The Saudi equity market will be opened to foreign institutional investors only; rotate into high-yield bonds which offer better value; large IPOs could drain money out of stock markets and raise volatility ahead
Saudi Arabia announces the much awaited opening up of its stock market to Foreign Investors
The Kingdom of Saudi Arabia's cabinet last week approved direct access to its stock market for Qualified Foreign Investors (QFI's), with the Capital Markets Authority (CMA) to propose regulations next month. The CMA will study the suggestions submitted by market participants by the end of the year, investigate the readiness of the exchange and coordinate with the various government entities involved in the implementation. The CMA anticipates granting access sometime during the first half of 2015. There will be restrictions on Foreign Ownership Limits and assets under management (AUM's) of eligible investors. Currently foreign participation is very low in the Saudi stock market (c. 4%), as it is open for direct access only to GCC individuals and institutions and for other investors only through swaps or intermediaries.
This development carries great significance for investors tracking global benchmark indices, as the next step could be for the inclusion of Saudi into the MSCI Emerging Market Index. The Saudi market has underperformed the Qatar and UAE markets, recently upgraded by the MSCI to emerging market status. While the MSCI reclassification of Saudi Arabia as an emerging market is yet undecided and some time away, it could command as much as 4% of the MSCI emerging markets index. Such an inclusion could prompt foreign investor inflows of around USD 10 billion.
Post the announcement the Saudi Index went up 4.5%, a six year high, with the large caps SABIC, Mobily, Samba and Savola (all constituents of our GCC Model portfolio) outperforming. We see continued upside on a longer term view, with consensus Saudi corporate earnings growth of 12.5% in 2015. Saudi corporates are increasingly generating free cash flow with dividend yields in excess of 6% representing a good alternative to fixed income investments.
The Saudi stock exchange (TADAWUL) has a market capitalization of USD 531 billion with 166 listed companies and a trading volume of over USD 2 billion daily. The Saudi Index is the only GCC Index well diversified in terms of sector representation, with banking, petrochemicals, telecom and consumer services taking up a large share of the benchmark. Saudi Arabia's GDP grew 4.7% in 2013 led by government stimulus measures amounting to USD 125bn. Saudi Banks are a good proxy for overall economic expansion. Petrochemical companies continue to benefit from fat margins of profit as end-product prices surge and crude oil input prices remain subsidized.
The Qatar Index has performed well this month, though we see continued volatility as an investigation into the Qatari World Cup FIFA bid may not be announced until September. Our long term investment thesis for Qatar is intact, based on high infrastructure spend and growing petrochemical wealth.
UAE corporates have announced a stellar set of results. Real estate developers boast a doubling of annual net income, while the average net income growth of UAE banks has been in the high teens. This should keep the market on a longer term positive trajectory.
However, investors should recognize that a lot of good news is already reflected in equity prices and forthcoming large IPOs could drain money from trading volumes in September, causing some price volatility.
Pockets of opportunities in reduced bond issuance
Global government bond benchmarks were unchanged for the week, as improving macroeconomic newsflow was counterbalanced by concerns on geopolitical risks. Regional credit markets remained flat as fund flows dried up. We witnessed renewed weakness in Russian bond markets as Western powers plan to deepen sanctions. US 10 year treasuries eventually regained the 2.5% yield, as jobless claims fell to a multi-year low.
The region welcomed one new issue in the high yield segment, Kuwait Energy, a relatively small exploration and production company for oil and gas. The issuer rated B- sold a USD 250 MM, 5-year maturity at a coupon of 9.5%.
Republic of Senegal issued USD 500 MM of 10 year sovereign bonds at 6.25%. African Export Import bank (Afreximbank) also priced 5-year-maturity USD500 MM - senior unsecured bonds at a coupon of 4.75 %. Tata Steel Ltd. is finalizing a dual tranche of 5.5 year & 10 year maturity, with a coupon guidance of low to mid 5 % and low to mid 6 % ranges respectively at the time of writing.
Our latest conviction trade idea is ONGC (Oil and Natural Gas Corporation of India). It is the largest Oil & Gas Company in India, strategically important player and direct beneficiary of the economic reforms planned by the new government. This July-2024-bond-maturity offers an appealing yield of circa 4.57% for its investment grade rating.
Bull market in global equities to continue with accelerating global growth
Global equities made new highs for the year, led by the SP500 – at new all-time highs – and by emerging markets, with good economic data from China leading that market. Earnings across the globe – and specifically in the US – continue to beat consensus, evidence for acceleration in global growth is mounting and central banks are supportive
In the US the economy is gaining traction. The IMF downgraded once more US growth for 2014, but kept the 2015 forecast unchanged at 3%, thus very strong macro momentum is expected for next year. We continue to advise investors to invest in a well-diversified large-cap US equity portfolio or in cyclical sectors. Two out of three US sector recommendations are outperforming the SP500 year-to-date: US technology and US energy. US industrials will most likely catch up as economic conditions further improve.
Geopolitical risks are plentiful and non-negligible – from the Ukraine to the Gaza to the Syria conflicts – and yet markets neglect them. This happens on account of central banks largesse and good earnings, overpowering factors as compared to overseas risk events. Money lavishly made available by monetary authorities eventually finds its way into financial markets, which surge until good catalysts – improving growth and healthy company balance sheets – are there. Thus we expect the bull market to run further, interrupted occasionally by volatility spikes.
European leading indicators surprised to the upside and we suspect this may be due to the European Central Bank (ECB) latest measures, aimed at supporting credit growth and thus business confidence. Chinese authorities managed as well to push the economy in expansionary territory and this in turn will be good for European exports and will provide a temporary boost to emerging equities too.
Korea – our investment idea in emerging markets – has announced a government plan to support smaller companies and consumption, after disappointing nation-wide growth numbers were released. Specifically there is a plan to introduce a tax for companies hoarding excess cash reserves; this should boost dividends, investments and promote higher wages.
In conclusion a mix of government or central bank intervention globally is helping economic growth, so there is no likelihood of any significant downside for equities in the second half of 2014. This does not rule out occasional knee-jerk reactions to political or corporate risks. Those should be viewed as opportunities to buy more exposure as they occur.