Credit Suisse: Middle East equities picking up

30/01/2017 11:53 AST

Improving macro indicators are starting to feed through to earnings forecasts says Fahd Iqbal, Head of Middle East research at Credit Suisse.

After a strong Q4 performance, we see near-term consolidation risks. However, we also see further upside beyond a potential consolidation. Headwinds remain from weak job growth, fiscal austerity and, for some countries, a stronger dollar.

We also see potential for geopolitical risks to increase under the Trump administration. We remain positive on the UAE and are buyers of Egypt on weakness; we take profit and downgrade Kuwait and Oman to neutral; we upgrade Saudi Arabia to neutral as it is no longer in a technical downtrend; we remain underweight on Qatar and Bahrain, though the former will likely see momentum continue in the short term.

The Middle East markets have enjoyed an impressive rally, with the region gaining 17 per cent in Q4 2016. This was by far the strongest performance by any region and allowed the Middle East to post a modestly positive return for 2016 overall.

The key driver for this was the strong recovery in both risk appetite (post the US presidential election) and oil prices (particularly after the unexpected OPEC deal). For most investors, the latter would seem to be the obvious driver for Middle East equities, but as we have highlighted many times in the past, the region has historically not shown any greater correlation to oil prices than the rest of the world due to the lack of energy-related equity listings. Indeed, during the period of high oil prices from 2010 to 2014, the Middle East had a lower correlation to oil than the global markets.

However, this has changed since the oil price crash and its central role in the region’s process of fiscal reform. With oil prices having improved, oil is becoming less important a driver to Middle East equities (correlation is topping out), but we have no doubt that a sharp move in oil prices would once again affect regional equities. Last but not least, we also highlight expectations of dividend payments as strongly supportive for the regional markets.

The majority of Middle East companies make annual dividend payments in calendar Q1 and, as a result, investors tend to position themselves accordingly towards the end of the preceding Q4. Given the high level of government ownership across the major listed equities in the region, the pay-out ratio has historically been above the global and emerging market average. After experiencing a contractionary economic environment over the past two years, economic indicators across the Middle East are beginning to show signs of improvement. The oil exporting Gulf Cooperation Council (GCC) economies are set to reap the benefits of higher oil prices and progress made on subsidy reform, while Egypt has successfully initiated the politically difficult steps towards preserving its foreign exchange reserves.

We forecast economic growth to improve to 2.2 per cent in 2017 from 1.4 per cent in 2016 for the broader Middle East region, while the GCC is expected to grow 2.3 per cent in 2017 from 1.7 per cent in 2016. The improvement in growth should be broad based across the major economies. At the same time, M2 money supply growth has bottomed out for the oil exporting GCC countries though it remains muted and contractionary for Qatar. This improvement comes hand in hand with a reduction in fiscal deficits and a further increase in debt issuance. Fiscal deficits reached unsustainable levels in 2016 but by 2018 we expect to see all major economies in the Middle East rein in their deficits.

CPI Financial