Global equity markets remain upbeat during the summer season supported by the receding likelihood of a near term increase in US interest rates, better than expected second quarter earnings and the relatively calm response to the post Brexit era. However, concerns remain over a slowdown in global GDP growth with the same being highlighted in latest the IMF release whichrevised global GDP growth downwards to 3.1% in 2016 from an earlier estimate of 3.2% citing Brexit as the main cause.
Last week, first cut second quarter GDP growth data for US was released with the economy growing at 1.2% as against expectations of 2.5%. Upward revisions are expected in the second or third release as macro data from the US such as labour market, retail sales, consumption, service PMI and housing market appear to reflect better growth prospects. On the currency front the US dollar traded lower against major currencies reacting to the weaker than anticipated macro data. Over the coming week many key macroeconomic data releases are expected including the important US non-farm payroll numbers.
Emerging Markets (EM) remain a beneficiary of dollar weakness, the low US interest scenario, low or controlled inflation in EM and resilience of economic growth in the region. As per the International Institute of Finance, EM attracted USD 25 billion (Equity USD 15 bn and Debt USD 10 bn) in July adding to recent positive sentiment.
Earning season is in full swing with 115 companies out of 160 companies in S&P Pan Arab Mid Large Cap index having reported their second quarter numbers thus far. At the aggregate level, net profit is 5% ahead of market expectation. Positive surprises came from the petchem, real estate and retail sectors whereby SABIC, Sahara, SIIG, Yansab, Saudi Kayan, Al Hokair, Emaar properties and Emaar malls reported better than expected numbers. In the petchem sector, higher pricing and stability in operations led to improvement in profitability. In the UAE banking space banks reported better than market expectation mainly due to lower provisioning and stronger fee income. Overall the second quarter results show resilience of corporate earnings despite an overall challenging macro environment caused by lower oil prices.
In Saudi, liquidity in the banking system remains tight with the loan to deposit ratio of many banks close to the regulatory limit of 90% and three month SIBOR rising to 2.24% as against 1.54% at the end of 2015. The Government continues to drawdown on foreign reserves with reserves declining by US dollar 11bn in June to US dollar 562bn, year to date Saudi foreign reserves have declined by US dollar 46bn.
Egypt is seeking a loan of US dollar 12bn from the IMF over a period of three years and also seeking to borrow USD 3bn from international market. The Egyptian equity market reacted positively with the local index rising by 8% last week, however the overall macro picture in Egypt remains challenging with rising inflation and a higher fiscal deficit. The Egyptian currency may further devalue by 20% to 30%. Overall we remain cautious on Egypt in the near term.
Oil price ended the week losing 7% despite a weaker US dollar due to the resurfacing of oversupply concerns. As per EIA data US oil production increased by 87k barrels per day over the last three weeks and US oil inventories increased by 1.6 mn barrels. Baker Hughes rig count rose for the fifth consecutive week, the count increased by 3 to 374 as compared to the May lows of 316. We are of the view that the supply demand gap in oil market will narrow by year end leading to a stabilsation of oil prices.
In terms of fund positioning we remain cautious on the overall environment and have increased cash holdings, we will monitor oil price developments closely. We remain overweight on UAE but have lowered the extent of our overweight positions in Saudi whilst retaining a bias toward defensive sectors.
Weakness persists in the Nigerian market as the country adapts to a new flexible exchange rate policy. On a year-to-date basis the Naira has lost 53% yet still trades at a discount in the parallel market. Macro indicators remain weak with inflation touching 16.5% in June 2016. Last week, the Central Bank raised interest rates by 200 bps to 14%. IMF recently warned Nigeria that its economy might contract in 2016 due to the fall in oil production and shortages of electricity. In Q1 2016 Nigerian GDP contracted by 0.4%.
In Sri Lanka, the Central Bank raised its key interest rates by 50 bps in a surprise move aimed at curbing high credit growth that is adding to concern about inflationary pressures. According to the Central Bank Governor the rate hike will not impact Sri Lankan growth rates based on strength in tourism earnings, remittances, domestic industries and services.
Our Frontier fund remains underweight Nigeria and overweight Pakistan, Vietnam and Bangladesh.
Pakistan benefits from improving fundamentals and the MSCI upgrade to Emerging Market status next year, while Vietnam benefits from being a low cost manufacturing hub and low inflation. Bangladesh benefits from higher GDP growth rate and current account surplus.
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