.

There is a disconnect between some economic data and market performance over the past few months, which is leading investors to be more sceptical about the accuracy of the data that captures the overall health of the economy.

The disconnect between some of the economic data and stock performance might be due to the increasing external uncertainties which cause temporary volatility in the equity market.

From the fundamental angle, the local equity market is likely to trend higher moving forward, with the expectation of improving corporate earnings as a result of robust economic growth and current fair valuation.

The Malaysian economy registered 5.8% year-on-year (YoY) growth rate in gross domestic product (GDP) in the 2Q, outperforming the consensus estimates for 5.4% expansion and 5.6% growth in 1Q.

The local economy posted broad-based expansion across all sectors (construction +8.3%, services +6.3%, manufacturing +6%, agriculture +5.9%, mining and quarrying +0.2%) on YoY basis.

On the expenditure approach front, the private sector was the main driver for the robust 2Q GDP growth with private consumption and private investment marked high single-digit growth rate of 7.1% and 7.4% respectively.

The growth in the private sector (private consumption and private investment) is in line with the improving consumer sentiment and business condition in the 2Q. According to the Malaysian Institute of Economic Research, both consumer sentiment index and business confidence index strengthened to a two-year high of 80.7 and 114.1 points respectively.

Both indices suggested that local consumers and business owners are turning positive on the outlook for local economy over the next three to six months.

Although government spending grew at a low single-digit growth rate of 3.1% in the 2Q, we believe the government expenditure is likely to pick up in the second half (2H) as the general election is not far away.

Moreover, the West Texas Intermediate crude oil price is hovering around the US$49 (RM206.78)-per barrel level, well above government budget assumption of US$45 per barrel. As such, it might enhance the spending power and flexibility of the government.

Looking at the external trade data, Malaysia’s exports grew faster than imports for three consecutive months, unlike in the 1Q where growth in imports outpaced the growth in exports for three successive months.

With stronger exports growth and slowdown in local imports, net exports growth turned positive in the 2Q.

In July, Malaysia’s exports expanded strongly at 30.9% YoY, after the slowdown in growth in June (+10%). Electrical and electronic (E&E) products, which accounted for 35.5% of the total exports, remained the main driver of exports, registering 28.3% YoY of growth in July 2017.

The sector is expected to remain strong in the 2H following the launch of Samsung Note 8 and the new iPhone’s anniversary edition, which are expected to drive the global demand for E&E products.

Technically speaking, the 3Q has the weakest quarter over the past 30 years, with an average return of -3.57%.

Based on our findings, the 4Q was the top performing quarter within a year. As such, given the improving economic outlook coupled with the end of seasonally weak quarter, the local equity market is likely to continue its strong momentum we saw in the 1H of this year.

The ringgit has strengthened by about 5.9% as of Oct 10 since February, but is still trading at a discount of 14.03% against its fair value as of end-July 2017.

The local unit is also currently trading well below its 10-year average level, suggesting the currency is attractive from a valuation perspective.

The implementation of the new Foreign Exchange Admin- istration rules that required local exporters to convert 75% of exports proceeds into ringgit has helped.

The strong performance of exports for the past eight consecutive months was one of the drivers to the robust performance of ringgit.

For the 2Q ended June 2017, on aggregate, the top 30 companies listed on Bursa Malaysia posted a tepid earnings growth of close to 3.3% YoY.

On a quarter-on-quarter basis, total earnings delivered by the top 30 companies declined by 4.5%.

The disappointing quarter result was one of the reasons for the unexciting performance in the local equity market in the 3Q.

As 2Q earnings have been factored into the stock prices, we believe the 3Q and 4Q earnings might be one of the drivers for the local equity market.

Global growth and recovery in domestic demand will benefit both domestic focus and exporting companies.

Big companies hit by foreign-exchange losses last year such as IOI Corp Bhd, Axiata Group Bhd and Tenaga Nasional Bhd might see decent YoY profit growth in coming quarters.

In addition, we are likely to see continued foreign fund inflow as global investors regained risk appetite as well as the attractive valuation for ringgit.