Pockets of global growth come under threat
The markets’ concern on future rate hikes and the winding down of US quantitative easing (QE) has taken a backseat, with the US launching air strikes on Iraq. Oil majors are starting to withdraw from the country, which would impact oil production. The US also imposed further sanctions on Russia and Russia retaliated by imposing sanctions on food imports from the EU (valued at Euro 11 billion annually). Gaza continues to boil over and consequently the global hospitality and transportation sectors are under threat, even as the WHO declares the Ebola virus an international emergency. Italy enters recession, China’s services PMI was at its lowest ever (though subsequent release of export numbers and industrial production show growth). The impact of all these diverse issues on global trade and GDP is yet to be estimated.
With the end of the US Fed QE – likely in October 2014 – we expect more volatility in global currency and equity markets. However volatility need not be perceived as a negative factor for investors. They can avail themselves of options on currencies and equities and of derivative strategies via structured products, yield-enhancing instruments in turbulent markets. The price of call and put options tends to rise as the underlying currencies and equities become more volatile. We therefore recommend investors explore derivative strategies in the coming months, to enhance yields in their portfolios.
GCC markets, barring the UAE, performed well for the week with the Saudi Index continuing its steady march upwards. MSCI Saudi has outperformed MSCI EMEA for the last 5 years. Economic data from the region has been positive. Activity across Saudi Arabia’s non-oil private sector expanded to a nearly two-year high in July, with the SABB HSBC PMI Index coming in at 60.1. The HSBC UAE PMI too showed continued strong growth across the non-oil private sector, with July’s headline reading at 58.0, significantly higher compared to the same month last year (54.5). This reinforces our in-house view that the UAE’s non-oil private sector will be the key driver of underlying economic activity in 2014. The real estate market in the UAE is stabilizing and tourism is increasingly contributing to non-oil GDP.
Qatar markets have recovered from last month's sell off, with the Emir confirming limits of 49% foreign participation limit in Qatari listed corporates. Qatari stocks are trading at attractive valuations, however volatility may continue till the announcement of the FIFA review.
Samba Bank in Saudi Arabia – a constituent of our GCC model portfolio – was the outperformer regionally. We continue to see value in Samba, which is well capitalized and geared to increased lending to the corporate sector. In the event of higher rates Samba, with stronger corporate loan growth and lower margin pressure, has the potential for faster loan repricing, harder to come by on retail loans mainly priced off fixed rates. SAIBOR closely tracks the USD LIBOR. The opening of the local stock market next year to direct foreign investments will be a positive factor, given Samba's strong brokerage positioning. Saudi banks will benefit from any interest rate hikes, as they have low cost CASA (current account to saving account) balances.
GCC bond markets still resilient to global volatility
GCC bonds held reasonably well amidst rising risk aversion in broader high-yield debt markets. Russia was the biggest loser in the EM space and Russian spreads widened the most, followed by other high beta sovereigns within emerging markets. Flight to safety dominated last week as 10-year US treasury yields reached 2.41 %. Gilts and bunds also followed suit, the latter sinking to all-time-lows. Regional bonds and sukuks saw some support,boosted by renewed liquidity as markets returned to normalcy after the long EID break.
The Hong Kong Monetary Authority mandated banks for a potential maiden sukuk sale. A benchmark issue size –$500 million to $1 billion –could be expected,with a duration of 5 years or less. Turkish fixed income markets were under pressure, along with other emerging markets given the US airstrikes on the ISIS militants last week;banks and corporate bonds on average widened by 50 bps. Bank Asya was the biggest loser in the Turkish banking space as talks derailed with Qatar Islamic Bank on a share acquisition deal. S&P revised the outlook on major Canadian banks from stable to negative.
Global equities range-bound as temporary factors cloud the outlook
We expect more volatility in global equity markets for the coming weeks, as multiple negative factors are clouding the outlook in the short term and no obvious catalysts are available after the end of the earnings season.
On the one hand the apparent easing of geopolitical tensions – Russian Defense Ministry announced Friday the withdrawal of troops from the Ukraine border – helped the SP500 recoup weekly losses and stage a 1.15% rebound on Friday. On the other hand retaliatory measures imposed by Putin will be affecting the European recovery and especially the common currency, as investors are betting monetary policy will be accommodative for longer amid uncertainty.
Indeed the European Central Bank (ECB) chief Draghi in his press conference did not lay emphasis on deflationary concerns, but explicitly mentioned geopolitical factors as key risks to the economy to justify low benchmark rates, although latest macro data were weaker than expected. And interest rate hikes do not seem to be imminent in the UK either – where the business cycle is much stronger– as recently announced economic numbers unexpectedly fell short of consensus forecasts.
Currently in developed market (DM) equities we are more comfortable with the US positioning – the US economy remains impressively resilient – as well as with our overweight on Japan. Here structural reforms remain the main catalyst, along with further possible stimulus by the Japanese central bank and increased stock buying by the Government Pension Investment Fund, which is reviewing its investment policy in this direction. We believe any heightened risk aversion causing strength in the Japanese currency and corresponding weakness in equities should be used by investors to hedge currency exposure and add to equity positions in Japan. And we continue to hold the view buying the dips will pay off in the US as well.
As far as emerging markets (EM) are concerned, we are focusing on increased EM currency risks as the end of the Fed tapering – expected by October 2014 – will trigger the unwinding of carry trades on high-yielding currencies. Overall we advocate patience during the forthcoming higher-volatility phase and advise to add selectively to equities only on further weakness by hedging currency risk where appropriate. We see Europe ultimately recovering, but bearing the brunt of Ukraine tensions and EM equities performance tempered by currency weakness as the end of tapering takes its toll.