Dubai: The "third depression", courtesy Paul Krugman; "double-dip recession", courtesy Nouriel Roubini; and now "unusual uncertainty", courtesy Ben Bernanke. The outlook for the global economy has never been more uncertain. And regional markets today, being tied to global currents, remain vulnerable to overseas sentiment.
Middle East and North Africa (Mena) equity markets have, in fact, been outperforming international equity markets in recent months, despite a sluggishness visible in low volumes and sideways movement. In June the MSCI Arabian Index fell 2.8 per cent, compared to a 3.6 per cent decline in the MSCI World Index. In the year to date, the region's performance is actually way ahead, sliding a mere 2.1 per cent compared to the 10.9 per cent fall in international markets.
Still, it is difficult to be enthused about investing (in the region's equity markets) at the moment, says Paul Cooper, managing director of Sarasin Alpen Bank. "Sentiment is poor, trading volumes are extremely low, and we are constantly being reminded of reasons to be cautious."
Eric Swats, head of asset management at Rasmala Investment Bank adds: "Markets themselves may be outperforming, but just outperforming [relative to elsewhere], not offering very good returns.
Regional investors are faced with a tough choice at the moment. A degree of diversification is normally sensible for most investors, but, with the correlation of financial assets rising in these still uncertain times, it is not always easy to achieve. Gulf News spoke to a few UAE-based asset and investment managers on the possibility of a ‘double dip' and how best to manage one's portfolio in the still uncertain times ahead.
"I don't believe the regional or global economy is set to move into a double-dip recession," said Gary Dugan, chief investment officer, private banking, at Emirates NBD bank. "There are too many good things happening in the global economy. Emerging market growth remains strong — witness the 15 per cent plus growth from Singapore so far this year. Interest rates will remain close to zero for the balance of the year. The US and Europe are burdened by debt but they are still growing. It is wrong to characterise a cautiously growing developed world as one on the cusp of recession."
Region's positives
Indeed, looking between now and year-end, a majority of analysts believe the region's markets will continue to outperform, and expect a better global environment as well to steady the global equity markets which have been causing much of the problem here.
"Specifically, while the developed world struggles to cope with high levels of government debt and record budget deficits, the budget surpluses and almost zero debt in the GCC stand out as a beacon of financial prudence," says Cooper. "Similarly, while investors worry that inflation pressures in the emerging world will force interest rates higher and slow growth in 2011, rates in the Gulf are likely to remain low because of the dollar currency pegs."
But within the region some may be better placed than others.
"A double dip is not really going to happen here in the Mena region most broadly," says Swats. "We have had some slowing of growth in certain geographies, particularly Dubai, but when you look at Saudi Arabia or at Egypt, the two biggest economies in the region, there may have been a little bit of softening, but by no means have you had a contraction of economic activity."
Even globally, he believes the double-dip idea is unlikely.
"It's more an anomaly for the economies not to recover after a contraction. Economic activity globally looks to be OK, and we are going to characterise it more as a mid-cycle slowdown than anything more sinister," he says.
Dan Dowding, senior executive officer at independent financial advisers Killik and Company, Middle East and Asia, points to the divergence of opinion on the issue, but if in the global context a double-dip were to occur, he says, "we could potentially see the markets [globally] fall 10 to 15 per cent, and vice-versa if bouncing back up."
In the near term, he adds, the markets are undecided, and will trade in the range of recent days, and this could extend out further if there is no further clarity. "A big issue overhanging the markets is one of uncertainty, with arguments for recovery and double-dip being equally strong," Dowding says.
So, what should investors be keeping an eye on, both globally and regionally?
The US and European markets in particular are at an interesting juncture. Economic data are drifting lower, while company results have generally continued to beat expectations. Though results in the region have done likewise, they are "not exceptionally robust", as Swats puts it.
Investors, say asset managers, should keep a close watch on the sustainability of the US economic recovery, particularly US jobs growth. They would also like to be tracking default risk in peripheral Europe, corporate profitability, Chinese economic activity, and raising of interest rates by central banks — when and by how much, besides volatility in the oil price.
Oil prices
With oil revenues so important to the region, this is a major factor investors need to always keep in mind.
"Should we get into an environment where growth slows substantially, we could see some downward pressure on oil prices," says Swats.
However, he does not expect to see oil prices spiral down, and points to the fact that they remain at high levels, even with a stronger dollar.
The other factor more specific to the region is that the public financial markets are overly dominated by the financial industry, which does remain under pressure as a result of a declining deposit base — or at least one which is not growing so much. Also, among outstanding loans, there are substantial amounts which are potentially problematic, if not in default. Banking managements are looking to scale back their lending activities.
"A fully-functioning banking system is a prerequisite for sustainable economic growth, and I am looking for progress in this area," says Cooper.
But a major negative surprise in the banking system is probably the factor that would lead us to turn more negative on the markets, Emirates NBD's Dugan suggests.
In this environment, while many of these [banking and finance] stocks are cheap, it is unlikely that we would see a substantially rally in the equity markets here by year-end without a rally in global equity markets, says Swats.
As for asset allocation, it is naturally no surprise to have asset managers recommend a combination of the usual: equities, bonds, cash and alternatives. But, as no size fits all, the usual caveat applies, neatly summed up by Killik's Dowding, though not specific to the region.
"Investors should be doing what they should always be doing — ensuring that that they comply with their risk tolerance, time horizon, and diversify across asset classes and geographic regions. Portfolios should include bonds [government and corporate], cash/money market funds, commodities, absolute return funds, equities [with exposure to developed and emerging markets] and appropriate capital-protected Investments. Where appropriate, portfolio protection could also be taken out via derivatives."
Among the region's portfolio managers, equities and fixed-income/sukuk still form a major part of the overall asset allocation, though the bias towards one or the other differs.
While equities may remain a significant part of the portfolio, they might be targeted mostly towards those with relatively high and stable dividend yields, solid balance sheets and sufficient cash flows to cover those dividends. For Rasmala, an investment bank geared towards regional equity markets, 60 per cent of an investor's portfolio is still allocated to Mena equities.
"We are very much advising [our clients] to consider opportunities in the fixed-income and sukuk markets as a way to clip a higher yield or coupon in an environment where equity markets are probably going to offer meagre returns or meander up a bit, down [a] bit, until the global economic picture becomes more clear," says Swats.
"Fixed-income/sukuk bond opportunities in the region are in fact at a very interesting point, where investors can target returns of 7 to10 per cent per annum without a lot of risk from the issuers of this region. Rasmala's core strategy at this moment is to allocate about 30 per cent to fixed-income/sukuk and 10 per cent to cash and murabaha.
By comparison, the strategy offered to Emirates NBD clients, is for balanced portfolios to lean towards fixed-income, some commodities and trading in and out of the equity markets.
Bond market appeal
In the case of National Bank of Abu Dhabi's recommendation, the bond market's appeal is equally strong. While local equities are "extremely cheap on certain measures, with some great value emerging," their performance depends on how the international markets behave and not on domestic fundamentals, says Mark Watts, head of Fixed Income at NBAD's Asset Management Group.
"We believe that it is time for the bond market to truly come to the fore in both the UAE and the GCC as a viable choice for investors who want an increased yield without exposing themselves to excessive volatility. Bonds have long been utilised in many other markets outside of the GCC as a core asset selection and are prized for their diversification characteristics and low volatility."
Cash doesn't find much favour with him. "The classic safe haven asset is the default position for many, but investors are finding that cash returns are extremely poor overall and are being slowly eroded by inflation," he explains.
While market development is still a work in progress, so too is the experience of investors in a region governed both by international forces and particular characteristics closer to home. Which means that asset allocation, in these unprecedented times and here particularly, is an ever-changing art.
