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A Cautious Tone

Weekly Equity Comment – 22 March 2017

Global Markets
Over the last two weeks global equity markets have softened somewhat with investors pausing to assess the likely impact of the latest 25 bps US Fed rate hike and ability of the Trump administration to fully execute pro-growth policies. With unemployment rate at 4.7%, inflation rate at 2% and other data points indicating strengthening of the US economy, the stage is set for the Fed to further increase interest rates. Investor concern centers over the pace and number of hikes for 2017/18 despite the FED Chair, Janet Yellen, signaling a steady measured approach. FOMC policy makers have started discussions on the process of unwinding some of the $4.5 trillion FED balance sheet but this is likely to be a very gradual and predictable process with policy makers closely monitoring trajectory of the US economy.

After a good start to 2017 sustainability of the global equity market rally depends on whether the global growth narrative overrides headwinds from higher interest rates. Macro data flow from the US remains quite supportive with strong numbers for consumer confidence, PMI, retail sales and better than expected non-farm payroll data. The ruling party in India won a landslide victory in one of the country’s most populous states paving the way for government reforms. China’s National Congress meeting set 2017 growth target of 6.5% as compared to 6.7% for 2016. The country is going to push forward SOE reforms, targeting ownership reforms at more than 100 central government-run enterprises to be completed by the end of the year through the introduction of private capital. China will also continue with supply side reforms with expectations that another 50 mn tons of steel capacity and 150 mn tons of coal output will be cut by year end, which should support steel and coal prices for 2017.

Regional Markets
Regional markets corrected taking cue from global markets along with the decline in oil price. The GCC markets were generally negative the only exception being the Egyptian market where the market rebounded 1% over and above the 4% gain in previous week supported by weaker currency and deferment of transaction tax on stocks. In UAE, softness was also due to lower investor interest as bellwether stocks like NBAD and FGB went ex-dividend. In the UAE market, index heavy weight stocks like Emaar properties corrected, the stock is expected to deliver double digit earnings growth in 2017 based on its project backlog and valuation remains attractive. In Dubai, realtors are expected to continue launching new projects in 2017 despite recent weakness. The market is expected to see a supply of around 9,000-10,000 residential units in Dubai this year. Strong dollar and weak spending are expected to pressurise performance of mall operators this year even as tourists arrivals in Dubai remain encouraging.

We were struggling to identify catalysts, even as conventional factors were weak, that could cause Saudi to correct further, it finally took the key old variable i.e. oil price to cause a warranted softness. Our cautious stance on Saudi is on account of non-supportive conventional variables considering that Q4 results didn’t spring a major positive surprise, stable liquidity conditions were reflected in valuations, sentiment was stable and valuations not within our comfort zone. In addition, historically the Saudi market has struggled to deliver gains from market cap to GDP levels of 70%.

Oil price which has been broadly stable for the last three months post OPEC agreement to cut oil production, softened with WTI price below the psychological level of USD 50 per barrel. Fundamentals are not supportive as US inventories and rig counts continue to trend higher while oil inventory is at all-time high of 528 mn barrels while the latest rig count stands at 631, up by 14 over the last week. The implementation of OPEC oil production cut remains as per the plan, however increase in the US shale oil production is offsetting these production cuts. The next OPEC meeting is in May, we think it is quite likely that the production cut agreement will be extended, however the key issue in rebalancing of the oil market is the responsiveness of shale oil producers.

In Saudi, the reforms in the Saudi real estate sector are moving at a faster pace than anticipated and this could support the sector in the medium to long term. In the Saudi healthcare sector, the government launched private sector participation program which aims to increase private sector involvement in the sector. Having introduced nine initiatives, two pilot projects will be executed and tested during Q2-Q3 2017 this year. Recently we met with a few healthcare companies and according to management of these companies they have settled the receivables issue with the government and payment is expected to be received in tranches, we think it should have a positive read across for the sector.

Positioning
As we enter the last phase of dividend season and with Q1 earning season approaching, investors are looking for the next round of catalysts. In the current environment we see limited catalyst for the UAE & Qatari markets which have seen price declines as companies moved to ex-dividend status. FTSE EM inflow has been providing some support to the Qatari market but we expect to see some softness with the event now behind us. Saudi is preparing for T+2 settlement and meeting the criteria for MSCI EM inclusion, we believe this will be a major development for the bourse. Over last week income mandates rose by 1%, while growth and trading mandates were up by 1% to1.5%. Currently we hold cash at an average of 6%. Post the FTSE and annual dividend events we look to reduce Qatari exposure and add to Kuwaiti exposure as valuations remain attractive whilst the expected increase in the weight of Kuwait in the MSCI FM index could potentially support further fund inflow.

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