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Weekly Equity Comment - 12 December 2016

The Mena markets have recovered to some degree over the past month and our flagship MDL is now up some 4.35% ytd as of 7 December. Our UAE funds are now up 10.7% for UGF, 11.95% for our UAE ETF and 4% for our UTF fund. Our Sharia funds are also performing well IMGF up 9.59% ytd and Sharia MDL up by 4.72%.

The key question is whether the rally sustains and continues. I am of the belief that the seriousness with which Saudi has approached OPEC and non-OPEC deals suggests that there is further upside to Mena markets. In addition global allocators are showing a bias toward USD based equities which should support the Mena markets given that most GCC currencies are pegged to the USD.

OPEC drives oil prices & Mena markets higher

In the aftermath of US election results, outflows from emerging market equities and bonds have accelerated. As per IIF data, portfolio outflows from emerging markets gathered pace; as c40% of y.t.d net portfolio inflows till October 2016 have been reversed in November seeing net outflows of USD 24 bn from emerging markets, two-third of it driven by debt outflows. One of the favored emerging markets, India continues to reel under the pressure of demonetisation as November composite PMI dipped to 49.1 from 55.4 in October; a pick-up in activity is expected once the old currency is replaced possibly aided by a monetary and fiscal response. The Fed hike on December 14 would not be a surprise for the market; Bank of England is expected to maintain status quo at its meeting on December 15.

Regional Markets

A major event last week was an agreed production cut of 558k BPD by non-OPEC members over and above the 1.2mn BPD cut agreed by OPEC members earlier, effective Jan 2017. More importantly, Saudi demonstrated its strong intent to balance the market as it indicated it could contemplate further cuts if required to bring its production below 10 MN BPD. With most 2017 demand growth estimates hovering around 1.1-1.2mn BPD the cut can potentially balance the market as inventory drawdowns gather pace over H12017; the backend of the oil price curve has already moved into backwardation. While acknowledging the compliance issues (more so with the incremental Saudi intent to cut) and US oil production recovery; from regional equity markets point of view the move is largely supportive for the sentiment and reinforces the optionality that GCC countries have to stimulate economic growth.

The Saudi market rally that begun after the successful bond issuance and release of overdue government payments is looking through the valuation levels as positive news flow dominates. For the banking sector, the cleared payment is expected to dilute the cost of risk concerns and improve liquidity, already indicated by softening SAIBOR. The payout by the government has been reflected in one of the biggest drawdowns of SAR 136 bn in government deposits with SAMA, the last major draw down coincided with the accession of King Salman when he handed out two-month bonus in Feb-2015. As a result, 2016 fiscal deficit could overshoot the budgeted figure which implies that any fiscal leniency in 2017 budget may not be warranted despite an OPEC deal. That said, one could argue that Saudi’s OPEC stance either creates a large enough sentiment offset to speed up reforms or indicates a tilt towards a more protracted reforms process rather than one that shocks the private sector. One clear takeaway is that Saudi’s oil stance definitely creates a favorable macro setup for an Aramco IPO over the next 12-18 months. Fundamentally we have been cautious on Saudi Arabian market given the various austerity measures being introduced in Saudi. Our current holdings in Saudi Arabia are geared towards stocks that are either less impacted by current environment or can potentially benefit from the National Transformation Plan.

The key themes from an investor conference that we attended recently in Dubai largely centered around restructuring, benefits from KSA’s reform plan, deleveraging and costs savings rather than growth. In Saudi, most companies expect fuel and utility prices to move higher from next year and are already budgeting for the same. The companies have pricing power but do not see an immediate cost inflation pass-through considering weak market conditions. As far as the impact of recent cuts in public employee allowances is concerned, we could sense from our meetings that the October paycheck on an average was 8-10% lower. In UAE, the current state of affairs for the banking sector is not expected to change materially for 2017 except margins which can get better driven by lower funding costs.

Considering the underperformance of UAE markets, no major negative surprises, upcoming dividend yield season and probable preference for dollar assets within the EM space if the new US administration follows up on its protectionism rhetoric we are increasing our overweight on UAE markets. We have cut our Saudi positions selectively while maintaining our over weights in banking and petrochemical sectors.

Dividend & Shariah Strategy

We have reduced our Saudi position after the recent strong rally, but maintain an overweight position in selective banks, petchems and the insurance sector. Income mandates hold close to 7-13% cash, which we will look to deploy by increasing our overweight position in UAE and Qatar as we approach the dividend season.

Growth & Aggressive Strategy

We have reduced our overweight position in Saudi Arabia after a strong rally but we remain overweight as oil prices continue their recovery. In the UAE we are highly selective, holding overweight positions in Dubai Parks, Emaar Properties and Tabreed, in addition to a number of banks such as ADCB & ENBD which appear attractive in terms of valuations and dividend yield.

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