FOREIGN INSTITUTIONAL fund inflows have greatly increased since Qatar and the UAE joined the MSCI Emerging Markets Index at the end of May2014, with Saudi Arabia expected to be included as soon as 2017. As of September 22 Qatar and the UAE will assume emerging market (EM) ranking on the S&P Dow Jones Indices as well, which will broadbase the appeal of these markets further to global fund managers.
According to Standard & Poor’s forecasts corporate earnings in Saudi Arabia will grow by 17 per cent in 2014 and 11 per cent in 2015, boosted primarily by petrochemical producers and banks. Saudi banks also stand to gain from expectations of US interest rate hikes in 2015 — driving lending rates higher while deposit rates on Shariah-compliant instruments remain subdued — along with infrastructure investments and increasing consumer spend.
As global crude oil prices have subsided in recent weeks, Saudi Arabia has lowered its production of crude oil by about 400,000 barrels/day last month and Opec has cut production targets for 2015 by half a million barrels/day. We made the point last week that a drop in the benchmark Brent price of crude oil to around $90 per barrel would not jeopardise government outlays on infrastructure and social spending in the GCC countries. Saudi petrochemical companies — comprising 22 per cent of the benchmark index — maintain their competitive advantage as their feedstock prices continue to be substantially lower than those paid by competitors.
New equity issuance is on the rise in the GCC region and this will keep investor interest in the region keen in the next few months. The IPO of the Emaar Malls Group is generating global interest and raising the profile of the UAE equity market. GCC markets witnessed higher trading volumes in bond markets last week as a flood of new bond issues coincided with profit-taking on pre-existing bond positions, particularly in the high-grade corporate segment. GCC bond market indices dipped slightly.
Bond issuer Jany — the commodity trading entity of Goldman Sachs — priced its maiden five-year $500 million sukuk bond at a yield of 2.84 per cent (90bps above the five-year benchmark). South Africa priced its maiden sovereign bond — 5.75-year maturity, $500 million — at 3.90 per cent, while ISDB — Islamic Development Bank — priced a five-year, $1.5 billion sukuk at 10bps above benchmark, which translates into a yield of 2.11 per cent.
The Press release following the meeting of the US Federal Reserve bank open market committee (FOMC) showed concern about future US price inflation pressures but at the same time chose to persist with its low interest-rate policy for a ‘considerable time’. US 10-year treasuries yields remain in a holding pattern and ended the week at 2.57 per cent, while UK 10-year Gilts and German Bunds ended at 2.54 per cent and 1.04 per cent respectively.
The path to higher US interest rates is now steeper, as future rate forecasts made by FOMC members were shifted higher, while short-term interest rates will remain low for the foreseeable future.
In the US low interest rates, low inflation and accelerating economic growth — which for next year is expected to be above trend, or around three per cent — put the economy in a sweet spot and US equities in a rising bull market. In this context the US cyclical sectors like technology, banks and industrials, are expected to perform better than benchmark equity indices.
In marked contrast, Europe and Japan have unique demographic challenges and both need to restructure, while most emerging market (EM) countries still face imbalances. Economic performance alone would justify an overweight allocation to the US only, were it not for the fact that the ECB and the BoJ are pursuing very aggressive monetary easing policies.
The outlook for EM equities on the other hand is not that rosy. In China the business cycle is slowing as the property bubble is cooling down and the economy is being gradually rebalanced away from excessive investments; Brazil just entered recession while at the same time displaying high inflation with growth hampered by infrastructure bottlenecks; Russia is affected by a lack of confidence in its authoritative regime. With the exception of India — where the long-awaited restructuring is being carried out by a new leadership – major EM economies display long-term issues acting as a drag on growth rates. On top of this, next year the Fed is expected to start a tightening cycle, which can drain capital away from EM countries.
Overall we expect developed markets (DM) to be better off in 2015 than EM and this to translate in their better equity performance. The IMF has warned of structural EM slowdown, with a post-crises growth forecast of five per cent, versus a pre-2008 expansion rate of seven per cent. As much as the pre-Great Recession period was EM- and China-centric, the post-crises time seems to be DM- and US-centric for some time to come.
This does not bode well once more for commodities, although abundant money-creation keeps the asset class range-bound.
Gold is sliding towards $1,200 per ounce — our long-term target — after breaking the $1,240 support level. Although the fall may well extend further down to $1,100, we see plenty of support between $1,150 and $1,100, which signify the marginal cost of production.
The writer is the chief investment officer at EmiratesNBD. Views expressed by him are his own and do not reflect the newspaper’s policy.
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