GCC equities remain supported by a strong macro backdrop; geo-political issues in Iraq are now well factored in; US economy and equity markets continue to outperform; new budget on 10 July will give direction to India equities
Strong economic leading indicators bode well for GCC
We are surprised by the exceptionally strong showing in GCC leading economic indicators (PMIs) and by good US employment data. Positive economic news flow drove GCC equities higher for the week, amidst high volatility and increasing traded volumes, as the UAE and Qatar indices bounced off the 200 day moving average. The S&P Pan Arab index closed up +1.6% for the week. Despite the large swings seen in regional markets over recent weeks, the macroeconomic view for the region remains positive, as shown by a slew of positive Purchasing Managers Index data.
The DFM index gained 4% for the week, whilst the ADX gained +2.8%. The UAE's PMI rose to 58.2 in June from 57.3 in May and just shy of the series high in April. The main driver for the higher UAE PMI last month was record expansion in output/ business activity as well as export orders. Fundamental valuations are once again compelling for the UAE and Qatari listed companies, which are projected to show 2015E consensus earnings growth of 30% and 15% respectively. Strong Q1 2014 GDP data from Qatar helped the Qatar Exchange break its six-day losing streak and gain +4.6% last week, in what was a broad-based rally. We continue to have a positive view on QNB, Doha Bank, Ooredoo and IQCD.
The Tadawul gained +1.1%, with Saudi Arabia's PMI rising to 59.2, a 5-month high. Output/ business activity grew at the fastest rate since April 2012, while new orders growth also accelerated sharply last month, with strengthening demand, increased sales efforts and an increase in construction projects being the main drivers of that growth. We still like the dividend paying stocks in the Qatar, Saudi and UAE markets and SABIC's recent dividend increase adds to our conviction.
The EGX 30 gained +1.9% as Egypt's June PMI came in at 51.5, the strongest reading this year, with the pickup in activity being attributed to improved political stability and improvement in the exports component of the index. However margins appear to be under pressure and the unemployment picture remains weak.
We expect summer volatility to continue in regional markets, with Q2 earnings season providing the next catalyst both regionally and globally. Quarterly results are off to a very good start in the GCC, with Almarai (Saudi's leading consumer staple company) posting an 8.8% increase in net income over the last year and 58% over the last quarter.
Subdued activity on bond markets in summer months
Regional bond markets traded sideways with credit spreads tighter over the week, as US treasuries sold off 10-year yields are currently at 2.64% on the back of a strong employment report. GCC credits with the exception of Damac Properties currently trading at 96 have performed generally well. Flows remained balanced given the short week for global markets (in lieu of US Independence Day 4 July).
We expect subdued trading activity regionally for the month of July and do not see further supply for local issuers.
Within the broader bond / credit markets, we see pockets of opportunities in LATAM, mainly Brazil and in Chile. In Turkey we prefer the corporate bond space especially euro-denominated debt; in India we like the corporate sector and in particular banks.
High expectations for Indian budget
Expectations of a pro-growth, anti-inflation Indian budget on 10th July are high. The government has already hiked rail fares, diesel, petrol and LPG prices as an indication of its commitment to shrinking the fiscal deficit, which conflicts with its mandate of reducing inflation. A privatisation policy raising USD 10 billion has also been tabled. The challenge ahead is to boost revenue without hampering growth. Supportive measures for industries that create jobs especially export oriented are expected. Budget beneficiaries would be the information-technology, consumer cyclical, financial, and automotive sectors.
Leading indicators point to sustained global recovery and support equity rally
In developed markets (DM) US indices printed all-time highs, the Dow Jones Industrials Average closed above 17,000 and most global equity markets recorded a positive week, driven by reassuringly strong PMI releases. According to the latest PMI data in pecking order the UK and the US economy are faring particularly well. The UK manufacturing index came in ahead of expectations and the US reading was basically unchanged versus the previous month, but the new orders component the most forward looking was at the highest level for this year. This comes of course for the US economy on top of very good employment numbers: the unemployment rate dropped to 6.1% and 288,000 payrolls were added for the month of June. Fed chief Janet Yellen also made dovish statements once more! saying that she prefers firmer rules rather than higher interest rates to address asset bubbles. In Japan, the Tankan Survey was not up to expectations, but again the leading component investments planned by companies was quite reassuring, as companies actually are planning to increase investments - a much needed boost for the economy. As for Europe, leading indicators continue to point to a sluggish recovery, so in the end Mr. Draghi will have to come to the rescue once more.
The above picture is quite revealing in terms of asset class behavior. US equities continue to offer upside: economic trends apart, valuations are not particularly stretched, as low interest rates upheld by Janet Yellen justify higher multiples. The dollar has strengthened, in particular versus the euro as per our view, since the outlook for higher yields makes dollar-denominated assets more appealing. UK equities are unlikely to outperform; given the strength of the UK economy we may be not too far off from the first rate hike. But currency traders are happy, as the British pound is gathering further strength and is headed towards new highs for the year supported by higher yields. Japanese equities remain very interesting: more investments point to firms taking heart from Mr. Abe's reform-driven ruling. European equities are supported by sluggish, but consistently improving economic trends and a weaker euro would be beneficial too, eventually.
We continue to prefer DM to EM equities, but will keep on watching out the China space carefully. Korea a major trading partner of China and thus far our key EM investment theme rebounded too along more encouraging signs from China.