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Can Malaysia’s shares continue to march higher?

Leslie Shaffer | Writer for CNBC.com
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Mohd Rasfan | AFP | Getty Images

Malaysia's stock market has quietly outperformed its Southeast Asian peers this year, with the benchmark index rising to a record high, but can it continue to rise?

The KLCI has climbed around 9 percent so far this year, tapping an all-time high of 1846.92 this week, compared with declines of around 2-3 percent so far this year for the Jakarta Composite, Singapore's STI and Thailand's SET index.

Analysts point to several reasons for the outperformance, including receding political risk after the May elections resulted in the ruling coalition party, Barisan Nasional, receiving less than 50 percent of the popular vote, its lowest-ever showing.

(Read more: Next emerging market sell-off may be time to pounce)

Since then, the market has reacted positively to the government's implementation of several long-awaited reforms to reduce the budget deficit, including a consumption tax to take effect in 2015, abolishing sugar subsidies and raising electricity tariffs on higher-income consumers and companies to cut a heavy fuel subsidy bill, analysts said.

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"The budget was market friendly. That was a very good signal," Tim Condon, head of research for Asia at ING Financial, told CNBC. "The signal that they sent was that the previous model of trying to get growth out of government spending and handouts was over, or at least going to be scaled back."

To be sure, there are some concerns about the quality of the market rally.

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Much of the KLCI's rise was driven by a climb in heavyweight state power firm Tenaga Nasional, which accounts for around 6 percent of the benchmark index, after the electricity tariff hike announcement, noted Bharat Joshi, an investment manager at Aberdeen, which has around $324.6 billion under management.

"It's more that specific stocks have been rerated upward or caught the eye of investors rather than the entire market," he told CNBC, noting that while the top 20 to 30 stocks have risen, the "middle guys" are generally flat to down.

Others aren't convinced the rally can continue.

(Read more: Why Thailand's political strife is far from over)

After the reform measures, "there would be a one-off repricing," said Condon. "I don't know how far that would have to go."

In addition, the index's around 1.2 percent gain so far in December was likely driven by traditional year-end window-dressing, said Terence Wong, head of equity research at CIMB in Malaysia.

"You still have external headwinds like tapering coming through and results seasons which haven't been great. That's holding back people's optimism," Wong told CNBC, adding he expects earnings to recover from this year's around 3 percent growth to around 11-12 percent for the next couple years.

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His target for the KLCI at the end of 2014 is 2030, suggesting he expects an around 10 percent gain from current levels around 1835, but he said that is the most optimistic target on the street.

Others are more negative. UOB KayHian expects the index to trade in a 1740-1960 range next year, suggesting a less than 7 percent rise.

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Consumer spending is likely to slow due to the withdrawal of subsidies and fresh taxes, said Vincent Khoo, an analyst at UOB KayHian. "It's coming in a gush," he said. "We will see domestic inflation above trend through 2015," he told CNBC. "That takes a bite into disposable income and that will affect domestic consumption trends."

Bank of America-Merrill Lynch has an "underweight" call on Malaysia's market, citing rising financial vulnerability to rising interest rates after its consumer credit boom.

Still, analysts do see some positives for Malaysia.

"The Malaysian market has always been a defensive market. Companies here pay a decent dividend. If you want some sort of income, then obviously Malaysian stocks attract," Aberdeen's Joshi said.

(Read more: Is Malaysia's property market headed for a Dubai-style crash?)

CIMB's Wong also noted Malaysia's shares may be somewhat insulated from potential foreign fund outflows once the U.S. Federal Reserve begins to taper its asset purchases. Foreign ownership in the market is currently around 22 percent, at the low end of its historical range of 20-28 percent, he said.

"In November, there was quite a bit of foreign selling. In spite of that, the KLCI charted new highs," Wong noted. "It's quite resilient and quite well supported by local funds."

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1