MARKET OUTLOOK January 2018 1.0 Fixed Income Fixed Income Outlook & Investment Strategy Given that it was the start of the new trading year, trading volume in the MGS market rebounded sharply in January 2018 to MYR 60.0b from MYR 27.6b in the previous month. There was a bear flattening on the MGS yield curve as the short end of the curve rose by 5-8 bps whilst the long end of the curve was broadly unchanged, the short end yields are more affected by OPR increases. There was no significant post OPR hike movement in bond yields as the increase was widely expected by the market. The MGS market was also supported by the appreciation of the Ringgit which breached the USDMYR barrier of 4.0 for the first time since August 2016. We expect that the direction of the domestic bond market will continue to be impacted by developments in the US bond market. The official guidance from the Fed is for 3 rate hikes in 2018, with the market widely expecting (93% probability) a 25 bps increase in March 2018. However, should inflation expectations increase in the US, there would be a risk that the Fed would decide on more rate hikes which in turn would result in higher US treasury (UST) yields. In January, the market started pricing in higher inflation expectation with the UST 10-year yield increasing from 2.46% to 2.72%. Inflation is expected to be bolstered by the low unemployment rate, the newly implemented tax cuts and a long-awaited raise in wages. The winding down of quantitative easing and increased inflationary expectations should result higher yields along the long end of the curve, preventing an inverted yield curve and thus allowing the Fed to continue its rate hike cycle. In Malaysia, following its rate hike in January there is little pressure on BNM on another rate hike for 2018. Core inflation, BNM s preferred gauge of inflation, has remained stable and within expectation at 2.2%. Whilst growth has been robust, there are no significant signs of overheating within the economy and growth should soften slightly in 2018 from 2017 s expected growth of 5.8%. As such, local investors will likely continue to be guided by external economic developments in the medium term whilst the perceived undervalued nature of the Ringgit will likely continue to attract fund flows in the near future. Page 1 of 6
MGS Market Whilst foreign interest in the MYR may persist, any downwards pressure on MGS yields may be hampered by rising UST yields. The yield differential between the UST 10 year and MGS 10 year has been well over 150 bps over the last 5 years, with the recent spike in UST yields the yield is only around 120 bps. A further increase in UST yields will reduce the attractiveness of mid to long end MGS vs US Treasuries, despite any perceived undervaluation of the MYR. The MGS 10 year yield may come under some pressure given that the last time OPR was at 3.25%, the MGS 10 year yield averaged 3.99% whilst UST 10 year averaged on 2.10% during that time period. With a higher UST yield and a similar OPR rate, the yield on the MGS 10 year could potentially move higher. We expect the long end of the MGS curve to have some support given the significant yield differential of 46 bps between the MGS 10 year and MGS 15 year. Corporate Bonds Market Corporate bond spreads continue to be wide with the spread between MGS 10 year and 10-year GG at around 60 bps. In 2017, we saw MGS yields decline broadly over the year whilst yields of highly rated corporate bonds of a comparable tenure actually increased slightly. Given the currently wide spreads, corporate bonds should be supported in the event of any increase in MGS yields. In the near future, the rising interest rate environment and impending general election are factors that could influence the direction of the market in 1H2018. Nevertheless, a slew of high profile rail projects such as the MRT2, MRT3, LRT3, ECRL and HSR are expected to invigorate capex especially from the construction/infrastructure sector. As such, the bulk of the corporate issuances will still be heavily weighted towards government-related entities that are tasked to finance these infrastructure projects. Investment Strategy Portfolio Duration Portfolio Duration For duration strategy, we remain structurally neutral on portfolio duration as Bank Negara has not signalled any further move in the near future. Despite the recent OPR hike, MGS yields remain supported on the back of the strengthening MYR. Duration strategy will however change if there is a shift in our expectations of the sustainability of the MYR appreciation thereby raising the risk of an MGS selloff if there is any change in the pace and quantum of US interest rate hikes. Page 2 of 6
Security Selection Focus on valuation play to take advantage of the volatile market to enhance portfolio return, which currently favors corporate bonds over government bonds in view of the wide corporate credit spreads. Participate in high quality lower rated corporate bonds in the primary market which offer higher yield pick-up relative to the secondary market as and when price discovery takes place for the new issuances. Page 3 of 6
2.0 EQUITY Global market review and strategy Dow Jones started the New Year with a solid performance, fuelled by strong macroeconomics data which suggest that momentum likely carried over into 2018. U.S. economy continued to expand at a healthy pace in the fourth quarter of last year at 2.6% on the back of solid consumer spending and resilient business capital expenditure growth, with employment growth remained resilient. In addition, stronger than expected earnings reports and guidance of a positive earnings outlook for 2018, benefitting from synchronized global economic growth and tax reform drove equity prices higher. This was despite a shallow market pullback on concerns over the government shutdown. For January, Dow Jones Industrial Index was upped by 5.79%. Meanwhile, as expected, the Federal Reserve left its benchmark interest rate range unchanged between 1.25 percent and 1.5 percent, as the economy continues to grow at a solid rate and the job market continues to gain strength. The Euro Stoxx 50 also ended the first month of the year on a positive note, registering a 3.01% monthly gain on optimism over economic growth and earnings. Positive data continues to flow in for the Eurozone, indicating 2018 economic outlook remains bright. Eurozone Gross Domestic Product ( GDP ) rose 2.5 percent in 2017, the fastest growth rate since a 3.0 percent rise in 2007, with consumer confidence index remained strong, indicating that the outlook for domestic demand remains very favourable. Current positive economic momentum and stock price growth is likely to continue for the ASIAN markets in 2018. We remain positive in China and Korea while neutral on Taiwan. China economic growth is forecasted to moderate slightly as policymaker focus on quality of growth. However, supply side reforms should improve efficiency and elevate corporate earnings in the longer term. Household consumer consumption remains resilient on buoyant job creation and rising incomes. For Korea, better corporate governance and potential improvement in shareholders return, coupled with normalization of South Korea China relations are catalyst to market. Taiwanese technology sector will continue to be supported by the global growth pick up as well as semiconductor restocking while staying selective on non-tech. India has seen earnings disappointment the past few years. Expectation started off the year high and dwindles down towards the end of the year. This time around, earnings should meet expectations given synchronized global growth, economic reforms (GST, Insolvency Banking code), and better monsoon. We maintain Neutral on India. ASEAN markets remained in tandem with the global markets momentum. The fundamental outlook for ASEAN has not changed significantly, though we should remain cognizant of the risk of inflation, accelerated rate hikes and any subsequent currency impact. Exports and tourism are still growing. Farming income, private consumption and investment remains subdued in Thailand and Indonesia, but bright in the Philippines and Vietnam. Consumer confidence is slowly improving across the region, and may tick up strongest in Indonesia if the rupiah is stable. The weaker sentiment and lower prices for ASEAN equity assets make it a more opportune time to find value, considering the improved outlook for growth vs a few quarters ago. Locally in Malaysia, external trade continued to perform favorably in Nov 2017, with exports up 14.4% y.o.y (expectation: 14.5% y.o.y, revised Oct 2017: 18.7%, YTD: 20.4% y.o.y) while imports also continued to register strong double-digit growth at 15.2% y.o.y (expectation: 14.8% y.o.y, Oct 2017: 15.2% y.o.y, YTD: 21.2% y.o.y). Page 4 of 6
Exports continued to be driven by the electrical and electronics ( E&E ) segment that expanded strongly by 21.0% y.o.y in November from 16.9% y.o.y in Oct 2017. This segment is envisaged to perform robustly, benefitting from the cyclical growth underpinned by a healthy external demand. Meanwhile, imports composition remains roughly the same with intermediate goods contributing the bulk at 54.9% (Oct 2017: 54.1%), capital goods at 14.0% (Oct 2017: 12.8%) and consumer goods at 8.9% (Oct 2017: 8.9%). Trade balance was sustained at RM9.95 bil (Oct 2017: RM10.44 bil), with year to date ( YTD ) balance at RM89.98 bil or 10.81% higher than the same 11 months the year before (Net exports contributed about 8.35% of 2016 GDP), suggesting a 1.0% growth contribution to GDP. IPI for Nov 2018 surprised on the upside at 5.0% y.o.y (expectation: 4.6% y.o.y, Oct 2018: 3.4% y.o.y) along with a buoyant manufacturing sales reading of 10.9% y.o.y (Oct 2018: 11.0% y.o.y), continuing to be supported by robust export demand. However, there is some expectations of a slower export demand in 2018, although mitigated by the extension of the E&E cycle as China hand phone brands delay the launch of flagships into 2018. Following BNM's guidance in November that the Monetary Policy Committee ( MPC ) "may consider reviewing the current degree of monetary accommodation," the central bank s MPC has decided to raise the overnight policy rate ( OPR ) by 25bps to 3.25% at its 25 Jan 2018 meeting. The stated rationale for the policy move is that the current growth momentum of the Malaysian economy as well as a pre-emptive move to prevent a build-up of financial imbalances that could occur from a prolonged period of low interest rates. The accompanying statement to the MPC appears neutral but the committee has kept the door open if incoming data should require further tightening. Over in the FX space, the Ringgit benefited from the greenback s weakness and expectations of the rate hike to trade down to 3.8985 towards the end of January. The Ringgit has strengthened 3.66% YTD and is one of the biggest gainers in the region, third behind the Thai Baht and Chinese Yuan. Global markets started 2018 with a positive note, continuing the strong run last year. This applies to the Malaysia market which has done well in the first month of the year. We maintain our positive view on the local market as the continuous robust global economic and still-benign inflation still point towards a risk on market. Other than the external tailwind, specifics drivers for local equities include 1) its laggard performance against regional peers with the possibility of catching up in the near term; 2) oil price recovery to boost local economy and improves sentiment; 3) Ringgit recovery is driving further foreign inflow; and 4) historically general election is a booster and positive driver for local market. Although we are positive on the local market but we are watchful on the near-term key risks such as 1) higher inflation expectation in the US which potentially lead to more rate hikes and higher treasury yields; and 2) potential revival of USD strength leading to weaknesses in EM assets. Locally we continue to favour sectors such as financial, oil & gas, consumer staples, externally driven small and mid-cap stocks and thematic play for the upcoming GE14. Page 5 of 6
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