Weekly Equity Comment - 26 September 2016

Regional challenges remain

Last week’s Fed meeting left rates unchanged but analysing the Fed’s risk assessment of a “roughly balanced” outlook on growth expectations there appeared to be a strong signal of intent to raise rates in December. The Bank of Japan reinforced its commitment to reflation but the final action showed its reluctance to take rates further into negative territory, instead it plans to target the ten-year yield at zero percent. The policy stance is aimed at countering unintended consequences of negative interest rates, by reducing pressure on banks’ profitability through a steepening of the yield curve. Whether it is a conclusive shift in monetary stance away from negative rates would entirely depend on inflation expectations which at present are muted.

Oil prices after much volatility ended flat last week, with plenty of noise before the scheduled informal meeting in Algeria. Rhetoric went from argumentative to a consultative nature with Saudi offering to cut production if Iran agreed to freeze production at current levels of 3.6mn BPD. We will get to know the result this week, our expectation is of a non-event.

Regional Markets

Our takeaway from an investor conference last week wherein we met around 50 companies from the region highlighted that corporates were cautious and faced a challenging environment. Our positive stance on the UAE was reinforced as company management appeared confident and highlighted the UAE’s relatively diversified economic base, non-domestic drivers and stable fundamentals. Specifically, real estate companies appeared fundamentally robust building on successful property sales while the retail sector remained stable on account of internationally driven tourism. Within the banking sector there was no undue concern with regard to asset quality and so an increase in provisions would likely be a gradual step to compliance with IFRS 9 by early 2018. Some optimism was also seen due to Expo 2020 spending which could kick start from 2017.

The situation in Saudi Arabia is complex, on the one hand macro headwinds continue in the form of stretched working capital cycles, pressure on consumer spending, dwindling contract awards and lower subsidies; on the other hand the hope for growth from the National Transformation Program (NTP) means there is cautious optimism among select corporates. It was clear that NTP execution means that Saudis are trying out many things for the first time which would invariably involve delays, there is no quick fix. With regards to the banking sector, the planned sovereign bond issuance and regulatory maneuverability mean the key issue plaguing Saudi banks, that of liquidity, is not unsolvable. For example, SAMA has already decided to place SAR 20 BN of deposits (1.3% of total) on behalf of government entities with various banks. An eventual inclusion of the Saudi bourse into EM index was also an important discussion point, post event (best case 2018) Saudi could figure in top 5 or 10 top constituents subject to an Aramco IPO, the key factor would be to move to a T+2 settlement.

In our funds and portfolios we continue to favor UAE and select Saudi companies. In Saudi, within the banking sector we are value size and quality. We see the petrochemical space as a decent diversification from domestic cyclical risk and have chosen names with earnings traction and sustainable dividend yields. Construction and consumers names have been avoided on continued headwinds and NTP plays are dictating the rest of our exposure. In UAE, select real estate and retail companies offer an element of positive surprise and stability. The overriding factor in the Qatari market has been its inclusion in FTSE’s Secondary Emerging Market Index in September 2016. The market had witnessed a strong run up into the event with fundamentals not justifying current valuations.

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