Tuesday, October 11, 2011

KLCI Investment Strategy: Positioning For 2012 Post Risk Aversion

# Maintain based case scenario of slower growth but absence of double-dip and Euro debt crisis fallout.

# Post earnings revision in banks, TNB and consensus, 2011 and 2012 EPS growth now 6.8% and 10% vs. 11.3% and 11.4% respectively.

# 2012 P/E of 12.8x (1.1 SD below 5-year mean), already largely reflecting earnings risk.

# However, short-term volatility to continue given time needed to resolve Euro debt crisis, most world indices still below their 200-day SMAs, VIX stubbornly above 30 and looming election risk.

# Cut FBM KLCI end-2011 target to more realistic level of 1,440 (13x 2012 P/E – 1 SD below 5-yr mean).

# But still long-term positive and introduce end-2012 target of 1,555 (13x 2013 P/E).

# Long-term positive due to: 1) resilient economy with ETP, consumerism (especially post “goodies” from Budget 2012), and Petronas award; 2) local non-GLC funds underweighted while GLC funds still has net inflow; and 3) ample liquidity with low interest rate in DMs means search for returns in asset classes post risk aversion.

# Unlikely to see valuation revisiting 08 trough of 9.3x P/E (equivalent to 1,025 or 2.9 SD below 5-year mean and earnings yield of 10.8%).

# Undertook worst case scenario analysis using Fibonacci Retracement, MYR-FBM KLCI regression (R2 of 0.8) as well as foreign shareholding hit trough using net buy/sell information.

KLCI Investment Strategy
# Persistent volatility implies short-term defensive.

# Worst case analysis came out with 1,112, 1,150, 1,280 and 1,293. The former two unlikely as P/E (10x and 10.4x) would be 2.4 and 2.5 SD below 5-year mean with earnings yield of 9.6% and 10%. The latter two possible which imply P/E of 11.6-11.7 or 1.7-1.8 SD below 5-year mean and earnings yields of 8.6-8.7%. Worst case 2 SD below 5-year mean (11.1x P/E and 9% earnings yield) of 1,227.

# Thus, 1,280-1,293 good levels to turn more aggressive bottom fishing post risk aversion and focus on fundamental stocks which have bombed out as well as high liquidity and Beta.

# Use 6-mth Beta to project hypothetical share prices of top 100 stocks if FBM KLCI hit 1,293, high predictability vs. recent lows. Provide good gauge of potential share prices when FBM KLCI meets different support/resistance levels.

# From the list, chosen 10 based on Beta > 1.5, decent fundamentals and high institution following and average 3-mth volume of at least 5m.

Trading Strategy Overview
# The recent surge in global markets on Europe concerted efforts to recapitalize
banks has somewhat mitigate the “fear” factor and sell-fulfilling prophecy of a global downturn. However, the situation is still fluid as any positive news could take the market higher but on the other hand, any resemblances of resistance to Euro
“rescue” plan could trigger risk aversion again and unwinding of carried trade.

# European debt crisis likely to take time to resolve as the detailed plan to recapitalize banks has been delayed to 23 Oct while Greece only has sufficient cash until 3 Nov. This is expected to keep investors worldwide on their toes. Until definite plans are put in place, the market is likely to remain volatile with risk on risk off trades sparring to find an upper hand. Looming election risk (post the recently announced Budget) could also exert pressure on the market. Moreover, sentiment could be hurt by Chinese government commencement of purchase in the country’s largest banks which may be taken as more issues about the banking system and potential trade war if US Senate voted in a law to force Yuan appreciation.

# Hence, slower growth but absence of double-dip and fallout from the Euro debt crisis (our base case scenario), we take stock of the economic situation (and our outlook – see separate report dated the same day), potential downside (from the extreme swings between risk off and risk on) or if indeed we have already hit bottom at 1310, expectations for the market and strategy for the short-term to ride through the gyration and positioning for 2012.

KLCI Market Outlook
# Our recent earnings downward revisions on banks and TNB as well as fine-tuning
(to exclude the impact of extraordinary items) and incorporating latest consensus
(FBM KLCI component stocks that are not under HLIB universe whereby most have
been revised downward) has resulted in our 2011 and 2011 EPS growth forecasts
being cut to 6.8% and 10% from 11.3% to 11.4%, respectively (see Figure 1).

# The higher growth rate in 2012 was mainly due to substantial earnings recovery in
TNB (gas supply shortage gradually resolved, especially when the Malacca
degasification plant is slated for mid-2012), MISC (exit from loss-making Euro
container route, higher charter out rate and new sources of income), Telcos (due to
accelerated depreciation by Digi and generally higher capex for node fiberization,
4G as well as various convergence tie-ups - all in 2011), Gaming (normalization of
2011 tax rate in Genting) and partly due to lower base in 2011.

# Despite the various earnings downward revisions by HLIB and consensus, we now
believe that earnings risk has been largely factored into the forecasts given that
most of the companies’ earnings are domestically driven where we expect the
economy to remain resilient, especially after the Budget 2012 which essentially
provide a boost (HLIB estimates to be amounting to RM9bn) to disposal income of
most households. Moreover, with current 2012 P/E of 12.8x, it is already at 1.1SD
below the 5-year mean.

Source: HLIB Research

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