Indonesia Equity Strategy: Bottom up to top down: Rotate from domestic-facing sectors to export commodities - JPM

· Cautious notes from the bottom up on domestic-facing sectors: Over the past month J.P. Morgan’s analysts in Indonesia have downgraded Cement (materials), Astra International (consumer discretionary) and sounded cautious notes on Banks after their 25% rally since the end of January. Viewed in aggregate, the bottom-up picture is that domestic-facing sectors have done well and the risk-reward ratio appears less favorable at current valuations.

· Domestic-facing sectors have significantly outperformed commodity exporters YTD: YTD MSCI Energy has underperformed Financials by 10.2% and consumer discretionary (Astra) by 6.6%. Industrials (United Tractors), another coal leveraged play, has also been a significant underperformer, trailing financials/consumer discretionary by 11%, while the Jakarta Agri sector has also trailed. A strong currency, healthy domestic demand and downward trending coal and CPO prices since the end of January all contributed towards the performance differential.

We think some of the drivers of the performance divergence could be set to reverse as we go into 3Q, favoring better performance from commodities.
· Our currency strategist Yen Ping Ho holds the view that the pace of IDR appreciation could slow and suggests an Rp8,450/$ rate as a possible trough (less than 0.5% from current levels).

· Our China Strategist Frank Li believes that the China is undergoing an “engineered” slowdown to combat inflation and expects sequential growth to reverse its deceleration in 3Q. Our Economics team forecasts 3Q GDP growth of 9% q/q SAAR from 8.3% in 2Q & 8.8% in 1Q.

· Indonesian CPO exports to China fell 46% q/q in 1Q on high prices relative to Soybean Oil. Industry Journal Oil World however expects Chinese Palm Oil imports to rebound in 3Q to its highest level in 2 years.

· We see a case for rotation – highlighting UNTR, INDY, PTBA, LSIP: We believe there is a case for investors to trim OW positions in domestic-driven sectors (Banks, Astra, Cement) and look to add to positions in lagging commodity stocks. We highlight UNTR (rights overhang now lifted), INDY (healthy leverage to prices, and has capacity to exploit a demand pick up), and PTBA (domestic coal demand growing as generating capacity is added). Our top CPO pick is LSIP on what we view as inexpensive valuations, and we would look to add Astra Agro on a pullback. We are cautious on PGAS, but its 6%/23% underperformance over 1M/12M could create an opportunity if fundamentals turn.