KUALA LUMPUR – Credit-Suisse Research believes the 45-month 34% US dollar underperformance of Malaysian equities (20% in local currency terms) was warranted but has now reached an end game.
In a recent research report, it said it had now turned constructive on Malaysia for 10 reasons:
* The consensus GDP growth forecasts are showing early signs of upgrades
* Earnings revisions have turned positive for the first time in close to five years;
* The ringgit appears attractive at current levels after significant devaluation;
* Equities have undershot their typical association with relative value creation;
* Repair in the macro environment benefits the heavyweight banking sector;
* Consumer sentiment in the doldrums appears set to recover;
* Its macro regression model warrants 8% potential upside for MSCI Malaysia;
* Malaysian equities have so far lagged the recovery in oil prices;
* Malaysia continues to be a consistently attractive yield play in EM; and
* fund positioning and analyst recommendations are extremely bearish.
“We screen for Malaysian stocks that offer superior dividend and FCF yields and are rated ‘Outperform’ or ‘Neutral’ by Credit Suisse sector teams. The list of 10 stocks includes the ‘Outperform’ rated CIMB, IJM and Gamuda,” it said.
Consensus GDP growth forecasts are showing early signs of upgrades
Dragged down primarily by lower commodity prices, consensus estimates for 2016, 2017 and (latterly) 2018 real GDP growth endured successive downgrades through most of the last two years.
The research house believes that with the recent stability in the commodity complex, it has witnessed the last of the downgrades to near-term growth expectations. Indeed consensus 2017E and 2018E real GDP growth have already been nudged up in the last few weeks.
The expected recovery in nominal GDP growth to 8.0% for year-end 2018 is consistent with a pick-up in year-on-year EPS growth to a robust c16% over the period from the current -6% in US$ terms.
Credit Suisse Malaysia said its economist Michael Wan expects a pick-up in growth to 4.5% in 2017 (above consensus expectations of 4.3%) driven by public infrastructure projects, commodity related investments and a boost to rural income from the recovery in rubber and palm oil prices.
It also noted the government’s US$48 a barel (bbl) oil price assumption for 2017 appears conservative (Credit Suisse Energy team forecasts year-end Brent at US$62/bbl) potentially giving the government more freedom to increase spending.
Moreover, the research house expects stable inflation dynamics and the central bank to hold policy rates at the current 3.0% through 2017 thus translating to a moderately equity-benign environment.
Earnings revisions have turned positive for the first time in close to five years
Credit-Suisse said as recently as six months ago Malaysia was recording the deepest negative earnings revisions of any mainstream emerging market.
Since then breadth in revisions have staged a swift recovery back into positive territory (more upgrades than downgrades to the 12-month forward EPS estimate) for the first time since June 2012.
Encouragingly, given the typical close association between breadth in earnings revisions and year-on-year price
In tems of US dollar performance of Malaysian equities, it appears that the market has not yet fully priced in the recent improvement in revisions.
Moreover, if net positive upgrades are sustained, this would remove the incessant upward pressure on forward earnings multiples challenging the market for the best part of the last five years.
At a sector level, the recovery in earnings revisions albeit led by, is not restricted to, the energy and mining space. Among the larger sectors, consumer discretionary and staples have recovered sharply well into net positive territory with industrials and financials improving to at least neutral levels.
Ringgit appears attractive at current levels after significant devaluation
The research house said the ringgit has undergone a significant 33% devaluation in nominal terms versus the US dollar since May 2013.
Malaysia’s 68% deviation below purchasing power parity (PPP) is surpassed only by Indonesia (69%) and India (74%) among mainstream MSCI Emerging Market countries, a level not seen in 15 years.
“This magnitude of deviation from PPP seems excessive considering Malaysia’s 2016 GDP per capita (in PPP dollar terms) of 27,300 is 2.3 times that of Indonesia and 4.1 times that of India,” said the research house.
Equities have undershot their typical association with relative value creation
From early 2007 to mid-2013 Malaysia underwent a remarkable improvement in relative value creation (return on equity less cyclically normalised cost of equity) versus overall emerging markets, from 400bps inferior to 200bps superior.
This was instrumental in driving the 70% outperformance of Malaysian equities relative to emerging markets in US dollar terms over the same period.
The subsequent reversal in fortunes for Malaysian equities’ relative performance is not surprising given the erosion in value creation back in line with the emerging market aggregate today.
However, given the 16-year association between the two metrics, the relative price performance in US dollar terms now appears significantly oversold.
Repair in the macro environment should benefit the heavyweight banking sector
Private sector credit growth has just bounced off a 13 year low at 5.6% year-on-year in January (from 4.2% in September last year). This modest reacceleration in credit growth has thus far been restricted to the corporate sector even as household credit growth has continued to slow down to at least a 10 year low.
Encouragingly, deposit growth recovering back into positive territory (albeit still lagging loan growth) should serve to moderate the pickup in the loan to deposit ratio which at 105% is currently at elevated levels which typically dampens credit extension.
It pointed out its Malaysia economist forecasts credit growth to remain stable at 5.5% out to 2018 and in the short-term he sees tentative signs of a pick-up with rising loan approvals.
Consumer sentiment in the doldrums appears set to recover
It believes with recovering commodity prices, benign inflation dynamics and a stable ringgit, consumer sentiment has ample scope to recover through 2017.
This would be in line with its economics team’s expectations of robust real private consumption growth of 6% for both 2017 and 2018.
Macro regression model warrants 8% potential upside for MSCI Malaysia
The research house said its four factor macro regression model for MSCI Malaysia, which historically explained 75% of the US dollar movements in the equity index over the past decade, suggested a potential 8% upside to year-end based on Credit Suisse forecasts for US ISM new orders of 59.0.
Its relatively constructive view on the ringgit was a year-end 2017 forecast of 4.15 and CPI inflation of 3.3%, and a modest slowdown in M2 money supply growth to 3.5%. This compares favourably to the potential 6% upside to its year-end 2017 target of 985 for MSCI EM.
Malaysian equities have so far lagged the recovery in oil prices
Credit Suisse Research said Malaysia was typically by far the most correlated MSCI EM Asian equity market to the oil price and the fifth most correlated in GEM after Russia, Chile, South Africa and Mexico.
However, Malaysia has so far been the laggard in the current phase of oil price recovery since February 2016. While Russia, South Africa and Chile returned 62%, 45% and 35% over this period respective in US dollar terms, Malaysia (+5%) has underperformed even Mexico (+9%) which of course has been subject to the greatest protectionist trade risks associated with the Trump administration.
The Credit Suisse Energy team’s Brent forecast of US$62/bbl for year-end 2017 leaves 20% potential upside for the oil price from current levels.
Malaysia continues to be a consistently attractive yield play in EM
Malaysian companies’ cash flow distribution to shareholders has been structurally higher than the emerging market average for more than a decade with a current payout ratio of 49% compared to 38% for MSCI EM. This translates into a dividend yield of 2.9%, some 14% (or 0.4ppt) higher than that of overall emerging markets.
Indeed, Malaysia’s dividend yield has been superior to that of emerging equities for 85% of the time over the past 10 years.
Reinvested dividends have contributed to the bulk of total returns of 46% for MSCI Malaysia over this period versus 36% for MSCI EM in US$ terms even as the price returns of 5% and 4% respectively are more comparable.
Fund positioning and analyst recommendations are extremely bearish
Malaysia stands out as by far the most unloved larger mainstream emerging market by dedicated EM funds.
Extraordinarily, the median dedicated emerging market equity fund position on Malaysian equities has now reached zero (no Malaysian holdings) for the first time on record for any of the larger MSCI EM countries.
On an asset-weighted basis the average fund holds Malaysia on a 70% below benchmark stance.
“This consensus bearishness is reflected on the sell-side as well with analyst buys less holds and sells (as a percentage of total outstanding recommendations) close to a seven year low (albeit with some recent improvement in sentiment) placing the market as the third most unloved larger emerging market (after Poland and Chile).
“These point to significant scope for a shift up in analyst sentiment coupled with a marginal buyer among EM funds to re-engage the market,” it said.