Global and regional markets started 2016 on a difficult note with a confluence of negative events.
China dominated headlines in the new year with depreciation of the yuan and a series of contractionary PMI data taking centre stage. The onshore yuan is now weaker by 1.6 per cent in the year to date following a 4.6 per cent decline last year.
Concerns remain about the slowdown in China as government policy attempts to drive consumption and services rather than capital expenditure. A weaker yuan has a ripple effect across Asian currencies owing to competitive positioning and creates market volatility because of the cashflow impact on some emerging market companies with regards to US dollar-denominated debt.
In the US, data on the labour market showed 292,000 jobs added in December, above the market expectation of 200,000. Further, data for the previous two months was revised upwards by 50,000. A key question remains as to whether the US will continue with the Fed’s anticipated four rate increases this year despite faltering global growth.
The World Bank’s global economic growth forecast was revised downwards recently to 2.9 per cent for the year compared with 3.3 per cent forecast in June last year. However, global growth in this year is expected to be higher than the 2.4 per cent growth of 2015.
Across the GCC, markets remain under pressure with Saudi Arabia being the focus. Investors are attempting to assess the impact of the partial removal of subsidies on company valuations and the fallout and possible escalation of the Saudi-Iran standoff.
The Saudi budget for 2016 and subsequent reform plans, although positive for the long term, are expected to affect corporate profitability in the Mena region’s largest market. The Saudi budget focuses on three key factors: improving efficiency of government spending, economic diversification and fiscal consolidation.
The government forecasts that the fiscal deficit will narrow in 2016 to 326.2 billion Saudi riyals from 367bn Saudi riyals in 2015. The fiscal deficit in 2015 stood at 15 per cent of GDP – lower than a market expectation of about 20 per cent. This year’s fiscal deficit will be financed through domestic and global debt issuances.
The Saudi government plans to improve productivity in the country and is expected to lay out a plan for curtailing public sector employment, as well as for asset sales and for privatisations through its Transformation Plan 2020. We believe all these steps are heading in the right direction. However, there could be some near-term pain for corporates as they adjust to a more competitive environment.
Subsequent to the interest rate lift-off in US, the effect on GCC countries has been higher borrowing costs for companies and individuals at a time when liquidity conditions were already tightening; but the pace of further rate increases is expected to be moderate.
With improved data coming out of the US, further rate hikes are expected in 2016, which would continue to act as a slight headwind for the private capital expenditure and the profitability cycle in the region.
Regional governments are, however, committed to continue spending on strategic projects and infrastructure such as Expo 2020 in the UAE and the Fifa World Cup 2022 in Qatar, which should continue to support growth. Overall growth in the region is expected to be about 3 per cent.
Mena markets faced turbulent and challenging times in 2015 as market participants weighed various factors such as the oil price collapse, geopolitical issues, reform progress and valuations. Although valuations at present are attractive, we expect such factors to continue to resonate into 2016 amid a global backdrop of Fed rate increases, commodity price volatility and slowdown in Chinese growth.
As the market prepares itself for a challenging geopolitical and lower growth environment, fourth-quarter earnings and subsequent announcement of dividend yields will be important drivers for market sentiment. Interestingly, dividend yields for most stocks in the region have increased sharply and the UAE is now hovering around the 5 per cent mark on the assumption that companies pay the same level of dividends as last year.
We don’t expect a fundamental change for the economic outlook in the region for first half of 2016. The level of oil prices will ultimately determine the timing of a re-rating for Mena markets and supply demand equilibrium on this front is likely to balance in the year’s third quarter. Despite an expected difficult first half for 2016, dividend yields and valuations across the region make for a strong investment case for investors that are prepared to have a medium to long-term view.
Saleem Khokhar is the head of fund management at National Bank of Abu Dhabi