The Malaysian economy was hit hard by the Covid-19 pandemic in 2021. We think that current entry levels for the KLCI Index look attractive, particularly for value investors.
iFAST Macro Research Team | Published on 24 Dec 2021
- We expect the economy to rebound in 2022, as the nation starts to ease movement restrictions on the back of rapid progress on the domestic vaccination program.
- The combination of a sustained global economic recovery and high commodity prices will support export and manufacturing growth next year. Domestic consumption will likely recover as well, as pent-up demand is unleashed following the economic reopening, and unemployment rate decreases.
- Monetary policy can remain accommodative, as inflation remains tame and is expected to stabilise over the next few years.
- We foresee a strong broad-based earnings rebound across all sectors, except for the Healthcare and Plantation sectors.
- Attractive valuations provide a good opportunity for value investors to enter Malaysian equities, while the solid dividend yield should also bulk up the total return for investors. We are upgrading our Star Ratings for Malaysian equities to 3.0 Stars “Attractive”.
We have upgraded our Star Ratings for Malaysian equities to 3.0 stars “Attractive” due to the attractive upside potential, cheap valuations and attractive dividend yields. Perhaps it is time for investors to reconsider this underappreciated market.
The unprecedented Covid-19 pandemic has dealt a big blow to the Malaysian economy as the prolonged lockdowns and economic slowdown has led to business closures and job losses. With the ramped-up speed of Covid-19 vaccination, overall daily Covid-19 cases have dropped to below 5,000 cases, and Covid-19 restrictions have been eased gradually in most areas.
That being said, we expect the prolonged Covid-led disruption to alleviate in 2022. Furthermore, the economic reopening would revitalize economic activities, restore domestic consumption, business operations, exports, and imports, and thereby underpin the recovery in 2022. Based on the recent positive economic data and latest Covid-19 developments, we believe Malaysia is now on the right track to full recovery.
The economy is expected to rebound post-pandemic
On the other hand, the nation’s GDP data announced recently has provided us further insight into the nation’s economic recovery pace. According to the Department of Statistics Malaysia, Malaysia’s economy shrunk by -4.5% year on year in Q3 2021. The downtick was mainly attributed to the sharp fall in private consumption and investment activities amid the reimposition of lockdown measures to combat the spread of the virus in July. Despite the surge in government consumption backed by higher spending on supplies and services attributed to the health-related expenditure in the quarter, the increased consumption could not fully mitigate the decline in private consumption and investment activities.
With that being said, we believe the worst has passed as the nation started to ease the movement restrictions on the back of rapid progress of the domestic vaccination program. With that, we expect the recovery of Malaysia’s economy will be regaining a better footing, and Malaysia’s GDP growth is expected to rise in Q4 2021 and beyond. Regarding the economic yearly growth projection, we reckon the Malaysia economy would wrap up the year 2021 with a growth of 3% to 4% while foreseeing an expansion of 5.7% in 2022, see Figure 1. With that, the local equity market is foreseen to grow alongside the sunnier days ahead for Malaysia’s economic recovery path.
Figure 1: Malaysia Yearly GDP Growth Forecasts YoY (%)
Rebound underpinned by strong exports and manufacturing amid improving external demand and robust commodity prices
Malaysia is a major exporting nation, where electrical and electronics products, chemicals, petroleum products, and palm oil are among the nation’s main exports.In September 2021, Malaysia expanded its trade surplus for 17 consecutive months (See Figure 2). This is because the exports continue to outpace the imports backed by high commodity prices and improved global demand buoyed exports. As a result, the YoY figures showed sustainable recovery for both oil and gas and non-oil and gas exports (See Figure 3).
With an expectation of improving external demand across the globe, Malaysia would be one of the beneficiaries as it is a crucial exporter globally. Growth in the local economy is likely boosted by external growth, as more demand for semiconductors bolsters the export sector. At this juncture, the countries including Singapore, China, the United States, Thailand, and Japan are the major trading partners of Malaysia, where they are highly relying on imported products such as palm oil, electrical, and electronics products. We also opine that the commodity price would continue to stay high, fueling the export growth over a more extended period.
Moving forward, we expect that the sustainable global economic recovery and high commodity prices will likely continue to support Malaysia’s export growth in the year 2022.
Figure 2: Balance of Trade for Malaysia
Figure 3: Total Exports for Malaysia
Notably, a slew of positive economic data, including Manufacturing PMI and Industrial Production Index (IPI), has further proven the recovery’s view of Malaysia’s economy, See Figure 4. After lifting Covid-19 restrictions, Malaysia’s Manufacturing PMI for October has entered into expansion territory after five months of contraction. At the same time, there is a slight improvement in Malaysia IPI for September, indicating a positive growth of production following the resumption of business activity and sustained growth in external demand.
Figure 4: Malaysia’s Manufacturing PMI and Industrial Production Index
Economy further supported by improving domestic consumption amid a recovery in the labor market
Despite a decline in domestic consumption in the last quarter, consumers’ pent-up demand will be highly unleashed after the economy’s reopening as people are allowed to move around freely, and businesses can operate without any restriction or disruption. In addition, the improved economic and business sentiment would resuscitate the labor market by creating more job opportunities. Hence, the rise of disposable income is expected to lead to a significant comeback in overall domestic consumption. At the same time, the unemployment rate is forecasted to improve to 3.5% by the end of 2023, which could further boost the growth of Malaysia’s economy in the long run (See Figure 6).
Figure 5: Malaysia Private Consumption QoQ Growth (%)
Figure 6: Malaysia Unemployment Rate Forecast (%)
Tame inflation allows room for continued accommodative monetary policy
On the other hand, headline inflation numbers have tapered down in June and July after spiking in April and May as the low base effect had worn off. This is in line with our view that the inflation spikes are most likely temporary due to the low base effect caused by the deflation in prices one year ago and that the recent inflation spikes are mainly due to cost-push stemming from higher commodity prices. In the future, we reckon the inflationary pressure in Malaysia would surge in Q4 2021 due to the pent-up demand following the easing of containment measures since the starting of Q3 2021. Beyond that, we expect the inflation rate to stabilize alongside the continued recovery path, with an expectation of 1.8% and 1.9% in the year 2022 and 2023, See Figure 7.
Figure 7: Malaysia’s CPI is expected to stabilize in upcoming years
In the effort to shore up the economy, monetary and fiscal policymakers have unleashed the taps. Throughout the year, the Overnight Policy Rate (OPR) has been lowered by 175 basis points from 3.5% to a historical low of 1.75%.
At its November rates meeting, the Monetary Policy Committee (MPC) decided to maintain its overnight policy rate (OPR) at 1.75% unchanged, targeting to continue to cushion the economic impact against the local businesses and households. Despite lower virus cases recorded in the recent weeks, the Malaysia growth outlook remains tilted downward as downside risk such as supply chain bottleneck, the possibility of lockdown’s reimposition, and weaker than expected global growth.
Taking into account the inflation outlook, we foresee BNM will continue to maintain the OPR at the current rate of 1.75% during the upcoming MPC meeting. Furthermore, we expect BNM to extend their accommodative monetary policy stance further with the first-rate hike postponed from 3Q 2022 to 4Q 2022 to aid post-pandemic economic recovery (see Figure 8). Hence, the extended low-interest-rate environment would remain favourable to the equity market going forward.
Figure 8: Malaysia Overnight Policy Rate Forecast
Earnings to rebound strongly in 2022 across all sectors, except Healthcare and Plantation
Going forward, with the economy finally reopening after the prolonged lockdowns, we do expect corporate earnings to improve.
At this juncture, we think the earnings revisions have bottomed and priced in most of the negatives. After being downgraded throughout 2021, downward revisions have stabilised in October, coinciding with the tapering of Covid cases in the country which allowed the government to fully reopen the economy and remove lockdown measures. In fact, in November, we are seeing slight upgrades to 2021 and 2023 earnings, which reflects better optimism from analysts.
KLCI earnings are expected to grow by 6.9% in 2022 and another 8.3% in 2023. Overall it may seem the KLCI earnings growth is sluggish, mainly dragged down by glove stocks who are expected to see a normalization in earnings post pandemic. If we were to strip out glove stocks from the equation, KLCI earnings growth are at much more palatable levels of 13.9% and 7.7% in 2022 and 2023.
Table 1: Earnings Growth Estimates by Sector
|KLCI Index (ex Glovemakers)||13.9%||7.7%|
|Telecommunications & Media||9.4%||10.9%|
|Source: Bloomberg, iFAST compilations. Data as of 30 Nov 2021.|
On another positive note, we are also seeing broad based positive earnings growth in 2022 across most sectors except for the Healthcare sector.
Earnings growth for the KLCI Index will be mainly driven by the financial sector – the biggest sector with a weight of 30.7%. The financial sector is expected to grow earnings by an impressive 10.8% in 2022 and 7.0% in 2023 amid a few key catalysts for growth including:
- Higher net interest margins as the central bank Bank Negara Malaysia finally starts to raise interest rates in 2022 and 2023 after cutting rates to a record low of 1.75% in 2020
- Improving non-performing loan ratio and easing loan loss provisions as the economy recovers
Another key driver for KLCI earnings growth is the consumer products and services sector, which is also expected to grow strongly in 2022. We think the sector will benefit from the reopening of the economy after lockdowns were finally relaxed recently. We foresee that pent up consumer demand will be unleashed as consumers will finally be able to spend in brick and mortar stores whereas holiday makers can resort to domestic travel to satisfy their travel itch.
Time to relook into underappreciated Malaysian equities; Upgrading Malaysia to 3.0 Stars “Attractive”
In terms of valuations, Malaysian equities look attractive as the KLCI Index is now trading at 13.3X forward P/E based on FY 2023 estimated earnings. We believe markets are pricing in some political uncertainty as the much anticipated general elections could be held in 2022.
That said, for value investors, the current entry level does provide a good opportunity. Our fair P/E for the market is 16.0X. As such, our target price for KLCI is 1,815 by end-2023, which represents a decent 20% upside potential from the current level of around 1,500. On top of that, the estimated dividend yield of more than 4% in the coming two years is set to bulk up the total return for investors.
All in all, we have upgraded our Star Ratings for Malaysian equities to 3.0 stars “Attractive” due to the attractive upside potential, cheap valuations and attractive dividend yields. Perhaps it is time for investors to reconsider this underappreciated market.
Figure 9: KLCI Index Price and Forecasted EPS
Table 2: Projections and potential upside for KLCI Index
|Malaysia (KLCI Index)||FY20||FY21||FY22||FY23|
|PE Ratio (X)||17.2||15.6||14.9||13.4|
|Expected Earnings Growth YoY||–||37.4%||6.9%||8.3%|
|Earnings Per Share (EPS)||71.2||97.9||104.7||113.4|
|Projected Fair Price|
(based on fair P/E Ratio of 16.0X)
|Potential Upside from Today (%)||–||–||–||21%|
|Estimated Dividend Yield (%)||–||–||4.1%||4.4%|
|Source: Bloomberg Finance L.P., iFAST estimates. Data as of 22 Dec 2021.|
Table 3: Recommended Products
|Malaysia||Aberdeen Standard Malaysian Equity SGD||iShares MSCI Malaysia ETF|