Weekly Equity Comment - 04 January 2017

Global Equity Markets

Global equity markets continue to perform well as expectations remain high with regard to growth prospects in the US as Donald Trump takes office on 20th January. In the US, third quarter GDP growth rate was revised upwards to 3.5% (third estimate) from earlier estimate of 3.2%, consumer confidence data was better than expected, the index stood at 113.7 as against 109.4 in November. China’s PMI for December stood at 51.9 as against 50.9 in November. Overall, the recent set of macro numbers has been skewed toward the positive. The US Dollar continues to strengthen on relative yield differentials; dollar index is currently at 103. Generally, a stronger US Dollar impacts emerging markets from a macro and flow perspective; as per IIF data EM portfolio inflow for 2016 at USD 28bn is the weakest since 2008 and 90% below the 2010-2014 average. Overall EM equities did better than EM debt as a higher US rates and higher commodity price outlook dilutes the dovish monetary outlook for many of EM countries.

Oil (Brent) price is stable around US 56/BBL even as US inventory levels have come in higher for the last two weeks and US oil rig count moving higher. Market focus has now shifted to implementation of the OPEC deal, and Kuwait and Oman have announced that they have reduced oil production already. The first meeting of a committee of OPEC and Non-OPEC nations responsible for monitoring global agreement to reduce oil production is expected to take place in Abu Dhabi on January 13. We expect the global oil market to gradually balance in 2017.

Regional Markets

For the MENA markets 2016 was a volatile year, however the year ended quite well as most regional markets closed in positive territory. The market volatility was primarily a result of MENA markets adjusting to a macro environment that was impacted by low oil price and the reformist approach of regional governments. Dubai was the best performing market, up by 12% followed by Abu Dhabi at 6% and Saudi market at 4%.

The Saudi Arabian budget for 2017 was better than market expectation; despite continuous fiscal consolidation, the pace of fiscal austerity is expected to be slower this year. The budget paints a more stable outlook for the economy with a higher government spending, the expenditure for 2017 is expected to increase by 8% to SAR 890 bn as compared to actual expenditure for 2016, with an increased allocation to healthcare, infrastructure and public program sectors. However, including the money paid out to settle overdue bills of SAR 105 bn in Q4 2016, the 2017 budgeted expenditure is 4% lower compared to 2016 actuals. The government has presented its financials adjusting for this amount as it pertained to earlier years but we do note the considerable impact of the same in the form of poor private sector sentiment and tighter banking sector liquidity for most part of 2016 and later through a positive sentiment that saw a sharp reversal on the bourse. The government has guaranteed to settle future bills within 60 days upon receiving them; a positive for the cash-strapped construction sector. While it allays future receivable concerns and could imply tight completion deadlines, the prioritization of government driven project activity is not expected to change.

The budget deficit for 2016 came in at 16.8% of GDP and is expected at 7.7% of GDP in 2017, driven largely by better revenue realization pursuant to the recent OPEC deal and energy price reform later during the year; the oil revenues are expected to increase 46% in 2017. There has been no immediate increase in fuel and utility prices as the government balances austerity and growth; in addition, a wait and watch approach before the execution of cash transfer scheme to lower income class is also a reason for status-quo here. The government also guided that there would not be any gas feedstock cost increase before 2019 which is positive for petrochemical names.

The budget deficit would be financed through a combination of reserve drawdown and debt issuance; total debt now stands at 12.3% of GDP (USD 56.8 bn local debt and USD 27.5 bn international debt) and the self-imposed debt/GDP ceiling of 30% to meet current AA2 rating requirement stands. The borrowing headroom, in addition to USD 540 bn of foreign assets demonstrate the balance sheet strength to steer the economy, however the focus ultimately is on diversifying the economy from government spending. The commitment to National Transformation Plan is clearly evident as allocation towards the cost of NTP initiatives has been increased four-fold to SAR 42 bn for 2017; this is further expected to increase to SAR 72 bn annually through 2020. The November bulletin from SAMA showed a 1% month on month decline in credit driven by short term loans, possibly on account of reduction in working capital loans after the government cleared overdue payments. We are cognizant of a possible credit growth vacuum that could show up on account of this factor but see the diluted asset quality concerns as a bigger relief for Saudi banks. The consumption trends continue to be muted as point of sales transaction value and ATM withdrawals both came in lower for the month of November.

As we approach earnings and dividend season, our positioning is skewed more towards UAE and Qatar. The focus will be on companies with higher dividend yields, stable cash flow and attractive valuation. The funds and portfolios on an average hold cash in the range of 5%- 8%, which we look to deploy tactically as and when the opportunity arises. Overall we favor the financial, petrochemical and utility sectors.  

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