News Column

Conviction reaffirmed in GCC equities and bonds

September 4, 2014

Large Saudi and UAE IPOs in the offing; more countries issue Sukuk bonds; European disinflation could spur European QE in Q4

Saudi and UAE IPOs are in the offing

The announcement by Emaar Properties that it would divest 15 per cent or more in a public equity issue in its mall subsidiary is boosting investors' risk appetite in UAE stocks and there is a strong likelihood KSA largest lender National Commercial Bank will announce an even larger IPO in October 2014.  The estimated value of the Emaar Malls IPO is AED 5 bn. ($ 1.36 bn), which is sizeable for the UAE market, which has a capitalization of AED 789 bn. ($ 215 bn).

The Saudi Arabian TASI was the best performer among GCC equity indices as it surpassed the 11,000 mark, with the announcement of the Saudi market opening up to direct foreign investments.  Expectations of strong global demand for petrochemical stocks supported the uptrend.  We expect continued interest in large-capitalization sectors i.e. financial services and petrochemicals.  Rotation into laggards can also be seen, with interest in Al Rajhi Bank and SIPCHEM building up as investors go bargain-hunting.

The Saudi Arabia Monetary Authority (SAMA) has released an updated set of regulations for domestic banks lending to consumers.  These new rules may result in a surge of consumer loan growth that has been declining over the past few quarters; improving Saudi demographics should provide support as well.

After rising two per cent in the previous week, the Qatari index retraced its gains as passive fund managers completed their portfolio adjustments prior to the MSCI Emerging Market Index rebalancing date (end August).

More countries issue Sukuk bonds

Fixed income benchmarks gained globally for the month of August, as muted growth in Europe and geopolitical tensions whetted appetite for the asset class.  Yields on US 10-year treasury notes fell to 2.34 per cent, German yields to 0.7 per cent, with Eurozone deflationary trends becoming more entrenched.  Junk bonds gained as well after the recent underperformance.  As long as central banks keep flooding markets with liquidity against the backdrop of subdued global growth, bond yields are expected to persist at multi-year lows.

US treasuries currently continue to offer more value than European government bonds, while UK gilts have slightly higher yields, but bear more currency risk.

In GCC and emerging markets the pipeline of debt issuance looks strong for the month of September.  Specifically we expect strong demand from global Islamic debt funds for the limited Sukuk supply.  These instruments are higher yielding than developed market government bonds and offer relative safety being asset-backed.  Next month issuers include: Kingdom of Bahrain, Burgan Bank (Kuwait), Republic of South Africa (Sukuk), Government of Hongkong (Sukuk), ICBC (Industrial and Commercial Bank of China).

Confluence of positives boost India equities

Indian GDP grew 5.7 per cent annualized in 2Q 2014, the highest since December 2011.  The agricultural, manufacturing and electricity segments led the rebound.  Improved sentiment and confidence in the new Government pushed the Indian SENSEX to all-time highs.  There is faith in the ability of the new government to up the ante on reforms, kick start capex and improve project execution, resulting in higher growth rates from 2015 onwards.  This is accompanied by a favourable backdrop of abating inflation trends.

Central Banks to play a large role until uncertainty on global growth is dispelled

Investors are witnessing continued central banks' intervention worldwide to support an otherwise sputtering business cycle.  The flow of liquidity – lifting all boats – makes for a positive setting in GCC markets as well.

Although the US Fed is on course to wind down 'Quantitative Easing' (QE) in October 2014 due to comforting economic trends – US Q2 GDP was revised higher to 4.2 per cent and investors celebrated by pushing the S&P500 past the 2,000 level - it is evident from the latest FOMC minutes there is no agreement among its members to raise rates anytime soon.  Indeed closer analysis of macro data offers some reasons for apprehension and thus for accommodative policies.  Consumption expenditure for the month of July was marginally down on account of limited wage growth, which speaks of an average customer still suffering in spite of the advanced stage of the recovery.

No sooner had Mr. Draghi - the ECB President - stated at the Jackson Hole economic symposium that he would be willing to take further policy measures in case of inflation continuing to undershoots targets, than again for the third time since 2008 Italy - the largest ugly duckling in the Eurozone - had to announce it had entered recession.  Actually Italy is plagued as well by a reduction of consumer prices for the first time since 1959, leading with little pride the whole of Europe into deflation (latest data point to anemic price growth across the Eurozone). So much so that expectations of extraordinary monetary steps - that is to say QE - are now running high among investors.

Japan, haunted by deflation for over a decade and hopefully getting rid of it just recently, also failed to announce overwhelming economic data - from employment, to industrial production, household spending and retail sales - due to a sales tax hike in April.  This portends more stimulus ahead in the form of more QE (the Bank of Japan is already buying $ 67 trn. worth of assets' per month).

In some major emerging markets (EM) it is no different.  In China the second largest bank by assets reported the slowest profit growth in 5 years.  A property slump and the slowdown of the economy, via more bad loans, will spell bad times for commodities.  The government - unwilling to see growth slipping towards the 7 per cent mark - is expected to support more credit creation and in general additional stimulus measures.

Where is all of this leaving investors?  With the outlook of continued reflation for risky assets, that is to say for equities, but not so much for credit due to its fair to slightly rich valuations; and also with the world of ultra-low government yields expected to come gradually to an end, but just gradually, as the challenges facing central banks seem to be quite formidable after the Great Recession.

In a nutshell, under central banks' interventionism investors should afford an overweight allocation to equities, be neutral credit and underweight government bonds.  Within equities investors should have a bias for geographical areas where economic growth, although kickstarted and supported by central banks, is close to being self-sustained; to date among major global economies the US is distinctly leading the pack.

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Source: CPI Financial

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