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Geopolitics at the fore: volatility re-emerges, risk-off likely to prevail in the GCC markets

General weakness to prevail in the regional equities this week

Gulf News

Dubai: Amid geopolitical tensions, global markets took a breather last week and the S&P 500 index (SPX) retraced from its all-time highs of 2,480 (August 8) and ended the week lower by 1.4 per cent. The volatility index, VIX, jumped by 5 points on Thursday — one of its biggest one-day jumps in history, and ended the week at the 15.5 level. However, oil markets continued to trade in a tight-range, with geopolitical risks broadly balancing the mixed crude outlook from the International Energy Agency (IEA).

The IEA in its latest monthly outlook revised upwards of its 2017 global oil demand estimate to a growth of 1.5 million barrels per day. It, however, adjusted downwards its 2015-18 average demand estimate by 330,000 bbl/d.

The demand outlook, in general, remains sanguine, with 2018 demand expected to increase further by 1.4mbd.

However, on the supply side, Non-Opec supply is expected to increase further by 1.4mbd in 2018 (US: +1mbd), and thus, global oil market rebalancing continues to be hinged on the trajectory of Opec production.

Opec’s compliance to its production quota apparently reduced to its lowest, year-to-date (YTD), in July to 75 per cent (YTD: 87 per cent, June: 77 per cent), and Saudi oil minister, Khalid Al Falih, reportedly said that further production cuts and/or cuts extension would be examined, depending on market conditions and be agreed upon by 24 countries.

In a nutshell, global oil inventories continue to decline. However, market rebalancing is likely to be much protracted and we continue to expect rangebound oil prices in the short- to medium term.

Looking ahead

Last week, the major regional equity markets ended on a mixed note, with Dubai (DFM), Abu Dhabi (ADX) and Qatar (QE) ending lower by minus 0.8 per cent, minus 1 per cent and minus 1.7 per cent, respectively. The Saudi index (SASEIDX) and Kuwait (KSE) bucked the global and regional weakness and ended higher by 1.1 per cent and 0.3 per cent, respectively.

Looking ahead, we expect general weakness to prevail in regional equities this week. The second-quarter earnings season is mostly behind us, with the exception of Dubai heavyweights, Emaar and Damac, which will report their earnings this week. We continue to prefer Emaar over Damac on a risk-adjusted basis.

The earnings reported by DFM companies last week was generally uninspiring, with the exception of Air Arabia, which reported a 21 per cent year-on-year growth in its bottom line and reported earnings that were 52 per cent above market expectations.

Arabtec reported its second consecutive profitable quarter in the second quarter. However, we believe that the recent earnings improvement is more than reflected in the share price, which is up 21 per cent since its late June lows. Arabtec won Dh2.2 billion worth of projects in the second quarter, broadly in line with company’s quarterly burn rate (the last four quarters at Dh2.1 billion).

However, we await further evidence of build-up/sustainability of the backlog (second quarter: Dh17.4 billion), and the continual improvement in gross margins (second quarter over first quarter: 5.1 per cent over 4.8 per cent) before obtaining a more positive outlook on the stock price.

Current valuation

Additionally, although recent recapitalisation has improved the company’s balance sheet strength, a first half CFO of a negative Dh1 billion isn’t comforting and we believe that the current valuation is expensive.

DXB Entertainments (DXBE), on the other hand, reported another loss, worse than the market expectations. However, we do see some positives within the reported results — second-quarter visits at 414,000 (first quarter at 586,000) and the theme parks’ revenue per cap being broadly flat quarter-on-quarter — does give some hope, given summer months and significant promotions during the quarter.

Additionally, the new management agreement with Meraas to manage a portfolio of leisure and entertainment offerings will support the recurring revenue generation.

However, the company’s business model being highly leveraged to visit numbers, these numbers render limited support to justify Dubai theme parks’ project economics.

Looking ahead, we believe any updated colour on the guidance for 2018 (and beyond), with visit guidance at IPO time being 7.2 million (theme parks: 6.6 million) for 2018, will dictate the trajectory for the stock price. The stock has significantly underperformed the broader market YTD (minus 38 per cent vs DFM’s +2 per cent), and we await any catalyst for the stock price.

Reported earnings

In Saudi Arabia, 21 index companies have yet to report earnings, and among the reported companies, reported earnings in the second quarter represented a decline of 12 per cent YoY and 16 per cent quarter-on-quarter, on a consolidated basis. Consolidated earnings in the second quarter for KSA banking sector declined by 2 per cent year-on-year (minus 3 per cent quarter-on-quarter), and came slightly ahead of the market consensus (+2 per cent). We see limited local catalysts for the market and expect the performance to be dictated by global developments during the week.

The US rates came under pressure last week on below-market expected CPI numbers for July (month-on-month: +0.1 per cent vs expected: +0.2 per cent), and US 10-year yields ended the week lower by 7 bps at 2.19 per cent.

However, credit spreads widened on heightened geopolitical tensions, with the JPM EM Index widening by 14 bps from the lows of the week to stand at the widest level for the month.

Regional credit default swaps followed global leads trading wider for the week.

Looking ahead, while geopolitics will continue to drive risk-on/off sentiment, the market will likely focus on US July retail sales and July FOMC (Federal Open Market Committee) meeting minutes to take cues on the rate hike trajectory in the US. The probability of another rate hike declined dramaticaty after disappointing CPI numbers, and currently stands at the lowest since last FOMC meeting on July 26.

Within regional credit markets, we are looking for a busy week that will likely see Bahrain come to the market with a new issuance and market participants return from the summer vacation. We see value in certain names, after the decline in rates, and in particular, seeing interest in DAAR’s short-end. Management highlighted that it may look to buy back sukuks due 2018 on a healthy cash balance.

The author is a vice-president at Shuaa Capital and is a part of the SHUAA Investment Management team, and the author can be reached at im@shuaa.com.

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