Alliance Research - Monthly Outlook

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• Investment environment remains tough. Investor risk aversion is not abating with downside economic risk present. Inflationary pressure is mounting globally.

• Equity- Global equities market took a dive beginning of this year and is expected to be sluggish. Malaysian stocks performed poorly with higher political risk premium and slower economic growth. However, most bad news is already incorporated into the market. Thus, it is time to increase the domestic equities allocation as market approaches its fair value.

• Foreign equities will continue to experience volatility with subprime and inflationary issues yet to completely resolve. It would be advisable to underweight the foreign equity.

• Fixed Income- Reduce exposure on local fixed income bond funds as higher inflation may dampen bond prices further. Investors should opt for defensive bond funds, which have invested in strong credit issuers.

• Regional central banks have been pressured to raise interest rates to help combat rising consumer prices. Inflation and interest rate hikes expected to dampen global bond prices. Hence, minimal allocation is recommended in global bond funds.

• Commodities- Despite the current weakness in commodities prices, the demand/supply situation especially in crude oil remains tight. We believe the drop is a mere technical correction.

• Cash- Investors should increase in cash allocation awaiting opportunities in the foreign equities and bond market. As Ringgit is expected to weaken in the coming months, putting structure deposits in foreign currency or gold would be advisable.

MARKET OUTLOOK

• Global equity markets struggled since the start of the year, with all key indices in negative territory YTD, following the emergence of subprime crisis in US, aggravated further by mounting inflationary pressure amidst commodity bubble.

• Major markets are expected to stabilize as crude oil prices retreated 15.5% to close the month at US$124/barrel on slowing demand and high inventory level.

• Dow Jones up 0.25% in July backed by the Fed's approval of housing rescue bill to support troubled mortgage finance giants Freddie Mac and Fannie Mae.

• On the domestic front, political risk premium remains a major threat though we expect it to subside after UMNO election in December 2008. Nevertheless, most bad news is reflected in the market and further downside for the market is limited. We peg the support at 1,100 points with year-end target of 1,150 points.

ECONOMICS OUTLOOK

• The global economy would likely remain sluggish against a backdrop of high crude oil prices and a struggling housing market in the US.

• Although IMF has raised its forecast for global growth to 4.1% in 2008 from its Feb forecast of 3.7% and 3.9% in 2009 from 3.8%, this represents the slowest pace of growth since 2002.

• Global inflation remains the key risk as inflation in advanced economies is expected to spike up to 3.4% and 2.3% in 2008 and 2009 respectively. The worst-affected would be Developing Asia, with 9.1% and 7.4% forecasted in 2008 and 2009 respectively.

• Domestic inflation would average 5.5% for the year, with 7.3% expected for 2H08. We believe BNM would most likely hike interest rates as well this year by 25 – 50 bps despite GDP growth slowing down to 5.2% from 6.0%.

FIXED INCOME OUTLOOK

• The June CPI increased to 7.7% against market expectations of 6.6%. Inflation rose due to higher fuel prices after the government raised retail oil and diesel prices by 41% and 63% respectively.

• Despite rising inflationary pressure, BNM held the OPR unchanged at 3.50% for an 18th straight meeting in order to avoid a fundamental economic slowdown. However, BNM added that generalized second-round effects of price adjustment may prompt a monetary response, renewing expectations on future interest rate increases.

• Going forward, bond prices are expected to trend lower and investors are expected to remain defensive. Trading focus is expected to remain short, to minimize price volatility as inflation continues to negatively impact longer-dated bonds.

• Similarly, US Treasury markets were rather volatile driven by rising inflation and renewed concerns over credit market losses. Nevertheless, US Treasuries traded higher after US government reported its economy grew at a slower pace. As such, strong flight to quality activities is apparent with investor shifting demand towards relative safer US Treasuries.