Three key investment themes to focus on

Pic By BLOOMBERG

The Chinese characters of “danger” and “opportunity” form the word of “crisis”, meaning that there will always be some opportunities hidden within dangers.

The volatility on global equity and bond markets might have caught investors off guard but we think there are three interesting areas that investors should look at.

1) Chinese Equity with Undemanding Valuation
The Chinese equity market, be it the onshore (China Securities Index 300 [CSI 300]) or the offshore (Hang Seng Mainland 100 Index [HSML] 100) equity market, has tumbled by more than 15% from its peak this year amid the increasing concern of a Chinese hard landing and escalating US-China trade tensions as well as the deleveraging campaign.

However, in late July, the Chinese government announced a package of fiscal stimulus indicating a vigorous fiscal policy to tackle external uncertainties and to support economic growth.

Given the China’s economy is now less reliant on exportled growth and more on private consumption, the fiscal stimulus is expected to offset the impact of trade war by boosting the private consumption in China.

On the valuation front, both the CSI 300 and HSML 100 indices are trading at an attractive valuation levels (close to -1 standard deviation [SD]), indicating lucrative upside potential for both the onshore and offshore China equity market.

2) Malaysia Small Cap for Appealing Upside
On the local front, investors might want to consider the local small cap sector as we see a higher upside potential for the small to mid-cap companies.

At this juncture, we see no catalyst for the ringgit to trend higher as foreign investors, be it equity or bond investors or foreign businesses, are unlikely to pile into the Malaysia market due to policy uncertainties.

The short to mid-term weakness in the ringgit could be a blessing for the small-cap sector as most of the companies tend to source a bigger portion of their revenue oversea.

The zero-rated Goods and Services Tax could increase the liquidity or working capital of smaller companies that have limited access to favourable credit facilities.

From the valuation perspective, the small-cap sector, as represented by the FBM Small Cap Index (FBMSC), is trading at an attractive level (close to -1SD of its five-year average).

The spread between the forward price earnings multiple for the FTSE Bursa Malaysia KLCI and FBMSC is currently close to a five-year high, indicating a more attractive valuation for the small-cap sector in comparison with the big-cap segment.

3) Longer Duration Bond for Higher Yield
On the fixed-income market, investors might want to consider the local long duration bond fund as the interest-rate sensitivity for the local bonds are relatively lower due to the illiquidity issue.

Given the current low inflation rate environment and strong economic growth, we expect Bank Negara Malaysia to keep interest rates unchanged for the rest of 2018.

Hence, by investing into a long duration bond fund, investors are poised to enjoy a higher potential return.

There is risk of investing into the local long duration bond fund should the US Federal Reserve tighten monetary policy faster than expected, which might see increasing foreign capital outflows and trigger a spike in the local bond yield. However, looking at current foreign holdings of Malaysian debt securities (close to 2.5 years low), we do not expect any massive outflows from the local bond market given the relatively attractive yield in the local debt securities compared to the developed market bond yield.

To summarise, for investors who are looking to tap into capital growth opportunities, consider adding positions into the domestic small-cap space or the Chinese mainland market.

Investors seeking for shelter against volatility may consider looking at the local longer duration bond space.