Broad prospect in small-cap space despite unfavourable outlook


RHB Investment Bank Bhd sees pockets of opportunity in the small-cap market despite the unfavourable short-term outlook, especially with the heightened expectation of volatility this year.

Its analysts Lee Meng Horng and Loo Tungwye said the economic recovery prospects and the high vaccination rate are among the main causes for optimism among investors.

“As such, we believe that a sector rotational play into key investment themes and a meticulous stock-picking strategy will bear fruit,” the analysts said in a note yesterday.

Amid a challenging market environment, the analysts noted that the performance of the 20 small-cap jewels identified in RHB’s 2021 edition was affected by fat tails, being undermined by various external events and uncertainties last year.

According to the analysts, the top 20 companies in its 2021 edition were underperformed with a value-weighted holding period return of -9.8%, since its book launch on May 5 versus the return of benchmark indices in FBM70 (-7.1%) and FBM SC (-6.8%).

“Given the uncertainties related to Covid-19 and political instability, the rallies of our selected stocks were short-lived and their subsequent performance was dragged by the few healthcare and commodity-related counters that generated big losses due to the swift changes in market dynamics,” stated the analysts.

Meanwhile, the FBM SC (1.3%) outperformed the FTSE Bursa Malaysia KLCI (FBM KLCI) (-3.7%) in 2021 as the main market remains weak in the absence of major positive catalysts, with policies from the 12th Malaysia Plan and Budget 2022 yet to provide a boost for the market.

“Nonetheless, FBM70 (-6.2%) underperformed the FBM KLCI as the index was undermined mainly by glove producers and companies that were clouded by environmental, social and governance (ESG)-related issues and the announcement of the prosperity tax,” they said.

The analysts also noticed a similar trend of outperformance in the small-cap space regionally except for Japan, Singapore and Indonesia due to the agility and unique catalysts of certain small-cap stocks.

Concurrently, the analysts said the drain in market liquidity should be a major talking point among market participants in 2022 as the government set the new policies set on the stamp duty rate.

“Compounded by the resumption of intraday short selling, we can anticipate significant market volatility into 2022, which will raise the risk premium, especially for small-mid cap stocks,” they said.

Notably, trading activities have already tapered off since mid-2021 as the market continued to be range-bound in the absence of major positive catalysts compounded by concerns over the new variant of Covid-19, the double whammy of the prosperity tax and stamp duty hike announced during Budget 2022.

Moreover, the total turnover for the FBM KLCI and FBM70 fell by 21% and 33% year-on-year in 2021, while FBM SC was up by 10%.

Currently, the FBM70’s and FBM SC’s current forward price-earnings (P/E) have retraced to below their five-year means, and the two indices are now trading at two to three times P/E discounts to that of FBM KLCI.

However, the analysts said it is still paramount for investors to exercise extra diligence in their stock picking, despite a better risk-reward ratio in terms of the relative forward valuation.

“We highlight that the valuation for MSCI Malaysia Small Cap Index continues to be at the north of the MSCI benchmark index, owing to the superb performance of many stocks in the small-cap space, especially the high-flying technology counters with premium valuations even in the region due to the crowded trading interest and growth on offer,” they added.

Looking ahead, the analysts believe that there is value in the market, especially on the full-blown economic recovery expectations supported by its in-house GDP growth forecast of 5.5% in 2022.

“However, Omicron could derail the growth path on top of escalating political risks, high inflation and potentially slowing demand,” they further said.

Additionally, the analysts advocate several key investment themes that include exporters, value stocks and election play.

Among the sectors to look out for in the small-mid cap are consumer discretionary, technology, logistics, oil and gas, commodity play and politically linked thematic play.

Meanwhile, the risks could be the prolonged pandemic, political instability, earnings disappointment, worsening economic conditions, liquidity issues and higher ESG-related risks.