AS the curtain falls on the first quarter (1Q2017), it is clear that the local stock market is having a party. The benchmark FBM KLCI is up 5.99%, its fastest quarterly expansion since 2013 and its best start to a year since 2007.

The return of foreign investors, who were net sellers over the past two years due to a weakened ringgit, is one of the factors that is fuelling the rally. Year to date till March 24, foreign investors have poured a net RM1.378 billion into local stocks, according to data tracked by MIDF Research. The past two years had seen a net outflow of RM19.5 billion in 2015 and RM3 billion last year.

However, the FBM KLCI is still lagging behind other emerging markets, slightly underperforming the MSCI Developed Markets Index, which rose 6.21% in 1Q2017. In comparison, the MSCI Emerging Markets Index has expanded twice as fast at 12.43% over the same period.

This lag is consistent with the trend over the past 12 months, says AllianceDBS Research head of research Bernard Ching. While improving fundamentals and sustained bullish sentiment will keep the Malaysian market buoyant in the near term, he says the upside to fundamental valuations has narrowed, though not yet stretched.

“Asset prices are likely to overshoot fundamental values in a liquidity driven rally,” Ching says. “As such, investors should look for profit-taking opportunities as and when they arise.”

The emerging question is whether the strong first quarter is signalling a strong year ahead for the FBM KLCI. It began the past two years in green, albeit more moderate, territory but finished in the red, down 3% last year and falling 3.9% in 2015.

Thus far, Bursa Malaysia has closed three consecutive years in retreat, although it is still, according to Bloomberg, technically, the world’s longest bull market at eight years and counting since the last correction over 20% in 2008.

Some indicators, such as the ringgit, are looking up, but have proved to be false hope before.

The ringgit has regained some lost ground against the greenback over the past three months, up 1.35% to 4.4255 as at March 31. However, it is still down 12% over the past year compared with 3.8905 on April 1 last year.

In US dollar terms, the FBM KLCI has gained 8.1% YTD, outperforming some regional peers such as the Jakarta Composite Index (+6.8%) and the Nikkei (+4.8%), though lagging behind the Straits Times Index (+14.2%) and the Hang Seng Index (+10.2%).

Banks and government-linked companies have driven the FBM KLCI’s rise this quarter, making up 7 of the top 10 gainers among its 30 constituents.

Corporate announcements and news flow are a significant sentiment driver this quarter. A notable example is Sime Darby Bhd’s 14.57% rise up to March 31 as excitement builds over its much-anticipated demerger plan that will see the plantation and property units separately listed on Bursa.

The demerger plan was announced in February, six months after Tan Sri Abdul Wahid Omar took the helm at Permodalan Nasional Bhd, the bumiputera equity firm that controls the majority of Sime Darby shares.

With a reputation in corporate Malaysia as a “Mr Fixit”, Wahid’s mandate is to improve the corporate performance of PNB’s stable of companies. When he took over, the cumulative performance of PNB companies underperformed the FBM KLCI.

The impact on investor sentiment was almost immediate — the collective showing of PNB companies overtook the benchmark in October and has outperformed the FBM KLCI year to date.

Elsewhere across the market this quarter, the shift in sentiment and investing appetite is also clearly visible as investors opt for commodity and cyclical stocks over more defensive counters.

While the inflection point came around October last year, the shift has been more pronounced so far this year.

YTD, commodity counters are collectively up 10.5% while cyclicals are up 10.8%. In comparison, defensive counters are up by a total of 1.7%.

Among the commodity counters that have done well are Press Metal Bhd which chalked up a YTD return of 66.1%, Felda Global Ventures Holdings Bhd (34.2%) and Batu Kawan Bhd (23.1%).

The outperformers among the cyclicals were AirAsia Bhd (62.6%), Ekovest Bhd (48.1%) and Malaysia Building Society Bhd (44.4%).

The defensive stocks that outperformed included My E.G. Services Bhd (25.2%), TIME dotCom Bhd (11.9%) and Axiata Bhd (9.1%).

Ching of AllianceDBS Research expects this trend to continue as cyclical stocks tend to outperform defensive stocks in a liquidity-driven rally.

“Earnings prospects for Malaysian equities have improved after the earnings downgrade cycle ended in 3Q2016. With a nascent earnings recovery and more stable commodity prices, cyclical stocks will outperform defensive stocks in 2017,” Ching says.

Outside of the 30 top stocks making up the benchmark index, small and mid-cap companies are also taking off and outperformed the FBM KLCI. The FBM70 Index has risen 12% since the year began, while the FBM Small Cap Index grew 15.5%.

Much of the bullishness has been seen in the technology counters, which is the best performing sector YTD with a 38.2% gain. Construction and property counters are also rallying by just over 15% each.

Driving the tech sector’s rally is excitement over Apple Inc’s upcoming iPhone 8, with most expecting strong sales. Players within the Apple supply chain such as Globetronics Technology Bhd and Inari Amertron Bhd were among the first counters to surge.

While Ching sees further upside for tech stocks, he says valuations are now quite fair after the YTD run-up and thinks a rerating will only happen once the iPhone 8 begins selling around the third quarter of the year.

Meanwhile, the property rally is driven by investors seeing the sector as a good proxy to the larger market, says Kenanga Research head of equity research Sarah Lim. However, the rally is detached from physical market fundamentals and is more driven by news flow.

Lim believes valuations have bottomed out and developers are unlikely to see substantial earnings misses this year. “More likely, we will see most developers on target or slightly beating estimates for the full year in terms of sales.”

Notably, the oil and gas sector rose 8.2% this quarter as global Brent crude oil prices remained steady around US$55 per barrel for most of the quarter, thanks to the six-month, Organization of Petroleum Exporting Countries-led output cut which began in January.

However, the outlook for oil and gas stocks remains uncertain, says Ching, and will largely depend on company-specific news flow and further movement in oil prices.

“While kitchen sinking and impairment charges are largely done, earnings recovery is still at a nascent stage and uneven, given the low utilisation rate (for vessel owners) and slow order book replenishment (for fabricators),” says Ching.

As at March 30, Brent crude was trading at US$52.96 a barrel, down 7.8% from its YTD high of US$57.10 on Jan 6.

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