Benchmark index changes, domestic investors may look elsewhere. The thirty stock FBM 30, to be adopted as the benchmark KL Composite index in early July, may not be universally adopted as the benchmark index due characteristics associated with its concentration in a small number of stocks and sectors. Public Bank, Bumi-Commerce and Resorts World benefit from a rise in their weighting in the benchmark index, while P Gas, PLUS and Digi will have their index weighting reduced, regardless of whether the FBM100 of FBM 30 is chosen as the alternative benchmark.

New PM’s actions net positive. PM Najib will embark on new initiatives to reinvigorate the ruling coalition’s popularity. Hints have been dropped over relaxing certain Foreign Investment Committee requirements and embarking on a new economic model. The slow spending from the fiscal stimulus packages and weaker than expected Q1 GDP growth adds further pressure on the leadership, so the next 2- 3 quarters are likely to be bumper ones for construction and building material companies.

Buy construction and monopolies, Sell high hopes. Our Buy list is construction and building materials heavy (Gamuda, IJM Corp, Sunway Holdings, Kinsteel, Lafarge, Hock Seng Lee), with some monopolies (Tenaga, Telekom, MAHB, PLUS, LITRAK) and selected consumer stocks (AEON Co., Resorts World, Guinness, KFC, JT International). Our top Sells are stocks where prices have exceeded consensus target prices by the highest margin (SP Setia, Bursa Malaysia, MISC, KL Kepong, Asiatic Development).

Lofty valuations but ample liquidity

The KLCI is 29% from its peak, but combined 1Q09 earnings of our research universe was down 26% YoY. We expect our market earnings to drop 8.4% YoY in 2009, putting the market at 15.6x 2009 P/E. By end-2009, we can look forward to market earnings growth of 9.8% YoY and a market P/E of 14.2x. Not compellingly attractive, and in our view, slightly expensive for the growth.

2010 earnings will be only at 2008 levels. At 1,060, the KLCI is trading at 15.6x 2009 earnings, with earnings projected to fall 8.4% in 2009, and recover 9.8% in 2010. This is not attractive given that it represents an earnings CAGR of just 0.3% p.a. from end-2008, that is, corporate earnings will be just 0.6% higher in end-2010 from the 2008 position. It is difficult to justify equities trading at 15.6x PE if the prospective growth is on average, less than 1% for each of the next 2 years.

The KLCI traded at 15-16x PE in 2005 with virtually no growth but there was then the prospect of double digit growth in the subsequent two years. The current 15.6x PE is merely 6% away from the mid-point of the previous bull market’s PE valuation, except today we have virtually no growth once 2009 and 2010 growth are taken together. With prospective 2010 corporate earnings growth in single digits, we consider a range of 13-14x PE as fair, as it implies a PE-to-growth of 1.3-1.4. This translates to an index level of 970-1,040.

Market valuation has moved too far, unsupported by growth. At under 12x, the Malaysian market did appear cheap in early 2009 relative to its 10-year historical average of 15.8x. The current 15.6x PE though, is just below this historical average and is just 6% from the 16.7x mid-point of the previous cycle’s valuation. Corporate earnings growth, at negative to single digit in 2009-10, suggests signs of a weak recovery, but market valuation, being near its mid-cycle value, is expecting and pricing in a V-shaped recovery in 2010. We see little evidence for this, and we believe markets have moved too far, too fast.

Disclaimer

This report is for information purposes only and under no circumstances is it to be considered or intended as an offer to sell or a solicitation of an offer to buy the securities referred to herein. Investors should note that income from such securities, if any, may fluctuate and that each security’s price or value may rise or fall. Opinions or recommendations contained herein are in form of technical ratings and fundamental ratings. Technical ratings may differ from fundamental ratings as technical valuations apply different methodologies and are purely based on price and volume-related information extracted from Bursa Malaysia Securities Berhad in the equity analysis. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance. This report is not intended to provide personal investment advice and does not take into account the specific investment objectives, the financial situation and the particular needs of persons who may receive or read this report. Investors should therefore seek financial, legal and other advice regarding the appropriateness of investing in any securities or the investment strategies discussed or recommended in this report.

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