MERRILL Lynch has upgraded its recommendation on Malaysia's equity market to overweight in view of the steady macro-economic backdrop and an expected 17% growth in corporate earnings.
Malaysia currently accounts for 6% of Merrill Lynch's model portfolio assets and is ranked second highest, after India, in terms of asset allocation in Asia-Pacific.
The research house has, however, downgraded Hong Kong to underweight, which has created room for the re-rating of the KLSE.
It said Malaysia was ranked highest in terms of valuation and returns. The KLSE Composite Index (CI) also stacked up well against its peers in the region.
“Earnings revisions remain among the most positive in the region, while valuation looks cheap in both absolute and relative terms,'' Merrill Lynch said in its latest research note on Asia-Pacific equity markets.
According to the research note, the CI's current price–earnings ratio of 11.8 times is significantly below its historic three-year average of close to 18 times and is also at a slight discount to the region.
Merrill Lynch forecast corporate earnings growth of 17%, coupled with a modest and sustainable dividend yield of 2.8%, and 12.8% return on equity (compared with 11.5% previously) as earnings before interest and taxation (EBIT) margins improve.
“This offers a pretty attractive return proposition given the high uncertainty of earnings in many other markets at present, in particular South Korea, Singapore and Australia, which have seen much weaker earnings trend of late,'' it added.
Another factor that prompted it to upgrade Malaysia's market was the contrarian indicator – the latest Pacific Rim Fund Manager Survey dated March 19, which highlights where there is likely to be rotation away from heavily consensus positions.
According to Merrill Lynch, many fund managers are increasingly underweight on the KLSE.
It believes that foreign investors had liquidated investments in Malaysia to fund their overweight position in Thailand, which continues to stand out as the most consensus overweight among 90 funds surveyed.
The CI had under-performed Thailand's SET Index by 15% over the past 12 months.
Given Malaysia's sound economic fundamentals and stable earnings growth, Merrill Lynch said, the consensus view of an underweight on Malaysia's market was a contrarian positive for its overweight recommendation on the KLSE.
Merrill Lynch said the near-term catalysts for the KLSE could come from the forthcoming fiscal stimulus package.
With the budget deficit being close to 5.7% of gross domestic product (GDP), the research house expects the government would be keen to encourage the private sector to pick up the pace.
It said the key elements to watch for in the stimulus package are reduction in mandatory contributions to the Employees Provident Fund (EPF) and in income tax.
Employees' contributions to the EPF, currently at 11%, was previously reduced to 9% on April 1, 2001, in the aftermath of the Asian financial crisis to boost consumer spending.
Merrill Lynch recommends that clients focus on domestic-oriented sectors that are best positioned to benefit from this de facto pump priming, namely, infrastructure, property development and gaming companies.
Tobacco and palm oil also continued to enjoy positive earnings revision, it said.