The increased weightage of financials is beneficial for the index as we anticipate that the rising rate environment will continue to drive growth in the financial sector in the coming year 

by IFAST RESEARCH TEAM 

AS WIDELY anticipated, AMMB Holdings Bhd and QL Resources Bhd were included in the KLCI Index on Dec 19, 2022, replacing Top Glove Corp Bhd and Hartalega Holdings Bhd, according to the FTSE Bursa Malaysia KLCI (FBM KLCI) semi-annual review. With the new additions, the benchmark KLCI Index is more heavyweight in financials, (35% weightage compared to 34.2% before) and less in healthcare (5.1% weightage compared to 6.2% before). 

The banking stock AMMB closed 0.7% higher while the consumer-staples giant QL Resources rose 0.5% on the date of announcement (Dec 2, 2022), valuing them at RM13.93 billion and RM13.63 billion market capitalisation respectively. Meanwhile, Top Glove fell 3.6% and Hartalega declined 1.8% respectively on the date of the announcement. 

Both glove giants that benefitted from the windfall profit during Covid-19 pandemic have been under selling pressure due to the supply-demand imbalance and thinner margins amid diminishing Covid-19 threats. The two glovemakers’ market capitalisations slid dramatically from their peak during the Covid-19 era, to RM6.94 billion for Top Glove and RM5.69 billion for Hartalega. 

The increased weightage of financials is beneficial for the index as we anticipate that the rising rate environment will continue to drive growth in the financial sector in the coming year. Despite the potential challenges of an economic slowdown and increased competition in deposits, we believe that the financial sector, particularly the banking sector, remains a strong and relatively safe investment option due to their strong fundamentals and defensive characteristics. The absence of the prosperity tax, lower provision losses, coupled with a widening net interest margin and strong asset quality in loan books, are likely to offset any losses from increased competition in savings deposits. While the potential for upside may be limited as the peak of interest rates in 2023 is already widely expected, we still favour this sector as a defensive play for investors to withstand market volatility. 

Meanwhile, we expect the new government will continue initiatives to reduce the cost of living, especially for the lower-income groups, which will continue to support the domestic consumer sector amid rising inflationary pressure. The defensive nature of QL will be serving as a top pick among investors who seek a value-oriented play. Also, the well-known and trusted branding name in poultry and marine-product-manufacturing segments will serve as the backbone for the company’s growth in the future, as the weaker ringgit will bolster profits from export. 

On the effective date of the changes (Dec 19, 2022), FBM KLCI was only down 0.1%. We believe that the fairly muted reaction was due to the fact that the market had already priced in the news. As a result of the reconstitution, the earnings integer for the KLCI has been upgraded from 112.1 to 113.9, as the higher earnings from new additions QL and AMMB cover the losses from both glove giants Top Glove and Hartalega. 

The EPS upgrade has resulted in an upgrade in 12-month earnings growth forecasts from 7.4% to 9.7%. Nevertheless, it is expected that fund managers will make changes to their portfolios due to changes in the KLCI, which may benefit AMMB and QL, but may lead to the potential selling of the Top Glove and Hartalega. 

The change in constituents does not alter our macroeconomic view and key drivers for the market. The KLCI has been beaten down due to market pessimism in 2022. However, we maintain our view on the overall macroeconomy and believe that the key drivers are still in place, driven by the reopening tailwinds and less-tightening stance from both fiscal and monetary authorities. Given the market is tilted towards risk-averse sentiment amidst the current macro backdrop, we believe both new additions (banks and consumer staples) will continue to perform well in the first half of 2022, thus the likelihood of having a significant change in the next KLCI semi-annual review is low. 

All in all, taking into consideration all the new information, we have upgraded the 12-month target price for the KLCI to 1,830 points, which is about 24% from its last closing price of 1474.69 at the time of writing. 

As such, we reiterate our constructive view on Malaysia equities albeit the much sentiment-driven sell-off in the recent months, underpinned by the compelling upside potential with solid fundamentals, cheap valuations and attractive dividend yields. Probably it’s time for investors to reconsider looking at this undervalued market. 

The views expressed are of the research team and do not necessarily reflect the stand of the newspaper’s owners and editorial board. 

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• This article first appeared in The Malaysian Reserve weekly print edition