Morgan Stanley initiated Malaysia's stock market (Kuala Lumpur Stock Exchange: .KLSE) at overweight, despite noting the MSCI Malaysia has gained more than 6 percent so far this year, as it pointed to five tailwinds.
Firstly, the government led by Prime Minister Najib Razak may call an election as early as September or October, Morgan Stanley said in a note dated Thursday U.S. time.
Malaysia tends to ramp up fiscal spending before elections, improving consumer and business sentiment, the bank said. Morgan Stanley pointed to two months before the dissolution of parliament as the "sweet spot" entry point for the best returns.
The ruling coalition, which has held power since the late 1950s, was broadly expected to keep its grip on power, despite a long-running scandal over allegedly embezzled funds from Malaysian state investment fund 1MDB.
Morgan Stanley noted that over the last two elections, the ruling party had dropped below 67 percent of the seats in parliament and 50 percent of the popular vote, but that the opposition remained divided.
The second driver of Malaysia equities is increased infrastructure spending, with the government's push for more private investments being driven by funding from China, the bank said.
"China is increasingly making investments in Malaysia as part of its 'One Belt, One Road' projects," the note said, adding China and Hong Kong made up around 40 percent of Malaysia's foreign direct investment in 2016.
Additionally, Chinese e-commerce giant Alibaba recently said it would open a 7 billion ringgit ($1.59 billion) regional hub in Kuala Lumpur, the bank noted.
The commodity recovery was also set to drive Malaysian shares higher, the bank said, pointing to a strong correlation between the two.
It noted that Malaysia's Composite Commodity Index, including oil, palm oil and rubber, has surged 41 percent from its 2015 trough, with oil and palm oil both expected to recover further.
Malaysian company earnings were also poised for recovery, Morgan Stanley said, estimating profit growth would improve to 8-9 percent in 2017-18 after three years of declines.
The bank also pointed to construction companies' "peak" order book levels, a 10 percent rise in palm-oil volumes with chances for price increases and a drop in banks' provisions as non-performing loans peak.
The fifth driver for Malaysia stocks was a "cheap and supported" currency, the bank said.
"We think domestic sentiment on the ringgit has stabilised, with lower political uncertainty and improving commodity prices," it said. "The conversion of export proceeds into ringgit is also supportive."