KUALA LUMPUR: Valuations for Malaysian stocks may be compressed in the second half of this year as rising cost of doing business, amid uncertainties surrounding the country’s new political landscape and world economy, eat into companies’ profitability. The recent revision in the local fuel prices is expected to spur inflation, which will translate into weaker consumer purchasing power and a possible hike in interest rates.

At the same time, the surprise outcome of the March 8 general election has raised doubts on whether projects under the Ninth Malaysia Plan would be implemented, while externally, the sluggish US economy remains a drag on the global market health. Kenanga Asset Management Sdn Bhd chief investment officer Chen Fan Fai said a downside risk to global stock valuations was likely in the next six to 12 months if the global economic slowdown persisted.

“Valuations may be compressed in the future,” Chen told The Edge Financial Daily over telephone last Friday.

Sector-wise, Chen expects plantation, besides oil and gas stocks to be resilient entities amid high commodity prices. However, the outlook for construction and automotive sectors is anticipated to be bleak amid costlier crude oil.

In a recent note, OSK Research Sdn Bhd said although Malaysian stocks had been persistently trading at a premium against regional peers via its defensive nature, the trend might not be sustainable in the months ahead.

This is in anticipation that foreign investors will be less willing to park their money in Malaysia to safeguard their portfolios against declining corporate earnings and other uncertainties in the country.

Based on the research firm’s estimates, the 100-stock Kuala Lumpur Composite Index will trade at price to earnings ratios of 14 times and 13.5 times in 2008 and 2009, respectively. The valuations translate into targets of 1,300 and 1,390 points for the local equity benchmark for the two years.

“At present, building up a portfolio of stocks is getting tougher as evidenced by the challenging business environment, going forward. In view of the current situation, we would advocate investors adopt a more conservative capital preservation strategy,” OSK Research said. Meanwhile, Malaysia’s inflation rate is expected to more than double this year. However, economists are not expecting major movements in local interest rates.

ECM Libra, for instance, foresees the nation’s inflation reaching up to 5.5% this year compared with 2% in 2007, hence a negative interest rate environment.

As local consumer prices were primarily spurred by external factors like more expensive crude oil, a rise in interest rates was not expected to tame inflationary pressures at home, it said in a recent note.

Such measure, it said, would instead curb the growth of local consumer spending which was expected to drop from 10.8% in 2007 to 6.7% this year. This follows the revision in local policymakers’ subsidy scheme.

“While this (higher inflation) will lead the economy to experience a negative real interest rate environment, Bank Negara Malaysia (BNM) is not likely to increase the Overnight Policy Rate significantly,” ECM Libra said.

For comparison, OSK Research has estimated local inflation to hover at an average of between 4% and 5% this year. The research firm expects the central bank to maintain interest rates at 3.5% till end-2008.