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September 2017
1
Contents
Highlights 1 Global markets and economy 2 Oil markets 3 Saudi Arabia 5
James Reeve Chief Economist
Samba Financial Group
Dubai, UAE
+971 (0) 54777 2151
April 2019
Economic Monitor
Highlights
Signs of a sharp deceleration in global growth are becoming more compelling. The latest batch of PMIs provided weak manufacturing readings for the US, Eurozone and Japan, while world trade activity is also under pressure. The US consumer is still in good shape, but investment is slowing as the tax stimulus fades and previous interest-rate hikes begin to weigh.
China is still feeling the effects of last year’s monetary squeeze, and although this is now being reversed, the positive impact will not be felt for some months yet. Policymakers might also feel disinclined to push stimulus too far given the existing credit bubble and—insofar as stimulus might weaken the RMB—relations with the US.
Having hiked interest rates by 1 percent last year, the US Fed is
now firmly back to dovish mode, and has indicated that there will be no more rate hikes this year. However, financial markets have been unnerved rather than reassured by this change of tone, worrying that the Fed might be expecting a recession. Although equity markets are up sharply year-to-date, there has recently been some retracement, and bonds remain in vogue. An inverting Treasury yield curve has also kept nerves on edge.
Oil prices have followed equity markets higher this year, driven mainly by output cuts from OPEC and Russia. But with demand looking fragile and US shale poised for another output spurt, these cuts will need to remain in place for the rest of the year if the market is to be balanced. On the assumption that they are, we anticipate Brent averaging $65/barrel this year, edging up to $67/b in 2020. Risks are weighted to the downside however.
Saudi Arabia’s macro-financial position remains sound: the interbank rate has eased and banks’ repo activity is reasonably strong. Private sector credit demand remains muted, but the PMI suggests that nonoil activity is picking up again. However, the return of deflation reflects not only base effects but intensive competition among suppliers and retailers.
Foreign inflows to the stock market have accelerated as investors
anticipate its full inclusion in the MSCI EM index. Valuations appear stretched, but cost considerations might be secondary to the strategic value of being in the stock market for the long term.
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Global economy and markets
Global manufacturing slowdown unsettles global investors
Signs that the global economy is slowing are now difficult to ignore. The latest batch of flash PMIs (for March) show manufacturing struggling in all three of the major advanced economies. Japan’s reading indicates that its industrial output has continued to contract which, given its large export base, is an indictment of slumping global trade as much as weak domestic demand. The US’s composite PMI was also down, with the services sector reversing the previous month’s gain.
Meanwhile, Germany’s manufacturing output has continued to slide. In part, this reflects regulatory disruption to car production, and concerns about Brexit, but more telling is falling demand in China, its fifth biggest export market. China is still feeling the effects of last year’s monetary policy squeeze, and although this is now being reversed, it is likely to be some months yet before the economy stabilises. Nor is it clear how far monetary or fiscal policy will be loosened given the authorities’ stated determination to reduce the country’s massive debt overhang.
A major stimulus might bolster demand in the short run, but given that it would be funnelled through state-owned institutions, it would also exacerbate the wasteful allocation of capital—and associated debt build up—that has gone hand-in-hand with China’s remarkable economic rise. Given that any stimulus is likely to pressurise the RMB it could also aggravate the US, with whom China is locked in trade talks. Progress in these talks appears to have stalled, with China apparently unwilling to submit to US “monitoring” of its commitments on technology transfer and intellectual property protection. Although US-Sino trade is only a small part of overall global trade, the impasse has further soured the mood of global investors.
Yield curve inversion further sours the mood
It is notable that despite the recovery of equity markets so far this year, bond markets have also rallied, indicating that investors are at least hedging their bets about the global outlook. German bond yields turned negative again in mid-March, propelled by the weak German manufacturing reading. This coincided with one segment of the US yield curve inverting, with three month Treasury yields surpassing those on ten year debt for the first time since 2007. This indicates that investors expect much weaker growth and inflation in the long run. The more important inversion is the two year/ten year curve, which has preceded every recession since the Second World War (albeit with wide variations in timing). This spread remains positive, though only just.
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Manufacturing PMIs (50+ denotes expansion; JP Morgan, Markit)
World
China
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Mar-16 Aug-16 Jan-17 Jun-17 Nov-17 Apr-18 Sep-18 Feb-19
Manufacturing PMIs (50+ denotes expansion; JP Morgan, Markit)
World
China
A number of indicators point to a slowing global economy. China is now easing policy in response, but there are limits on how far it can go
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Mar-16 Aug-16 Jan-17 Jun-17 Nov-17 Apr-18 Sep-18 Feb-19
Manufacturing PMIs (50+ denotes expansion; JP Morgan, Markit)
World
China
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Mar-18 May-18 Jul-18 Sep-18 Nov-18 Jan-19 Mar-19
US: Ten vs Two Year Treasury Yield Spread (percent; Bloomberg)
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Fed amplifies its dovish language
The Federal Reserve is very mindful of such indicators, and Jay Powell has indicated that there will be no more interest rate hikes this year, and that the Fed will stop unwinding its balance sheet in September. But rather than galvanising markets, Mr Powell’s dovish comments appeared to unsettle investors, who are beginning to worry that the Fed itself is expecting a recession.
We think a recession is unlikely given the health of the consumer sector. But a combination of the lagged effect of previous monetary tightening, a fading fiscal stimulus, unresolved trade tensions, and Congressional polarisation will weigh heavily on the investment outlook. In a bid to offset this we expect the Fed to cut rates by 50 bps next year, though it could well be by more if these factors combine to trigger a more pronounced downturn.
Fiscal woes should pressurise the USD, but this is not a given
The deteriorating US fiscal position (a product of the unfunded tax cuts in 2017), and the Fed’s dovish stance would normally weigh on the USD. However, this is not a given: the dollar rose during the past two recessions as global investors sought refuge in US Treasuries. Indeed, EM currencies tend to be more influenced by global demand for risk assets, rather than the relative value of USD securities. For the moment, we are sticking with our view that the USD will weaken as the US economy slows and the fiscal position worsens, but there is clearly a growing risk (for oil demand) that the dollar will be supported by safe haven flows and actually strengthen this year.
Oil markets
Oil demand outlook appears fragile
Oil demand is heavily influenced by the dollar. It is therefore surprising to see China’s oil demand (in terms of the monthly change in imported volumes) heading into negative territory in February despite a steady strengthening of the RMB from the end of last year. There are plenty of caveats here, such as the timing of China’s New Year, the lagged impact of exchange rate changes on demand, and the fact that the series is quite volatile. But it does chime with a change of tone from the International Energy Agency (IEA). In its February Oil Market Report the outfit noted a “sharp slowdown” in oil demand in the fourth quarter, with “large falls” in Asia and Europe. It also noted a more “pessimistic” sentiment within oil markets about the outlook for the global economy.
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US: S&P 500 vs UST 10 Year Yield (Bloomberg)
UST 10 year yield (bps)
S&P 500
84
86
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100
Mar-18 May-18 Jul-18 Sep-18 Nov-18 Jan-19 Mar-19
USD Index (Bloomberg)
-6-4-202468
1012
Ap
r-1
7
May
-17
Jun
-17
Jul-
17
Au
g-1
7
Sep
-17
Oct
-17
No
v-1
7
Dec
-17
Jan
-18
Feb
-18
Mar
-18
Ap
r-1
8
May
-18
Jun
-18
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18
Au
g-1
8
Sep
-18
Oct
-18
No
v-1
8
Dec
-18
Jan
-19
Feb
-19
China: Crude Oil Imports (metric tonnes, m-o-m, 3m rolling avg.; China
Customs Admin.)
Oil prices have risen in line with OPEC Plus’s efforts to rebalance the market. But against a backdrop of fragile demand and another probable surge in US shale output, the group will have to maintain its production discipline for the rest of the year
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Markets had seemed to be more focused on the output reductions from the OPEC Plus group, rather than the challenging demand backdrop. The OPEC Plus group, which includes Russia, has so far removed 2.1m b/d of oil from last year’s peak, helping to reduce stocks. Prices responded in kind, with Brent touching $68/b in mid-March, a 30 percent year-to-date gain.
OPEC Plus production discipline is under spotlight
But as the economic outlook dims, so markets are mulling whether and for how long these cuts should be extended. Following a meeting in Baku in mid-March, the OPEC message was not exactly decisive: the Saudi oil minister said that the cuts would need to stay in place for the rest of the year, citing ongoing inventory builds in some segments of the market, while his Russian counterpart was more hesitant, suggesting that no decision on this could yet be taken. Russia’s budgetary position is more flexible than many oil exporters, with a breakeven oil price of around the $40/b mark. It is also keen to expand into new markets, most notably by filling the void left by Venezuelan exports to the US. It is notable that Russia had cut only around a third of what it had committed to up the end of February, though in a subsequent statement the Russian Oil Minister, said his country was “on track” to meet its commitments.
US shale output set to rev up again
OPEC’s deliberations come against a backdrop of an increasingly robust outlook for US shale production. There was a surge in drilled-but-uncompleted (DUC) wells last year as companies raced to meet legal drilling requirements set by landowners in a context of pipeline capacity constraints in the prolific Permian Basin. Thus, many wells were drilled but the oil left underground in lieu of pipeline capacity being expanded. With new pipelines set to be rolled out, the expectation is that Permian shale will see a fresh production spurt this year (largely in H2).
There are other structural reasons that underpin the US shale growth story. Increasingly, super majors such as Chevron and ExxonMobil are dominating the Permian. These firms have both the cashflow to ride out periods of low oil prices, and the technology to overcome issues stemming from congested well placement. Both Chevron and Exxon expect to treble their Permian output over the next five years or so. Chevron says it has only tapped about 8-9 percent of its reserves. With enhanced recovery techniques, one would expect a minimum recovery rate of 40 percent (Chevron is also in the happy position of owning the land it is drilling on and therefore has no drilling right fees to pay).
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-15
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Ap
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Jun
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g-1
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Ap
r-1
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g-1
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Ap
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g-1
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Ap
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Oil: US Shale Output from Permian ('000 b/d; Rystad Energy)
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-11
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No
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Ap
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2
Sep
-12
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-13
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-14
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-14
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-15
Au
g-1
5
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-16
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-16
No
v-1
6
Ap
r-1
7
Sep
-17
Feb
-18
Jul-
18
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-18
Oil: Dated Brent vs Brent Net Long Positions(ICE Futures Europe, Bloomberg)
Net long positions ('000 contracts) Dated Brent ($/b, RHS)
10
11
12
28
30
32
34
36
OIl: OPEC vs Russia Production (m b/d; Bloomberg)
OPEC Russia (RHS)
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Venezuela on its knees, while US mulls whether to extend Iran sanctions waivers
The final pieces of the oil supply story are Venezuela and Iran. In Venezuela, US sanctions, civil unrest and now widespread power outages are likely to mean a further substantial fall in oil production in March, following a 150,000 b/d decline in February. Iran, meanwhile, actually managed to eke out some small gains in oil exports in January and February, though overall output has continued to fall. Prospects for some stabilisation of Iran’s output depend partly on whether the White House rolls over sanctions waivers for big Iranian oil clients such as India and China in May. The Administration is said to be split on this issue (with a hawkish National Security Council set against a softer State Department). The President’s instincts are plainly hawkish, but he will have to weigh these against concerns that oil (and hence gasoline) prices might spike if the waivers are removed. We think the waivers will be removed, but it is likely to be a close run thing.
Our oil price forecast is unchanged, but downside risks are increasingly obvious
Drawing these strands together, it seems that OPEC and Russia will need to revive the production discipline that was the defining feature of 2017 and the first part of 2018. Assuming this can be achieved we think Brent will average $65/barrel in 2019, edging up to $67/b in 2020 as the USD weakens. Clearly, though, there is plenty of downside risk, ranging from Russia’s evolving attitude, the extent and duration of any slowdown in China, safe haven flows to the USD, and the possibility of Iran waivers being extended.
Saudi Arabia
Financial conditions are stable, and liquidity is ample
The macro-financial position of Saudi Arabia remains broadly stable. True, there was a sizeable $10.6bn outflow on the financial account in the fourth quarter (balance of payments data were only available to the third quarter, but this can be gleaned from SAMA’s reserve asset data). Yet reserve assets remain substantial,
Saudi Arabia: Economic Indicators 2017 2018 2019f 2020f 2021f 2022f 2023f
Real GDP (% change) -0.7 2.2 0.6 2.2 3.0 3.5 3.7Real nonoil GDP (% change) 1.2 1.6 2.3 3.0 4.2 4.6 4.9CP Inflation (average %) -0.8 2.5 -0.6 2.5 3.0 3.1 3.1Fiscal balance (% GDP) -9.1 -4.7 -9.1 -8.1 -6.8 -5.1 -3.4Current account (% GDP) 2.1 10.7 8.1 9.4 11.0 11.7 11.6Net Foreign Assets (% GDP) 71 63 70 70 72 80 86Bank deposits (% change) 9.5 2.8 6.0 5.0 7.0 9.0 9.0Private sector credit (% change) -0.7 2.9 4.6 6.0 9.0 12.0 14.0Sources: national authorities, IMF, Samba
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Venezuela: Oil Production ('000 b/d; Bloomberg)
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Feb-18 Apr-18 Jun-18 Aug-18 Oct-18 Dec-18 Feb-19
Iran: OIl Exports ('000 b/d; Bloomberg)
Saudi Arabia’s macro-financial position is stable, while activity appears to be quickening in some economic sectors. Foreign inflows to the stock market in line with the market’s inclusion in various global indices. Valuations appear rich, but foreign investors are likely to be taking a long-term view
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at some 64 percent of 2018 GDP—one of the highest ratios in the world. In addition, much of this outflow is likely to have been investment undertaken by state entities, which should yield future current account inflows. Pressure on the Saudi riyal in the forward market remains minimal.
Domestic liquidity is ample, with a loan-deposit ratio of 78 percent for the banking sector as a whole (SAMA’s definition). Total deposits in January were slightly higher than a year earlier, as were demand deposits for businesses and individuals. Banks’ repo activity was down compared with a year earlier, but the general trend since mid-2018 has been upward. The flipside of this is subdued private sector credit growth of just 3 percent year-on-year in February.
Nonoil GDP growth edged up in 2018
Data released by the General Authority for Statistics show that the Saudi nonoil economy grew by 1.5 percent in 2018 (based on GDP by Sector), marking a modest pick-up from the 1.2 percent rate in 2017. The overall economy returned to quite a decent rate of growth at 2.2 percent from -0.7 percent as oil production rebounded.
Consumer-facing sectors have benefitted from government support to households
The story of last year was largely one of firmer government consumption helping to support certain sectors of the economy withstand a number of headwinds. These included the disappearance of more than 1.5 million expatriates, higher fuel costs, and the impact of VAT. The experience of Wholesale and Retail Trade is instructive: this is a sector that relied heavily on expatriates on the supply side, and would clearly be impacted by higher transport costs and VAT. Expatriates might not consume much individually, as they are in the country to save, but when so many depart, it is bound to have an impact on demand too.
Impelled by Saudiisation, the sector has seen unprecedented consolidation over the past couple of years, with the disappearance of tens of thousands of “Mom & Pop” stores, and significant market share gains by the bigger players. This in itself is no bad thing, given potential economies of scale, but coinciding with the imposition of VAT and higher transport costs, disruption has been significant. As such, Trade had a rocky first half, contracting in both quarters. However, the steady disbursement of Citizens’ Account payments—a means-tested monthly government payment to households—along with an inflation allowance for public sector employees (subsequently introduced by much of the private sector) boosted Trade in the second half.
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Saudi Arabia: Commercial Banks' Non-Statutory Deposits with SAMA
(SRm; SAMA)
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Foreign Exchange Reserves: Top Ten by Country ($bn)
-5.0
-3.0
-1.0
1.0
3.0
5.0
7.0
Q2-17 Q3-17 Q4-17 Q1-18 Q2-18 Q3-18 Q4-18
Saudi Arabia: Nonoil GDP by Sector (y-o-y percent change, 2010 prices; GSTAT)
Construction Trade Petrochemicals TOTAL
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0.9 1.2 1.5
-4.0
-2.0
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4.0
6.0
8.0
2014 2015 2016 2017 2018
Saudi Arabia: Nonoil GDP by Sector (y-o-y percent change, 2010 prices; GSTAT)
Construction Trade Petrochemicals Total
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Points of sale transactions, a proxy for retail sales, are still growing robustly in both value and particularly volume terms. That said, with volume outstripping value, spending per transaction is on a downward path. This reflects the growing price-consciousness of the Saudi consumer and heavy discounting by retailers.
Greater price sensitivity is likely to remain a feature of the sector, but the rollover of the inflation allowance for 2019 should increase real disposable incomes this year and Trade is likely to see further decent growth over the next twelve months. In the medium term, retail spending should be bolstered by growing home ownership (note the sharp pickup in bank mortgage lending, albeit from a low base).
Manufacturing set for a tougher 2019
Manufacturing, which is made up largely of petrochemicals production, had a strong 2018, particularly in the first half. This reflected generally buoyant demand for petrochemicals in the Kingdom’s main market, Emerging East Asia. However, headwinds are gathering: the Baltic Dry Index (a proxy for global trade volumes) is down some 60 percent from last year’s peak. Partly, this reflects jitters over rising protectionism, but more important has been the credit squeeze initiated by the Chinese authorities in 2017/18. This is now being reversed, but the lagged effects mean that demand is still being squeezed, with ramifications for East Asia. We expect China’s demand to stabilise by the second half of 2019 as the policy reversal begins to have an impact. However, Manufacturing is still expected to have a weaker year compared with 2018.
Construction sector may have reached bottom
Construction has had a tough few years. Latest import data show that contractors are still unwilling to hold much inventory in the current climate. The sector has had a number of issues to deal with, from delayed receivables, weaker government capital spending, higher fuel costs, and disappearing expatriates. As with retail, there has been considerable consolidation, and balance sheets have been strengthened as a result (at least compared with 2016). Government capital spending is also set to increase by 20 percent this year according to the budget (note here recently-announced plans for a number of projects in Riyadh, worth SR86bn). And SOEs such as Aramco, Sabic and the PIF have their own spending plans. While this year is still likely to be challenging, the worst could well be over for the sector.
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Mar-18 May-18 Jul-18 Sep-18 Nov-18 Jan-19 Mar-19
Global Trade: Baltic Dry Index (Bloomberg)
0
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Q4
-13
Q1
-14
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Saudi Arabia: Value per Points of Sale Transaction(SR; SAMA)
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Q4-16 Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 Q2-18 Q3-18 Q4-18
Saudi Arabia: Commercial Banks' Real Estate Lending
(retail, year-on-year percent change; SAMA)
-30
-20
-10
0
10
20
Saudi Arabia: Private Sector Imports of Building Materials
(new letters of credit, value, y-o-y, 3 mo rolling avg; SAMA)
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PMI indicators are positive
Looking at the nonoil economy as a whole, there are other positive signals. The PMI shows new orders in March reaching their highest level for almost four years, with a net 33 percent of businesses reporting larger order books than the previous month. Output also picked up, with respondents citing improving market demand. Optimism also remained resolutely high with some 42 percent of respondents anticipating higher output in 12 months’ time (the rest anticipated no change in output).
Competition is still pretty intense, however. Output prices remained below the 50 breakeven mark, despite a decline in input prices, indicating that firms are still determined to protect market share at the expense of thinner margins.
Housing weakness and base effects see deflation return
This dynamic is clearly visible in consumer prices. Data for January show that consumer prices fell by 1.9 percent in year-on-year terms, reflecting the high, VAT-impacted comparator of January 2018. February saw a more marked contraction of 2.1 percent (note that there have been month-on-month contractions for the past 7 months). Much—but not all—of this softness is to be found in the housing and utilities category, which in turn reflects the disappearance of so many expats. Looking ahead, it is likely that deflation will be the theme for 2019. We have penciled in a 0.6 percent contraction in prices, but this could well be overly-conservative given that it assumes a return to month-on-month price growth. Given the influence of rents on the overall basket, and the excess capacity in the expatriate housing segment, a revival of monthly price growth is far from guaranteed.
Since deflation is concentrated in this particular expatriate segment, it is unlikely to have much positive impact on real disposable incomes for the typical Saudi household. But as noted above, the roll-over of the inflation allowance will certainly help to boost purchasing power.
Foreign inflows to Tadawul pick up
Saudi Arabia’s $536bn stock market was formally submitted into indices run by the FTSE Russell and S&P Dow Jones in mid-March. The more important move will come in June when the Tadawul is included in the widely-followed MSCI EM index, which is worth some $5.2trn. The Tadawul is projected to be the eighth largest bourse in the MSCI EM by September, with a 2.7 percent share, out-ranking Mexico, Indonesia, and Poland.
-3.0
-2.0
-1.0
0.0
1.0
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No
v-1
7
Dec
-17
Jan
-18
Feb
-18
Mar
-18
Ap
r-1
8
May
-18
Jun
-18
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18
Au
g-1
8
Sep
-18
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No
v-1
8
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-18
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Saudi Arabia: Consumer Prices (12 month percent change; GSTAT)
25
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Saudi Arabia: PMI - New Orders (50=breakeven; Emirates NBD, Markit)
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Saudi Arabia: PMI - Input Prices vs Output Prices (50+ denotes increase; Emirates NBD, Markit)
Input prices Output prices
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In a prelude to the FTSE Russell inclusion, foreigners were net buyers of around $430m in the week through March 14, the highest on record. Foreign inflows can be expected to accelerate as MSCI EM inclusion nears, but by how much is moot. One can expect a decent amount of passive inflows as those fund managers whose assets track the benchmark reallocate their portfolios accordingly. No doubt a good proportion of active investors will follow suit if only from a “fear of missing out”.
Valuations look stretched, but investors are likely thinking of long-term potential
Yet the Tadawul’s “value proposition” is not particularly compelling at the moment with a current p/e of 19.35 versus 13 for the MSCI EM. Margins are higher thanks to the light tax burden, and this also supports a decent dividend yield. But the index is dominated by materials (essentially petrochemicals) and financial firms. Materials’ firms seem set to come under pressure from waning East Asian demand (polyethylene prices are already down some 13 percent from last year’s peak), and—in the medium term—higher input costs as subsidies are removed. Banks and insurance firms have solid long-term growth prospects as various types of insurance become mandatory, and as housing finance gains traction. However, bank net interest margins could come under pressure if, as we, expect interest rates are cut next year.
Overall, therefore, we see the earnings-per-share growth consensus of 26 percent for this year as optimistic. But large institutional players might well ignore rich valuations as they stake out their positions in the region’s largest bourse with an eye to the long-term opportunities offered by the Vision 2030 programme. This, after all, aims to boost significantly and permanently the private sector’s contribution to the country’s value added.
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May-18 Jul-18 Sep-18 Nov-18 Jan-19 Mar-19
Polyethylene: May Futures Contract(CNY/tonne)
-5000
-4000
-3000
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-1000
0
1000
2000
Saudi Arabia: Value Traded by Foreign Investors in Tadawul
(SRm; Saudi Stock Exchange)
7500
8000
8500
9000
9500
10000
May-18 Jul-18 Sep-18 Nov-18 Jan-19 Mar-19
Polyethylene: May Futures Contract(CNY/tonne)
April 2019
PUBLIC
10
Disclaimer This publication is based on information generally available to the public from sources believed to be reliable and up to date at the time of publication. However, SAMBA is unable to accept any liability whatsoever for the accuracy or completeness of its contents or for the consequences of any reliance which may be place upon the information it contains. Additionally, the information and opinions contained herein: 1. Are not intended to be a complete or comprehensive study or to
provide advice and should not be treated as a substitute for specific advice and due diligence concerning individual situations;
2. Are not intended to constitute any solicitation to buy or sell any instrument or engage in any trading strategy; and/or
3. Are not intended to constitute a guarantee of future performance. Accordingly, no representation or warranty is made or implied, in fact or in law, including but not limited to the implied warranties of merchantability and fitness for a particular purpose notwithstanding the form (e.g., contract, negligence or otherwise), in which any legal or equitable action may be brought against SAMBA. Samba Financial Group P.O. Box 833, Riyadh 11421
