2012 was an eventful year, with the key global central banks announcing fresh stimulus measures, bringing in a much-needed respite for asset markets. Globally, economic data remained mixed, with pockets of strength in the US, while eurozone data was broadly disappointing. Moreover, the fiscal cliff overhang in the US weighed on investor confidence.
The year also saw a change in leadership in China, while the US witnessed a close fight for the presidency. The standoff between China and Japan over a territorial dispute led to geopolitical worries, which continue as this article is being written. While the MENA region also had its share of geopolitical tensions and risks of Arab Spring contagion, most of the GCC economies remained unscathed as massive economic packages alleviated any possible social tensions in the region. The GCC economies witnessed strong economic growth, with most GCC oil exporters operating at close to capacity owing to the tight supply of oil. The IMF has estimated the GDP growth for the MENA region in 2012 at around 5.3 percent, with oil exporters performing better than oil importers.
What to expect
As we look ahead to 2013, even as the global economy appears to be slowly getting into better shape, it is likely on an extended slow growth path. The successful political transition in the two major global economies, the US and China, has removed a lot of political uncertainty, and economic indicators in these economies are showing signs of improvement.
However, significant tail risk remains due to headwinds from the eurozone, the US debt ceiling issue and geopolitical tensions. The US faces challenges that require decisive long-term strategic action. Meanwhile, Europe is grappling with severe economic and political headwinds and the euro is an experiment fraught with stresses. Unlike the US, the lack of visible leadership and decisive decision making in Europe leaves us less confident that concrete steps will be taken to address underlying issues in the region.
The successful political transition in the two major global economies, the US and China, has removed a lot of political uncertainty, and economic indicators in these economies are showing signs of improvement
The US economy also appears to be in a more robust position, having absorbed three large doses of quantitative easing. We anticipate the US will do the right thing and get its house in order much faster than it will take Europeans to figure out a permanent solution to the problems facing the eurozone. With the global economy still not out of the woods, we expect the major central banks to continue with the extremely loose monetary policy and low interest rate regime for the foreseeable future, leading to excess liquidity in the global economy. Investors will therefore be hard pressed to earn a decent yield on their investments.
GCC welfare spending
The GCC economies continue to witness strong growth, with most nations other than Saudi Arabia continuing to operate at close to capacity owing to the tight supply in oil markets. Given the large youth population with high unemployment levels and rising food inflation, governments in this region also continue to spend on the non hydrocarbon sectors and social infrastructure, to contain any possibilities of an Arab Spring contagion. According to some estimates, there has been about $150bn worth of social welfare spending in the Gulf since the unrest began. As per IMF projections, nations in the region should continue to grow much faster than the developed world in the foreseeable future.
We believe that ample market liquidity and augmented government expenditure on infrastructure and social sectors in the GCC region will percolate to the corporate sector, rendering support to robust earnings. For 2012, Saudi budget estimates suggested revenues of SAR 829bn and expenditures of SAR 820bn, projecting a surplus of SAR 9bn. These estimates appear extremely conservative, as revenues for 2013 could be as high as SAR 1150bn if the average Arabian light oil price hovers around current levels.
The budget reflects governments’ continued focus on sustainable development initiatives that requires investment in key sectors such as infrastructure, education, healthcare, and social and other development initiatives. On the corporate earnings front, the weakness in the dominant petrochemical sector was largely offset by growth witnessed in other non-oil sectors. Demand pressure continues to hurt the petrochemical sector, while increasing government spending helped to propel growth in the banking and retail sector.
The GCC markets are highly correlated to movements in oil prices. Against a backdrop of slow growth in advanced nations, the demand scenario for oil from these economies remains weak. Additionally, plans for lowering American dependence on imported oil appear to be taking shape; however, we expect that the higher oil demand from emerging markets and geopolitics should interplay with the above factors to help stabilise oil prices around the current levels in the medium term.
GCC markets are highly correlated to movements in oil prices
The current dividend yield of 4.1 percent in MSCI GCC is significantly higher than the dividend yields for most other MSCI emerging market indices. Within the GCC market, we continue to remain positive on the UAE but cautious on Saudi Arabia, with both economies being key beneficiaries of a relatively tight oil market and large government spending, providing visibility for robust business and earnings growth. With the current ongoing earnings season, Saudi Arabia’s Tadawul stock exchange (TASI) is trading higher at 11.34xCY2013 earnings, as compared to 10.29x in middle of October 2012 while the trailing 12Month (TTM) PE is now as high as 14.78x. The TASI index is now trading closer to most key global indices and at a premium compared to most GCC markets based on 2013 earnings. This indicates that any disappointment on account of expectations for 2013 earnings could result in a sharp market correction. Moreover, Saudi Arabia is also trading at a lower dividend yield, compared to the other MENA region economies. Saudi Arabia’s Tadawul All Share Index (TASI) underperformed most of the developed markets in 2012, posting a return of 6.5 percent, while the S&P 500 clocked a return of 13.4 percent.
Real estate promise
The real estate market in the GCC, especially in Saudi Arabia and the UAE, is also set for a good year ahead. We expect a strong pickup in demand for Saudi residential properties, as the newly passed mortgage law is expected to assist the banking sector in expanding lending for home purchases. We expect robust growth in mortgage lending over the next decade, as the new law is expected to provide opportunities for lenders, property developers and middle-class Saudi homebuyers. Abu Dhabi is becoming more appealing, too, as new residential communities are offering more affordable and better accommodation. That said, we expect the vacancy rates to nudge higher and plateau in 2014, on account of the steady increase in supply.
High oil prices have provided flexibility on spending to governments in the GCC region and are creating an environment for sustained capital market performance in the region. It is important to ensure that government policies deal not just with the short-term problems, but also address the long-term employment opportunities and structural issues facing the region. The IMF has raised concerns over the unprecedented rise in spending, and warned of a possibility of their combined surplus turning into a deficit by 2017.
Recent projections by the IMF indicate that Saudi Arabia would need a breakeven oil price of $98 per barrel in 2016, compared to $80 per barrel in 2011, to balance its budget. It is therefore important that the investments today are in productive assets that are able to create alternative sources of revenue and employment opportunities in the future.
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