Equities still remain the preferred play

Dubai: Investors are inevitably wary these days. The uncertainty surrounding the postponement of debt payment request from Dubai World upon which the local stock markets retreated sharply — by more than 20 per cent in two days — has amply demonstrated the understandable basis for caution. Markets here are expected to face more selling pressure in the coming days.

Once again, it has underlined some basic principles for the region's investors to take on board: the importance of being clear about your strategy, your appetite for risk, your assessment of what is driving market sentiment, and how to diversify in terms of asset allocation in case it is protection and hedging which are the key motivation, rather than a relentless speculative impetus.

Asset managers say that cash allocation right now is almost negligible, given the recovery in global markets and increase in risk appetite. The bias is increasingly towards equities, obviously riskier, globally and within the region.

Within equities in the region, it is said, there are certain sectors and markets that present opportunities going forward, but a degree of prudence is urged.

Markets and sectors cannot be generalised. Even amid rampant bullishness, there are rotational plays between cyclical and defensive equities, for instance, between ‘growth' and ‘value' stocks, and between those you might hold for the short term and those worth holding onto for longer.

In searching for value in particular, investors will look at companies that are clearly priced ‘right' and have strong fundamentals. That is, most probably, that they are profitable, have a low leverage and a steady cash flow, and preferably with growth potential.

In the bigger picture, globally, both equities and bonds have attracted keen interest, driven significantly by the liquidity injections of governments devoted to boosting money supply by quantitative easing. The outlook may become tougher for bonds soon, with yields having been diminished by institutional demand, while becoming vulnerable to supply overhang rooted in widening budget deficits.

Internationally, the uptrend in equities have slowed down, in fact, almost flat, as money flows now need to be backed by the evidence of a more fundamental recovery. That's where the disturbance of market confidence by stories of debt renegotiation and creditor nervousness has its impact.

Opportunities

When it comes to equity markets of the region, there seems to be a kind of consensus among fund managers and analysts, namely that opportunities are still there to be had.

With relatively lower leverage and more government support in some cases, almost all such observers are positive on Saudi Arabia, Qatar and Egypt.

Looking at the defensiveness in the current market mood, the UAE for some managers is negative, but for others it's still an option, but on a selective basis. Dubai and Abu Dhabi had anyway been witnessing a correction since the highs of mid-October.

By the time the Dubai Financial Market rallied in October to the high of a 66 per cent increase from its lows in February, it was already looking expensive. Hence there was a correction already in motion when it plunged last week.

In the first two days as the UAE markets went down, other regional markets also fell. But Qatar and Egypt were quick to recover, and were up 4.8 per cent and 4.7 per cent respectively since Wednesday. At the close on Thursday, Bahrain rose 0.19 per cent and Kuwait 0.71 per cent.

"After the initial kneejerk reaction where the selling was indiscriminate, each regional market gradually should follow its own fundamentals," says Shakeel Sarwar, head of asset management at Securities and Investment Company (SICO), Bahrain.

"Currently, I am negative on the UAE and Kuwait, neutral on Bahrain and Oman and positive on Saudi Arabia, Qatar and Egypt. Assuming that no major negative macro development happens on the global or regional front, we may see some selective value-based buying coming into the region, if not a broad-based rally."

Tudor Allin Khan, chief economist at Al Futtaim HC Securities, agrees. "For regional equities, we would ‘overweight' those economies with strong financial sectors and clear government support mechanisms," he says. "We favour Qatar and Saudi Arabia, but also see the banking sector in Egypt being a de facto beneficiary of the concern of exposure to Dubai debt."

Al Futtaim HC Securities had already placed an ‘underweight' recommendation on Dubai after the market reached the highs in October. "We were advising our clients to avoid countries where financing and government support were uncertain," Khan says.

When it comes to sectoral allocation, without unduly generalising, the common recommendations seem to be ‘defensives' and ‘late cyclicals', as well as those companies more exposed to the international economic recovery. The infrastructure sector remains a favourite for all, with the expectation that governments will continue to spend their way out of recession in 2010.

Bottom-up approach

"We don't usually generalise on a sector because we take a ‘bottom-up' approach, which means we quantify what are the effects [of the latest events on price], then compare the value of the company to the market price," says Fadi Al Said, head of equities, Middle East and North Africa, ING Investment Management. Besides certain stocks in the UAE which might offer the right price, he also prefers Saudi Arabia and Qatar.

"I prefer to wait till the beginning of [next] year when we would have finished building our positions, but we continue to prefer non-cyclical companies at the right price and late cyclicals like infrastructure players in Saudi [Arabia] and some of the sectors that are more exposed to the global recovery such as petrochemicals, shipping sector maybe, and infrastructure-related industries."

Sarwar of SICO has similar recommendations, extending his choices to Oman and Bahrain. "I like infrastructure, industrial and telecom plays in Saudi Arabia, large-caps in Qatar, and selective financials, telecoms and industrial stocks in Oman and Bahrain," he says.

Given the same view on governments' infrastructure spending, and the cash-rich generation nature and defensive play in times of crisis, Khan is positively disposed towards construction companies and telecom respectively.

Amongst those who are inclined to choose the UAE, there seems to be agreement on defensive sectors such as etisalat, Air Arabia and Aramex (respectively up 1.47 per cent, 2.13 per cent and 2.53 per cent after last week's crash). With uncertainty as to the size of loan provisions, most managers and analysts consulted are sceptical of the banking sector. Real estate also failed to find much favour.

"In the UAE I will be very, very selective and very, very defensive," says Haissam Arabi, chief executive of hedge fund Gulfmena Alternative Investments. He also favours Qatar, Saudi Arabia, Egypt and, to some extent, Lebanon.

On commodity stocks, particularly basic industries and energy related, Khan has an overweight. "Commodities would be the first to recover on the back of an economic recovery," he adds. "The increase in global liquidity has driven up commodity prices and we do not expect a reversal of this trend any time soon. The concern of future inflation has also seen commodity prices rally."

Now for those who opt for a more global diversification, the bias is indeed more towards equities now, say managers. However, views differ on the geographies.

For Eric Swatt, partner and head of asset management at Rasmala Investments, the focus is on emerging equity markets.

"Not so high in the US, not so high in Europe and Japan, but [more so] in Asia, Latin America and Mena region, specifically Saudi, Egypt and Qatar," he says.

However, there are asset managers who believe the developed markets do hold promise and cannot be left out of the portfolio.

"In terms of equities, Asian and Emerging Markets do still provide some excitement," says Jahangir Aka, senior executive officer, SEI Investments. "We also believe the US has good opportunities. However, in our opinion Japan and Europe will lag."

Khan of Al Futtaim HC Securities believes developed market equities will probably outperform emerging market equities, given the increase in risk premium and the concern of securing funding in developing economies.

Though the bias is towards equities, bonds of a particular kind are still not to be completely overlooked. "We have reduced our weight on corporate bonds and the riskier end of the bonds because the yields have thinned," says Aka. "Spreads have begun to widen because of the [Dubai news]. We are still overweight, but nowhere near as in 2009. On the riskier bond side we believe there's still some further returns to be gotten."

Khan, however, is completely against any allocation to sovereign debt. With growth and inflation rates moving higher in 2010, this is a better environment for equities, he says.

Fragile

But better does not necessarily mean firm and sure-footed.

"The market environment for risky assets such as equity and real estate is still positive, with high levels of liquidity, low interest rates and average valuations," says Deon Vernooy, senior executive officer, Emirates Investment Services (EIS) Asset Management.

"Having said that, that environment also seems to be rather fragile, and any major sovereign or corporate defaults may upset the positioning in these asset classes. Until such time that institutions and individuals that have stretched balance sheets have de-leveraged, this situation will continue, and the basic stance of investors should be extremely cautious," he says.

Aka agrees with Vernooy to be cautious on real estate. "People should continue to watch very carefully, not positive, not negative—I would not put any more money in—is real estate. People are jumping into real estate and that's not a great play."

What about alternative asset classes, then: private equity, hedge funds, which have been receiving bad press during the credit crisis? "Given investors' rediscovered need for liquidity and the limited availability of leverage, these [sectors] remain challenged going into 2010," Aka says.

How about gold, whose rise has been relentless this year? It was being quoted at $1,208.67 (Dh4,433) on Thursday, rendering the fabled $1,000 level almost a distant memory.

"We would not recommend an allocation at these levels, as a defensive strategy towards increased uncertainty in the UAE," Khan says.

Given the rally throughout the year and the latest resilience shown by markets worldwide, Rasmala Investments' Swats has more faith in equities.

"I wouldn't chase gold, though everyone is piling onto it. It has taken on a momentum of its own, so it may be risky to buy at these levels," he adds.

So, equities seem to be the preferred route right now to making or keeping riches. But it's still a selective matter, in an era of heightened uncertainties.

For the region

Internationally