Saudi leads rally in Q4 2016

KUWAIT: Regional markets saw a solid performance in the last quarter of 2016. The GCC MSCI total return index advanced a notable 16 percent on the quarter and managed to close the year up 9.5 percent thanks to a stellar performance by the heavily weighted Saudi market in 4Q16. Other markets didn’t fare as well and some ended the quarter flat. Total GCC market capitalization stood at $951 billion at the end of the quarter, having gained $106 billion during 4Q16 and $50 billion in 2016.

Internationally, most developed equity markets made strong gains in 4Q16 led by the US. The MSCI World total return index, which captures the performance of equities in developed markets, gained 5 percent in 4Q16, closing the year up 10 percent. Volatility continues to come off the levels seen in late 2015 and earlier in 2016, despite the occasional spikes around big events like the US election and Fed meetings.

The US election was a key catalyst during 4Q16, with the surprise outcome setting the pace for the quarter and year. US equities welcomed the Trump victory with enthusiasm, with the S&P 500 and DJIA repeatedly breaking new highs; the indices were up 3 percent and 9 percent, respectively, in 4Q16. The midDecember Fed rate hike was almost entirely priced in, but equity markets were buoyed further by a more hawkish Fed outlook.

European stocks also put on a strong performance in 4Q16 despite several political, security and financial sector hiccups. The Euro Stoxx 50 advanced 10 percent on the quarter supported by continued flow of positive economic data and the ECB’s decision to extend its bond buying program..

At the same time, investors turned negative on emerging markets (EM), as outflows from EMs rose dramatically. EM equities retreated-1 percent in 4Q16, though they still recorded a gain of 10 percent in 2016. According to the IIF, the Trump victory gave rise to the longest period of retrenchment of flows since the start of the series in 2005. Net outflows from emerging equity markets (which do not include flows to the GCC) were $8.1 billion in November, compared to a monthly average inflow of $5.5 billion year-to-date (ytd). Despite these outflows coming off in recent weeks, EM markets are still bracing for a more hawkish Fed, a stronger USD and potential trade tensions that might materialize under the new US administration.

Regionally, the recovery in oil markets continued to provide support to GCC stocks, with equities continuing to show strong links to crude prices (Chart 3). OPEC’s recent agreement to cut oil output have boosted oil prices with Brent now hovering around $50/barrel, double their January 2016 low. But despite their recovery, oil prices remain relatively low and a concern for regional fiscal sustainability and growth. A prolonged period of low oil prices could force governments to further reduce capital spending and benefits, and further pressure liquidity. This has been more of a concern for investors in Saudi Arabia, Oman, and Bahrain than in other markets.

Driven by a successful bond sale, the Saudi market put on a stellar performance in 4Q16. The government’s record $17.5 billion international bond sale appeared to shift sentiment in the market. The Tadawul-All-Share index was up 33 percent qtd and closed the year up 5 percent. According to EFG Hermes, net inflows to Saudi equities in October were $427 million compared to a monthly average of $63 million since January 2016. Markets had been concerned throughout most of 2016 about declining liquidity, delayed payments to contractors and tightening austerity. Corporate earnings also showed signs of weakness as profits of listed companies for 9M16 were off by 5 percent y/y. While the purchasing managers’ index (PMI) remained in expansionary territory, it fell to its lowest level ever in October before rebounding in November.

Kuwaiti equities registered good gains with the value-weighted index up 8 percent qtd. The long-awaited acquisition of a controlling stake in Americana by a UAE-based investor boosted sentiment. Also, corporate earnings of listed companies surprised on the upside in 9M16 despite having declined 6 percent y/y. A sample of 11 blue chip companies announced net profits 19 percent higher than the mean estimate. Volumes were also up in 4Q16 after reaching record lows the previous months. The daily average traded value was $ 46 mil- lion in 4Q16 compared to $22 million in 3Q16.

UAE equities underperformed in 4Q16, impacted by the broader EM retrenchment. Abu Dhabi Securities Exchange (ADX) general index was up 1.6 percent qtd and closed the year up 5.6 percent. Meanwhile, Dubai Financial Market (DFM) general index advanced by 1.6 percent qtd and maintained its lead for the year regionally, up 12.1 percent. With their relatively large foreign investor base and representation in EM indices, UAE equities were hurt by the sharp EM outflows. Inflows to UAE markets in October, the last month for which this data is available, were $50 million compared to a monthly average of $165 million since January 2016.

Qatari equities lost ground early on in the quarter before bouncing back up on the OPEC deal. The Qatar Stock Exchange (QSE) general index was unchanged in 4Q16, ending the year also flat. Sentiment in Qatar has suffered on a lack of clarity regarding potential cuts in government spending and declining liquidity. Meanwhile, corporate earnings for 9M16 continued to reflect weakness with a sample of listed companies’ profits down 12 percent compared to a year ago, the biggest decline in the region. Foreign flows to Qatar in October were strong for the third consecutive month as money managers continued to amend portfolio allocations following the recent FTSE upgrade to “emerging market” status.

GCC remains undervalued compared to other emerging markets. Price-to-earnings per share (P/EPS) for global emerging markets is around 19, above P/EPS for any of the GCC markets (Table 1). Regionally, UAE equities continue to look the most underpriced among the main GCC markets especially following the rallies in Saudi and Kuwaiti in 4Q16. Saudi equities are the most expensive by that measure.

Market liquidity increased notably in 4Q16, led by a jump in activity in the Saudi market. The daily turnover in 4Q16 averaged $1.2 billion, up by 50 percent from 3Q16 average. The rise in sovereign bond issuances domestically since the beginning of the year had directed liquidity away from equities. With GCC governments now looking to raise debt internationally rather than just depend on domestic borrowing, activity in the equity markets might see further pick up.

GCC markets will continue to follow up on governments’ fiscal and reform plans for the coming years, as well as oil price developments. Internationally, with a new US administration, investor’s focus will be on the US in the coming few months, as they seek to ascertain the shift in key policies (monetary, fiscal, regulation, trade...) and their implications for capital markets globally.