Malaysia. abc. *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations

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1 July 212 Neel Sinha* Head of Research, Southeast Asia The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations 1

2 July 212 Introduction has a high weighting for utilities and other defensive sectors. This is also reflected in low market volatility and low correlations with global indicators. Domestic matters therefore carry a larger weight when making investments in. Market structure Although the two biggest sectors financials and industrials constitute around 45% of MSCI, the market has a higher proportion of stocks (35%) in defensive sectors (consumer staples, utilities and telecoms) than other Asian markets. Neel Sinha* Head of Research, Southeast Asia The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch neelsinha@hsbc.com.sg *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations As a consequence, s market volatility is low compared with the rest of Asia. If we look at earnings and total market volatility, scores low (i.e. it is relatively stable) on both counts. In terms of PE multiple volatility, is the most stable market in Asia. Market performance (Index levels) Average calendar year performance of MSCI Indices Ax J 1 Jan-95 Feb-96 Mar-97 Apr-98 May-99 Jun- Jul-1 Aug-2 Sep-3 Oct-4 Nov-5 Dec-6 Jan-8 Feb-9 Mar-1 Apr-11 May MSCI Rel to Asia ex Japan (RHS) market composition Sector Weights FINANCIALS 3% INDUSTRIALS 15% TELCOM SERVICES 12% CONSUMER STAPLES 12% UTILITIES 11% CONSUMER DISCRETIONARY 11% MATERIALS 6% ENERGY 4% INFORMATION TECHNOLOGY % HEALTHCARE % MSCI is a well diversified universe. The top-five and top-1 stocks are not dominated by any particular sector, making up 35% and 56% of the index, respectively. On this measure it is more diversified than Singapore and Hong Kong and substantially less than other ASEAN markets. It also means that stock selection plays an important role. Also, has a growing domestic fund management industry, which is a large holder of stocks in the market. 2

3 July 212 is one of the smaller markets in the region, with a 5% weight in MSCI Asia ex Japan. Liquidity is not very high and turnover is just 1% of the Asia ex Japan market. : Stock market liquidity MY Note: Chart represents the number of months that the market takes to turn over. Source: Bloomberg, HSBC Largest stocks in Stock rank Stock name Index weight 1 CIMB GROUP HOLDINGS 1% 2 MAYBANK 8% 3 SIME DARBY 7% 4 GENTING 5% 5 PETRONAS CHEMICALS 5% Top-5 35% 6 TENAGA NASIONAL 5% 7 IOI CORPORATION 4% 8 THE PUBLIC BANK 4% 9 AXIATA GROUP 5% 1 DIGI COM 3% Top-1 21% Correlations is a domestically driven market in that it has a high correlation with domestic M1 money supply (.66), higher than the regional average of.44, and a lower correlation with global equities (.48) than the regional average. This is a reflection of the market s composition the larger stocks have a distinctly domestic flavour. Correlations of MSCI Asia ex Japan Macro correlations Since 21 Since 21 ISM Exports.49.6 Money supply Fund flows.68 past 1 years past 5 years previous 5 years Indices Past 15 years Past 1 years Asia ex Japan Aworld.38.5 Source: MSCI, Bloomberg, Thomson Reuters Datastream, HSBC 3

4 July 212 Earnings and valuation s earnings are less volatile than the rest of the region. Currently, earnings have moved back to trend growth after a decline in 29. Compared with other ASEAN countries, earnings volatility is also low. Actual vs trend earnings Nov-99 Sep- Jul-1 May-2 Mar-3 Jan-4 Nov-4 Sep-5 Jul-6 May-7 Mar-8 Jan-9 Nov-9 Sep-1 Jul-11 May-12 Actual Earnings Trend MSCI annual EPS growth* % y -o-y 226.1% - Malay sia *The volatility in reported annual earnings growth is often due to exceptionals and oneoff items like asset disposals or write-offs. Although s economy is highly sensitive to global growth (its gross exports to GDP ratio is one of the highest in Asia), this is not reflected in the stock market, where the largest players are in utilities, telecoms, palm oil and gaming. The earnings momentum chart shows the level of earnings upgrades and downgrades in a 12-month forward period. This indicator shows that analysts optimism for earnings over the next 12 months has started to rise. While they are still revising up their forecasts, it is happening at a slower pace than in late 21. Earnings momentum* vs MSCI returns 12-month forward EPS growth* vs MSCI Index (%) (%) Momentum MSCI MY Index y -o-y (RHS) EPS grow th MSCI MY Index y-o-y (RHS) *Number of EPS estimates up as a % of total number of revisions in estimates *Percentage change in trailing 12-month and 12-month forward EPS 4

5 July 212 This muted optimism is also evident when looking at stock upgrades and downgrades. The number of upgrades has started to decline, suggesting that analysts are becoming more cautious about n stocks. This is also evident in the recommendation consensus score, which ranks and rates analysts stock recommendations. After reaching a high level of bullishness, this ratio has started to turn towards the historical average. Upgrades as % of total earnings revisions* vs MSCI returns Recommendation consensus score (%) % upgrades MSCI MY Index y -o-y (RHS) Analysts feeling more bearish Analysts feeling more bullish Recommendation consensus score (RCS) Av erage ±2SD *Number of EPS estimates up as a % of total number of revisions in estimates Note: The recommendation consensus score (RCS) assigns a score of 1 to each buy recommendation, 3 to hold and 5 to sell is currently trading at a forward PE of 13.8x, while the average over the last 1 years has been 14.1x. The expected EPS growth is 12.4% for this year compared with 15.7% for the region. has traded at a 1% premium to Asia ex Japan region historically but currently the premium is much higher at 4%. : PE band chart Relative valuation Price level Dec-2 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 16x 14x 12x 1x PE:MY/Ax J has always traded on a higher forward PE multiple than the rest of the region. Part of this premium can be explained by its low correlation with global equities, having the highest weighting in defensive sectors, low earnings volatility, and a large domestic institutional investor base. Telecoms is the most expensive sector, followed by energy. The cheapest sectors are financials and materials. 5

6 July 212 n ROEs have hovered between a low of 11% in 21 and a high of 15% in 28. Current forecasts point to a ROE of close to 14%, showing a strong recovery since 28. PB ratios have hovered in a range of 1.4x and 2.4x, but these include some extremes. The average is about 1.8x, with current valuations above that level. : Earnings and bond yields : PB vs ROE/COE (12-month forward) 12 1 BY EY PBR ROE/COE Source: MSCI, Thomson Reuters Datastream, Bloomberg, HSBC Source: MSCI, Thomson Reuters Datastream, Bloomberg, HSBC 12-month forward PE vs 1-year average and standard deviations from average Current PE Rolling 1-yr avg Rolling 1-yr SD # SD from avg Energy Materials Industrials Consumer Discretionary Consumer Staples Financials Telecom Utilities MSCI Fund flows In the last decade, mutual funds have taken money out of (about USD1bn). Large inflows, in particular in 23-7, peaked at a cumulative USD4bn by early 27. Since then, foreign investors have been selling n equities. Although they have been net buyers since 29, the level of buying has never been sufficient to build back the investment exposure these investors had before the financial turmoil in 28. This is also reflected in fund weightings, with most investors being underweight, both for AEJ and GEM funds. 6

7 July 212 Cumulative foreign institutional funds since June USDbn funds active weights and Z-score relative to benchmark Funds Current -1M -3M -6M -12M Active weight Z-score Source: EPFR, HSBC Jun-3 Dec-3 Jun-4 Dec-4 Jun-5 Dec-5 Jun-6 Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Source: EPFR, HSBC Economic basics After being known as a major producer of tin and rubber, s economy has long since diversified. Today is an industrialised nation whose main trading partners are the US, Japan and Singapore, and a major exporter of semiconductors, electronic goods and palm oil. The country also has significant reserves of oil and gas. The oil and gas sector supplies more than 4% of government revenue. Leif Eskesen Chief Economist for India & ASEAN The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch leifeskesen@hsbc.com.sg As an export-dependent nation, was severely affected by the global recession that followed the financial crisis of 28. In 21 the government laid out an Economic Transformation Plan (ETP), an ambitious initiative to double income per person to USD15, to reach developed-nation status by 22. The aim is to focus on high value investments and reduce dependence on lower-end manufacturing. While the economy has slowed in recent quarters, domestic growth momentum is providing a healthy cushion. This is partly due to favorable labour market conditions, subsidies and wage hikes, which have supported consumption. Investment has also picked up, supported by both private and public-sector spending related to the ETP. Economic policy primer In September 1998 Bank Negara (BNM) pegged the USD/MYR exchange rate in response to the Asian Financial Crisis. It moved the currency to a managed float in July 25 and since then has progressively liberalised the FX market, including allowing the use of MYR for trade settlement and inter-company foreign currency borrowings. In recent years the central bank has taken a more hands-off approach to the n ringgit than its regional peers. This has helped to lend greater stability to the currency amidst the volatility of global capital flows after the global recession. On the fiscal side spending remains generous ahead of the general election, which has to be held before March 213. The administration has introduced a minimum wage policy, income-support programmes and civil service pay rises. However, more broad-based productivity improvements and efforts to enhance the investment climate will be needed to meet the ETP target of achieving developed-nation status by 22. 7

8 July 212 Key economic data % Year f Consumer spending Government consumption Fixed investment Stockbuilding (% GDP) Domestic demand Exports Imports GDP Industrial production Unemployment (%)* Consumer prices Current account (% GDP) Budget balance (% GDP) MYR/USD* month interbank rate (%)* *Period-end Source: CEIC, HSBC estimates Political structure has a bicameral parliament composed of an upper house (Senate) and a lower house, the House of Representatives (Dewan Rakyat). The head of government is the Prime Minister, who is appointed by members of the House of Representatives. Key regulatory bodies s central bank, Bank Negara, promotes monetary and financial stability. The Securities Commission supervises exchanges, clearing houses and central depositories. Bursa offers exchange-related services including trading, clearing, settlement and depository services. The major index is the Kuala Lumpur Composite Index (KLCI). 8