Special Features
Emirates NBD CIO Private Banking Office - Be Risk Averse -
We believe there is a risk of a correction in global equity markets. Global developed market equities had a modest but significant setback last week. The S&P 500 fell 1.7% last week, the largest weekly fall since the week ended November 12, 2010. We believe equities face a number of challenges. Firstly equity ownership is at relatively high levels. The recent Merrill Lynch survey showed that 67% of global institutional investors were overweight equities in February, the highest level in the survey’s history dating back to 2001. Secondly global growth is at risk of a setback due to the very high oil prices. If growth expectations fall, analysts may cut their corporate profit forecasts thereby further undermining the equity markets. Finally higher oil prices means higher inflation and potentially higher interest rates something that equity markets tend react negatively to.Whilst global developed equity markets look to have a set back from their recent highs local equities are hitting new lows. Sentiment in the MENA region remains poor. A wave of retail selling pressure appears to have followed the previous selling pressure from international investors withdrawing some of their capital. The protests in Libya have only served to worsen the near term outlook. The DFM Index is now down to the lows of July/August last year‐ levels that seem unwarranted by the long‐term fundamentals, however investors are not focused on the long term. Since November 2010 the DFM General index is down 17% whilst the US equity market S&P 500 Index is up 11%. The gap that has opened up between the markets seems unfair. Both Dubai and the United States have witnessed an improvement in their respective economies. Also one could say that the rise in the oil price probably further underpins the Dubai economy more than the US. The Saudi Tadwul General Index is down 6% since November showing that the whole region has been afflicted. The Tadwul index fell through a key support at 6000 and is possibly headed down to a new support at 5760.
What would be needed to calm nerves in the local markets? Clearly we need to see geopolitical problems abate. As much as Tunisia and Egypt started the crisis they could also help bring some stability. Political reform and new stable political regimes are a pre‐requisite of less volatile markets. A signal of stability will come via the oil price. Unfortunately at the moment the risks remain to the upside for the oil price. The WTI oil price of $98 is close to 20% higher than a year ago. In order than the inflation impact of the oil price were to be more neutral would require the oil price to settle back at $85. However unfortunately for the moment we believe the risks remain to the upside for the oil price.
With Libya drawn into the geopolitical problems afflicting the MENA region, the implications for the oil price are more worrying. Libya its for around 1.6m barrels a day out of OPEC’s total supply of 30m b/d. OPEC had 5m b/d of spare capacity at the start of 2011. The fear is that if Libya and say Algeria were to stop production because of geopolitical problems OPEC’s spare capacity would drop to just 2.4% of total capacity, a level that in the past has led to a very substantial spike in prices. Current high levels of inventories should provide some near term cap on a rise in prices. OECD crude inventory stands at 48 days of demand cover in addition oil products provide a further 42 days of demand cover.
We recommend investors take a defensive stance in current market and geopolitical conditions. Preservation of wealth is the uppermost consideration. A combination of cash, bonds, gold commodities, and only modest exposure to equities is appropriate for most investors seeking capital preservation. Developed market government bonds rallied last week as many investors sought out safer investments. US 10 year yields have fallen from the 3.65% level to 3.40% over the last two weeks. Gold has risen from $1313/oz in late January to over $1400/oz in recent trading. The local bond markets have generally held up well however the Dubai CDS the cost of insuring against default)has risen to 452 basis points from 400bps over the course of the last couple of weeks. We are still comfortable buying local bond markets in combination with the added security of US government bond markets.
The driver for sentiment in the near term will be the geopolitics. However it is also important to follow the flow of economic data. We suspect that the flow of economic news and data in the coming months will be more heavily hit by the pickup in the oil price. After a run of very strong data we expect US and European economic data to show some weakness in industrial and consumer confidence and maybe some initial indications of a slowdown in activity. The rise in oil prices will detract from consumer spending power particularly quickly. Also industrialist may be more hesitant to build industrial production growth if they fear a global slowdown. In the last week the Chinese industrial confidence survey surprised the market with a weaker level than had been expected, although export orders were stronger than expected.
