CIO Office Investment Outlook Q4 2018 - Emirates NBD€¦ · Emirates NBD CIO-Office Q4 2018 5 EMIRATES NBD WEALTH MANAGEMENT INVESTMENT OUTLOOK Q4 2018 Game of Trillions On September

WEALTH MANAGEMENT

Game of TrillionsCIO OfficeInvestment Outlook Q4 2018

2Emirates NBD CIO-Office Q4 2018

EMIRATES NBD WEALTH MANAGEMENT INVESTMENT OUTLOOK Q4 2018

The first half of 2018 has been tough for investmentreturns. As we wrote in our previous quarterlypublication, markets had to adapt to the changing faceof globalisation, made of divergences in growth andrising political risks. However, whilst reiterating our viewthat volatility was (and is) here to stay, we alsoexpressed our positive views on risky assets, and hadincreased our allocation to US equities.

In the third quarter, global equities delivered a positive+4.3% total return in USD, led by the US (+7.6%). TheEmerging Markets’ picture was more mixed with -1%,mostly attributable to China. If global fixed income wasalso slightly negative, EM bonds were slightly positive.Finally, the US Dollar and oil showed some signs ofstabilisation compared to H1.

Our view of the world hasn’t changed. Volatility willremain significant especially around the US mid-termelections, but we expect markets to reflect thecombination of sound near-term fundamentals,acceptable valuations, and overall bearish investors’positioning. We have increased our allocation toequities in mid-September by starting to add toEmerging Markets, with a very moderate calibration.

Don’t get us wrong: the world is full of risks, from tradeto Brexit and Italy, including stronger US Dollar, higherrates and more expensive oil. They are here to stay, butat least they are well identified.

With regards to trade, it has now become clear thatChina is the main target of the US, with reducedpressure on Canada, Mexico, Japan or Europe. To thatextent, we consider that the current valuation ofChinese assets simply does not reflect their long-termprospects, even with full tariffs. With regards to Europe,we are concerned about Brexit and Italy and thus don’trecommend government bonds. On the Dollar, we areexpecting some stabilisation as the Fed is explicitly not“accommodative” anymore, and its guidance willprobably not become more hawkish in the comingmonths. Finally, a strong oil price is an issue for themost dependant economies (we are tactically cautiouson India), but a blessing for our region, which reinforcesour positive stance, especially in fixed income.

Our detailed views are presented in this document. Inaddition, 10 years after Lehman’s bankruptcy, we havedecided to review our expectations for long-term returnsand risks, and our asset allocation framework, to getprepared to a more challenging future. We will presentour conclusions in our 2018 Year Ahead publication,and in the meantime we share a picture of theinvestment landscape evolution in the last decade, titled“Game of Trillions”.

Maurice GravierChief Investment Officer

Q1-18 Q3-18Q2-18

DM Equity EM Equity Global Fixed Income

EM Fixed Income

Dollar Index Oil (WTI) Gold (USD) Hedge Funds (USD)

-12

-8

-4

0

4

8

12

16

-1.3

1.7

5.0

1.4

-8.0

-1.1

1.4

-2.8-0.9 -1.5 -2.4

1.6

-2.3

5.0

0.7

7.5

14.2

-1.2

1.7

-5.5 -4.9

-1.0

0.2

-0.4

Source: Bloomberg as of 30 Sep 2018

Exhibit 1: USD % returns for major asset classes – signs of hope in Q3

Introduction – Signs of Hope in Q3



Our Convictions at a Glance

Asset Allocation and Portfolio Construction

˃ Tactically overweight equities versus governmentbonds and cash

˃ Increasing active strategies, rather than passive betaexposure

˃ Considering for the future: buying gold, EM assetsand FX, neutralise US equities

Equity Convictions

˃ Slightly overweight US and EM, Asia in particular(but short term cautious on India)

˃ Positive on Technology (with selectivity), Healthcare,Global Oil

Fixed-Income Convictions

˃ Overweight EM hard-currency debt and positive onUS Treasuries

˃ Strong conviction on GCC debt, especially sovereignand selectively financials

Oil Outlook

˃ Oil prices to be range-bound between USD 70/b-80/b with volatility

UK Real Estate

˃ Brexit looms – favour alternative within commercialand expect volatility in residential

Exhibit 2: ENBD Asset Allocation Templates, as of September 2018. Absolute (TAA), and relative (vs SAA)

Aggressive

Abs. Rel.

2.7% -5.3%

12.2% -1.0%

20.1%

13.5% 1.8%

45.8% 0.8%

31.8% 2.0%

12.7% 2.5%

44.5% 4.5%

3.0%

4.0%

7.0%

100.0%

-0.9%

Moderate

Abs. Rel.

5.0% -4.0%

26.2% -1.0%

19.1%

8.2% 1.5%

53.5% 0.5%

26.2% 1.5%

7.3% 2.0%

33.5% 3.5%

3.5%

4.5%

8.0%

100.0%

-0.7%

Cautious

Abs. Rel.

11.0% -4.0%

41.8% -1.0%

14.1% 1.0%

5.5% 1.4%

61.4% 1.4%

13.0% 1.0%

4.6% 1.6%

17.6% 2.6%

4.5%

5.5%

10.0%

100.0%

-0.8%

Asset Class Sub-Asset Class

Cash USD Cash

Bonds Dev Market Govt

Dev Market Credit

Em Market

Bonds Total

Equities Dev Market

Em Market

Equities Total

Alternatives Gold

Hedge Funds

Alternatives Total

Total

YTD Performance (USD)

Introduction2Our Convictions at a Glance3

Equity Strategy9Fixed Income Strategy15Asset Allocation Outlook20Oil Outlook23

Contributors29

Game of Trillions5

UK Real Estate25



Contents



Game of Trillions

On September 15 2008, Lehman Brothers filed forbankruptcy, with over USD 600bn of assets, includinga disproportionate exposure to the US real estate andits infamous subprime mortgage segment. This day wasdecisive in turning a US problem into a devastatingglobal financial crisis. The 10th anniversary triggeredmassive media coverage, filled with experts of whichmany explained 1. Why it happened, 2. Why it wasmeant to happen and hence predictable for smartpeople and 3. How similar and scary is the currentsituation. We can’t help stressing out that this is in a wayreassuring, as overconfidence is a constant feature ofany big crisis – none of it in history has ever happenedwhen everyone was warning. Having said that, the pastdecade has been extraordinary for global economy andmarkets, and has set a trillion US dollars as thevertiginous unit of measure. In this Game of Trillions,“winter is coming” and we are currently preparing for thenext decade through a reassessment of our long-termasset-allocation framework. For the time being, we arestill confident in the near term and wanted to take apicture of this money iceberg made of growth, moneysupply, debt and wealth.

According to the latest numbers from the IMF, the worldeconomy as a sum of individual GDPs expressed incurrent USD prices weighs a total of 87.5tn. Using theIMF methodology, the US is almost a quarter of the totalwith 20tn. China takes the second place with 14tn. Indiaand its 1.2bn citizens is between Italy and France at2.8tn which is also comparable to the Middle-East as aregion. Emerging Markets as a group cumulate 35tn(40%). Using the same dataset in 2008, the globaleconomy was 63tn.This might not be impressive interms of annual growth (around 3% p.a. in currentprices) but the 24tn difference is bigger than the size ofthe American economy today. Emerging economiescontributed 15tn to this expansion, of which China 9tn,and India 1.6. The US represented 6tn out of the 9tnaddition from developed economies. To sum it up,talking about 2018 GDP in current Dollars in nominalterms, the global economy has expanded by 24tncompared to 2008, of which two thirds came fromemerging countries and one quarter from the US (notmuch from the rest). This amount is comparable toadding another America to the world in 10 years.

The global financial crisis has triggered anunprecedented response, and creativity, from CentralBanks (CBs). Rates went to zero (ZIRP), and oftenbelow (NIRP). More crucially, the Central Banks balancesheets (i.e. money creation) have been used like neverbefore, not only to provide emergency liquidity to thesystem and support “troubled assets” (an alreadycontroversial measure), but on an ongoing basis andmassive proportions, to directly buy securities from themarket. The aim of this policy is to flood the system withcapital to stimulate the economy via lending, to helpbanks deleveraging and restructuring their assets, and

The global financialcrisis has triggered anunprecedentedresponse, and creativity,from Central Banks



Game of Trillions

to push investor’s money into productive areas by killingreturns in safe havens – the so called “financialrepression”. It also de facto dramatically reduces thecost of debt for governments which is obviously not anexplicit goal for these independent institutions. CentralBanks have massively bought debt from governments,from the private sector in many cases, and even equities(CBs from Japan and Switzerland, for example).Quantitative easing, which is academically presented asan “unconventional” monetary policy, is in place for 10years and in all major economies in the world. If wefocus on the 4 largest (the US Fed, EMU’s ECB, Japan’sBoJ and China’s PBOC), the combined size of theirbalance sheet is currently around USD 20tn,approximatively 5tn each. Ten years ago, this total wasless than 7tn. USD 13tn have been “created” in thedecade by these 4 Central Banks alone, essentially tobuy securities from the market on their balance sheets.

What about debt? The combination of quantitativeeasing with extraordinary low interest rates has been,on purpose, an extremely favourable backdrop forborrowing money. As the global financial crisis was allabout excessive debt, wisdom, if not simple commonsense, would suggest that these accommodativeconditions would be used to deleverage, repair,reform and protect from future crisis. According to theInstitute for International Finance, the world’s totaldebt is currently close to USD 250tn (247tn at the endof Q1-2018). Compared to 10 years before, thedifference is… +70tn. This is almost 3 times thedifference of annual GDP between 2018 and 2008.Have banks lost the plot again? No, in fact, the totaldebt of the financial sector has only grown by 5% inthe decade, adding 3tn, which is reasonable inabsolute. It is indeed very reasonable as back in 2008there were large amounts of liabilities hidden in off-balance sheet items; however, today banks are bettercapitalised. Therefore, they are not to blame (bank

regulation has to be praised). Households have added10tn which represents 25% in a decade whichshouldn’t come as a surprise given the emergence ofa global urbanised middle class. Governments are byfar the largest contributors with an 80% increase intheir debt pile in a decade, totalling a whopping 30tn.Part of it is linked to the direct cost of the crisis, butmost of it is a combination of easy money, budgetcomplacency and absence of reforms. Non-financialcorporates are also a major contributor with 27tn,+58%. Finally, out of the astonishing current stock ofUSD 250tn of global debt, emerging economiesrepresent “only” 60tn.

So, with the economy growing, Central Banks givingaway money and economic actors increasing theirleverage, no wonder that the investment returns havebeen spectacular. The S&P500 for example delivered atotal return of 190% in 10 years (and as we rememberSeptember 2008 was still much higher than March 2009trough). As regards the value in USD, the World Bankcalculates that the combined market capitalisation of allequity markets in the world is currently close to 80tn, upfrom 32tn in 2008. This is not a total return measure(this does not include the dividends paid in the decade,also in trillions), it’s again about the size: global equitymarkets are worth almost USD 50tn more – andaccording to the World Bank the number of listedcompanies has been stable around 43,000. The UStotal market cap is currently around 35tn andcontributed almost half of the additional 50tn. For thefirst time in history, two companies have individuallyexceeded 1tn in value, Apple and Amazon. 1tn is alsothe total amount of expected share-buy backs in the USthis year, another all-time record.

Finally, the picture wouldn’t be complete withoutmentioning global wealth. According to Credit SuisseResearch Institute, the world total wealth wasapproximatively 280tn at the end of 2017, and weconservatively assume it is still there. Back in 2008 itwas 220tn, +60tn in 10 years or +27%.

To sum up: the decade has started with a devastatingdebt crisis, which has been addressed by adding evenmore debt to the system at a cheaper cost due toCentral Banks. The most visible usage of these trillionshave been boosting market returns, rather thanreforming governments’ finances. The economy is 24tnbigger in 2018 than it was in 2008, but the stock of debtis 70tn heavier, and there has been 12tn of additionalmoney supply.

For the first time inhistory, two companieshave individuallyexceeded 1tn in value,Apple and Amazon



Game of Trillions

Without a doubt, 250tn of debt is a terrifying number,and overlooking it by considering 280tn of wealth wouldbe a communist utopia – through governments,everyone is indebted, while the wealth is highly andincreasingly concentrated – almost half of it belongs toless than 1% of the adult population, the estimated36mn people with more than USD 1mn in assets.

Having said that, let us be very clear: 250tn of debt isnot a sufficient reason per se to fly away from any riskyassets and wait for the world to collapse again.Actually the excess of debt has been the motto formany doomsayers who have called for an imminentcrisis every single week of the last decade. Followingtheir advices would have led to miserable investmentreturns, actually missing out one of the greatest ralliesever, because markets do not react to one singlefactor. Being aware of this 250tn of debt is howeverrelevant when it comes to building a long-terminvestment strategy.

Let’s start with the bad news. The amount of total debtcreates constraints and significant vulnerabilities togrowth: lower potential, and more painful downturns. Thefuture will be risky, volatile, and the level and trajectoryof interest rates are crucial. Mountains of public debt andaccommodative monetary policies limits the ability ofauthorities to provide support when the next crisis hits,especially as banks are less exposed. Why would theyspend money they don’t have, to bail-out “non-systemic”

asset owners, with no political benefit? Speaking ofpolitics, populism is not here only to stay but to flourish,as inequalities are only rising within Westerndemocracies, amplified by budget constraints (debtagain), lack of reforms, and on a ten year horizon,machines entering the workforce and climate issues. Inthat context and given the concentration of wealth,defaulting on sovereign debt might become an option,where outsized debt meets populism. These are the riskswe integrate to our long-term thinking: capitalpreservation at the core of our asset-allocation, and afocus on sustainability (sustainable solvency, sustainablebusiness models, and more socially responsibleinvestments). This is also why gold is part of our strategicassets – a currency that cannot be printed irresponsibly,which could also at a point apply to cryptocurrencies.

Now, the good news. The last decade hasn’t just beenabout pumping easy money into markets and seeinequalities skyrocketing, it has also been prolific withincredible new sources of value, from technologicalbreakthroughs to the rise of the middle-class inemerging markets, and these secular themes are asvalid as ever. EM represent 40% of the globaleconomy, and two thirds of the growth of the lastdecade, but only a fifth of the global debt and of globalmarket capitalisation. Of course, they are risky,volatile, sometimes vulnerable, and timing matters, butfor the long-term they might be the winners of theGame of Trillions.

EM represent 40% of the global economy,and two thirds of the

growth of the last decade



Game of Trillions

2008 2018

Global economy(sum of annual GDP)

Top 4 Central Bankstotal balance sheet

Global debt Global equitymarket cap

Global wealth0

50

100

150

200

250

300

6387.5

+24

720

180

250

32

80

220

280

+48

+70 +60

+12

Source: IMF, Central banks websites, Institute for International Finance, World Bank, CS Institute of Research

Exhibit 3: Game of Trillions – All figures in current USD tn

What would 1 trillion USD buy you?

89% ownership of Apple 100% ownership of Boeing, HSBC, BP, Pepsi,Toyota, Ford, Daimler, and

Ferrari, combined

25,000 tons of gold (10 years of the world

production – but only half ofan Olympic pool in volume)

If you pay 1mn per day to reimburse an interest-free 1tn debt, you’ll be done after 2,739 years.

The total land value of San Francisco – or the total

residential value of Paris

The combined wealth of theworld 15 richest persons – or of the poorest 2.5 billion

Reimburse the national debtof Greece, Argentina,

Turkey and Nigeria(combined)

Or reimburse 2/3 of current US students loan debt

Pay 3 years of USGovernment debt interest

(interest only)

Or eradicate hunger and bring clear water to every human being on

earth for 25 years



Equity Strategy – A lookback at Q3 2018

With +10% net return over the first nine months of theyear, the S&P500 outperforms the other DevelopedMarkets such as Japan (+7% in Yen) and Europe (flatin EUR, negative in USD). The MSCI GCC shonewithin Emerging Markets with a +16% net return, aidedby KSA. UAE markets have had mixed returns: theAbu Dhabi Index is up 19% while the Dubai Index islagging -10%, weighed down by negative performancefrom the real estate sector. KSA gave up some of itsgains in Q3; however, oil over USD 80 bodes well foran economic recovery. KSA banks continue to lead thesector, up 34% YTD, supported by rising rates,improved liquidity and increased government deposits.

In June we went overweight US equities and in mid-September we added a slight overweight to EmergingMarket equities – earnings dynamics for the former,long term potential for the latter. US equity marketsprinted their best quarterly performance in the last fiveyears, with an unusual outperformance of the DowIndex (almost 10% return) versus S&P500 andNASDAQ (around +7%). Trade war has not affectedinvestor sentiment in the US, as the industrial sectorrepresents 22% of the Dow.

The MSCI AC World Index though still positive in Q3(+4% net return) lagged the US, dragged down by theEMs underperformance. The MSCI EM Index finallybounced back towards the end of the quarter.Altogether, it is down 7.4% (in USD) YTD and 1% inQ3. China is the heavy weight in the MSCI EM Indexat 27%. The domestic Shanghai Comp. Index fell 17%YTD (in USD) as trade tariff rhetoric escalated. Chinagovernment stimulus measures seem to have at leastfor now stymied the negative effects of trade tariffs.

The genomics and healthcare sectors have been theoutstanding performers in Q3 and in 2018. TheFAANG stocks continue to rally. Facebook, Amazon,Apple, Netflix and Microsoft combined are responsiblefor more than 50% of the gains in the S&P 500 Indexin 2018. The only detractor in this group is Facebook,facing tougher privacy and security issues. Cyber

security is increasingly becoming an area of concernfor governments and corporates. Particularlyvulnerable to attack are social media groups withterabytes of member data, and payment servicescompanies such as Equifax (145mn users wereaffected) with bank and credit card details.

˃ The US outperforms whilst the rest of the world lags

˃ The EM sell-off is compounded by currency woes

˃ Technology and Healthcare led the sector hierarchy

˃ The KSA market gave up some gains, higher oil should lead to a comeback

˃ Higher oil prices are not fully reflected by the energy sector performance

YTD 2018 2017

China Tech

US Bank

Robotics

India

World

Semis

Energy

US

KSA

Aero/ Defense

Global Tech

FAANG

Genomics

-20% 0% 20% 40% 60% 80% 100%

94%-14%

21%-1%

44%1%

30%3%

25%4%

41%5%

8%9%

22%11%

4%14%

39%16%

38%18%

58%25%

47%37%

Exhibit 4: How have our strategies fared in 2018?

Source: Bloomberg, 30 Sept 2018, MSCI Indices, NY FANG, ROBO US & SOXX US Index

The genomics andhealthcare sectors

have been theoutstanding performers

in Q3 and in 2018



Equity Strategy for Q4 2018

We believe that US equities have a little more roomto run, as the economy surprises on the upside,supporting future earnings growth. The consensusexpectation for S&P 500 companies in Q3 is +20%year-on-year earnings growth. As we follow theearnings growth, we are still positive on Technology andHealthcare. Global E&P companies are still lagging oilprices; however, their dividend yields (5 to 6% forEuropean E&Ps) are attractive and sustainable givenour outlook on oil price.

EMs should narrow the performance gap with theUS: There are three key catalysts currently governingglobal equity markets: trade tariffs, emerging market riskaversion and the strengthening US dollar. The US dollarnow shows signs of stabilising post its recent run up andEMs have begun seeing inflows. We recommendgradually and opportunistically increasing positioning inthe broader EM segment and China. We would like to

see EM currencies stabiliting and trade tariff talkdeescalating before making strongly bullish calls. Thegrowth differential in favour of EMs and their attractivevaluation (Price/ Earnings at 10.8X 2019E) should leadto a comeback. We differentiate amongst EM countriesand prefer those with strong fundamentals (balance ofpayments, current account, FX reserves) and low USdollar debt.

A marked differential in performance between the USand rest of the world continues. Over 5 years theMSCI EM Index returned 19% compared to 86% for theS&P 500 Index. In 2017, both EMs and DMs had a stellarperformance, however their paths have diverged fromthe end of January 2018. Year-to-date a 20% differentialin performance exists in favour of the US vs the rest ofthe world. We expect US equities to deliver modestlypositive returns in the coming months, which could createthe backdrop for EMs to start outperforming.

˃ Still slightly overweight US, with some residual upside potential

˃ Sequentially add weight to GEM but cautious on India in the short term

˃ Positive on Technology and Healthcare, as well as on global Energy

Tota

l Ret

urn

YTD

(%)

Forward P

/E (x)

Total Return YTD Forward P/E

Tech Healthcare Energy Cons.Disc

DM World Industrial Utility Material RealEstate

Cons.Stpl

Financials Telecom EM-10%

-5%

0%

5%

10%

15%

-20

-15

-10

-5

0

5

10

15

2017.1 16.7

12.7

16.1 15.1 14.4 15.3 14.212.8

17.6 17.8

10.6 11.7 10.8

Exhibit 5: Global sector returns and valuations compared to the world, DM and EMs

Source: Bloomberg, MSCI Net Return Indices as of 30 Sep 2018



US Equities – All About Growth

The S&P 500 had its best 3-month performance since2013. Companies in the high growth technology,consumer discretionary and healthcare sectors aredriving the returns. Rate-sensitive sectors of theS&P500 are among the worst performers (Staples,Telecoms, Real Estate to name a few) as higher rateshave made government bonds more attractive. Growthas a factor is continuing to lead value by a 12% marginYTD. Consumer confidence is at an all-time high.

Lower tax rates leading to improved margins, buybacksand repatriation. The Trillion Dollar Equity Club, whichcurrently only consists of Apple and Amazon asmembers, could soon see other entrants from the techworld. US stocks entered the fourth quarter at an all-time high; with risks on the rise, it prompts us toevaluate how much further stocks can run after a nine-year rally.

EnergyMaterialsInfo TechTelecom

S&P 500Financials

Cons. Disc.Industrials

HealthcareUtilities

Cons. StapReal Estate

0% 20% 40% 60% 80% 100% 120% 140%

125%

54%

32%

31%

24%

20%

19%

17%

16%

11%

10%

8%

Exhibit 7: US Q2 earnings growth by sector

Source: Factset, 03 Aug 2018

MXWOU Index SPX Index

60

80

100

120

140

160

180

Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Sep-18

172.2

106.9

Exhibit 6: US equity performance vs rest of theworld (5 years)

Source: Bloomberg as of 30 Sep 2018, Data rebased to 100 as of 27 Sep 2013

Lower tax rates areleading to improvedmargins, buybacksand repatriation



US Equities – All About Growth

As long as US companies can continue posting strong profit growth, stocks can keep rising.

˃ Equity generally performs positively in the late stages of an economic expansion. During the lastquarter US, GDP growth came in at 4.2%. Capital expenditures are accelerating and rates are going upfor the right reasons. The US is experiencing one of the lowest unemployment rates in its history.

˃ Earnings growth is estimated at 21% in 2018 for the S&P 500 companies, after an impressive +25% inQ1 and Q2.

˃ It’s not all about the tax cuts. Operational performance beat expectations. In Q2, revenue for S&P 500companies was up 9.9% y/y and margins at 11.9% are the highest in a decade. Additionally, share-buybacks in 2018 are estimated at USD 1.2tn (USD 700 bn already completed).

˃ Earnings growth has helped containing valuation to reasonable levels. P/E for the S&P500 is around18x 2018E and 16.5X 2019.

˃ Realised and implied volatilities are low. After 34 moves of more than 1% in H1 and H2, the US marketshave not seen a single day in Q3 with more than a 1% move. However, there is a potential source ofvulnerability to short-term worries.

Markets however don’t evolve in straight lines and the US midterm elections should generate turbulence.

Exhibit 8: Equity Positioning

Tactical Strategic

Source: Emirates NBD CIO Office

Consumer spend, e-commerce& digitisation, growing middle-class and millennials

Higher oil prices: Oil E&P

Investment Theme Where to invest

Top Innovation Sectors

European oil majors GCC – KSA Banks, Petchems & Healthcare

Geopolitical concerns Defence

US

EMs

Improving economy andEPS growth

Cloud Services, Robotics, AI, E-commerce,Blockchain, SemiconductorsTechnology in industry

Genomics, Digital, Wearables, Life SciencesHealthcare

Digital Payments, CybersecurityFinancial services



Equity Strategy – India on Hold

Concerns around the banking sector and Non-Banking Financial Corporations (NBFC), INRweakness, impact of stronger oil prices, along withelections less than a year away are raising questionsaround the trajectory of Indian capital markets. Havingsaid that, real rates are positive, the current accountdeficit is range-bound, the fiscal deficit is reasonableand inflation remains under control. As a result, our longterm investment thesis for Indian equity marketsremains unchanged. We are cautious for the short-termand would tactically reduce exposure to generateflexibility and to be able to seize the opportunities oncewe see stability in the INR and oil prices.

Indian equity markets have had a bull run since2009 as the Nifty Index is up 208% (in USD) and 345%in INR, without a sustained drawdown of 20%. Indianmidcap companies have outperformed large caps overa 5-year period, as domestic demand and consumptionhave led to an exponential growth within this segment.This trend reversed in 2018 as the large capscontinued the 2017 rally, however midcaps have notkept up. In Rupee terms, YTD total returns (netdividends reinvested) for the MSCI India Index are5.2% whilst the MSCI India Midcap Index has fallen13%. The devaluation of the INR has led to the MSCIIndia Index falling 7.6% YTD in US dollar (total returns,dividends reinvested).

Indian equity markets have been supported bystrong domestic inflows which have helped balanceoutflows from international investors. Corporates areconfident of business growth over the next 12months. CAGR in earnings for the broader market isat 25%. Apart from the fears of a currency and tradedriven financial crisis, the key risk for markets remainsthe election outcome in May 2019. MSCI India istrading at a Price/ Earnings of 20x which is one ofthe most expansive within EM but close to its recentaverage. Growth remains an important factor formarket performance. Though the Indian market hashistorically always traded at a premium to emergingmarkets, it is currently almost double that of the MSCIEM Index which trades at a Price / Earnings of lessthan 12X.

For the longer term, we would position portfoliostowards the stronger consumption plays as the1.3bn population and increasing middle class willcontinue to reshape the economy. We would focus onconsumer companies dedicated to India’s digitisationand beneficiaries from the under penetration ofecommerce and digitisation. We would book profits onthe Technology Services sector as the weaker INR hashelped IT companies achieve gains of 50 to 60% YTD.

˃ Strong economic growth appears sustainable

˃ Legitimate concerns around shadow banking, the impact of oil prices and the weakening Rupee

˃ Corporate profit growth is expected to grow by more than 20% p.a. in next 3 years

˃ Our fundamental conviction on the market is intact – focus on valuations across various sectors

MXIN Index MXINMC Index

90

95

100

105

110

115

120

Sep-17 Dec-17 Mar-18 Jun-18 Sep-18

Exhibit 9: Indian large cap companies haveoutperformed the mid-caps, last 1 year

Source: Bloomberg as of 30 Sep 2018, Data rebased to 100 as of 29 Sep 2017

Corporates areconfident on businessgrowth over the next

12 months



Equity Strategy

Artificial Intelligence is most likely the biggestdisruptor globally along with the use of big data foranalytics and internet traffic growth. Robots and AIassistants are the visible offshoots while healthcare,agriculture and manufacturing is where the real impactcan be felt. Zumes, a fully automated pizza deliveryservice, cooks food enroute to customers.

Increasing use of digital media is driving advertisingrevenues. Annual ad revenue for Google and Facebookin 2017 was greater than USD 200bn.

Internet of Things (IoT) in healthcare involves mobiledevices that connect patients, caregivers and medicalproviders. Around 150mn installed units actively helpingpatients and caregivers, is expected to grow to 646mn(not including fitness trackers like FitBit) by 2020,representing a revenue opportunity for the medicaldevice industry of nearly USD 117bn.

Shared Mobility: More than half of the world’s carsto shift away from combustion engines by 2040.High-end semiconductor chips and data processing arerequired to facilitate communication in the autonomousvehicle industry. The logistics, shipping, aircraftindustries are making huge inroads into Electric modes.By the end of 2019 BMW will have already have soldhalf a million of its electric vehicles worldwide.

Digitalisation and the power of the app are changinghow business is conducted. Uber is valued at USD70bn. Meituan, the leading service e-commerceplatform (food delivery) in China, had 310mn users in2017. 800mn active mobile money users globally.

Cloud computing (est. USD 300bn size by 2021) isdriving demand for servers, storage, data bandwidth,and consultancy services. Amazon Web Servicesremains the runaway leader, followed by MicrosoftAzure and Google Cloud Platform.

Institutions are increasingly adopting blockchainfor increased security in clearing. JP Morgan has 74banks on boarded already. Walmart will only on boardnew suppliers on its blockchain network.

Streaming and Video Gaming: The popular BattleRoyale based game, Fortnite, has 125mn active playersand a USD 1bn+ run-rate of in-game spend. Netflix willexceed 200mn global streaming subscribers by 2020.

Global Emerging Trends and Disruptors: Don’t miss these growth opportunities



Fixed Income Strategy

A challenging year so farBond investors have had a challenging year copingwith negative returns, and dealing with idiosyncraticrisks. President Trump’s reflationary trade has causedshocks to the asset class globally, strengthening theUS dollar and influencing monetary policies across theglobe.

Higher policy rates are needed in this late economiccycle in the US, to avoid overheating, provide financialstability as well as leeway to cope with more difficulttimes in the future.

The current economic expansionary phase in the US isnow the second longest on record. We still expect thecycle to extend in the medium-term before it inevitablyturns. The yield curve has meaningfully flattened: theyield differential between the 10Y and the 2Y hasdropped to 24 bps, and to 26 bps between 30Y and 5Y.If this continues, the curve should invert, with the shortertenors offering higher yields than the longer ones. In the

past, this has been a red signal for the economy, as itoften foretells that a recession may be on the horizon.This is indeed the only worrying signal as of now, giventhe current pace of growth in the US. Another possibleheadwind for the economy could be excessive interestrate hikes by the Fed which at a point could take theirtoll on activity.

Our stance is unchanged despite the current tensionson 10Y rates. US Treasuries are attractive to us at thecurrent levels, for two reasons. Firstly, we consider theyield as attractive on a medium to long-termperspective. Secondly, US Treasuries play a risk-mitigating role; with the current yields, their hedging anddiversifying power reconstituted against riskier assets.Within a fixed income portfolio, allowing us to take riskselsewhere, especially within Emerging Markets.

EM Debt is our long-standing conviction, and is intactamidst all the country-specific and idiosyncratic issuesencountered during the last quarter.

US Treasuries Overweight Benign inflationary outlook, strong demand for US-Dollar based assets in atightening cycle, attractive yield, and a good hedge on investment portfolios. Overweight

Global Investment Grade OverweightStrong corporate earnings and growth expectations alongside higher headlinecoupons lure demand for corporate bonds. Deleveraging of corporate balancesheets offer a decent risk-reward adjusted returns.

Overweight

Global High Yield Neutral

Global high yield has no further upside and has being a key beneficiary fromtheir equity counterparts stellar perormance and earnings outlook, particulary inthe US. European high yield is expensive and reflects the relatively betterfundamentals as compared to the US. Asia high yield has further upside fromcurrent levels.

Neutral

Emerging Markets Debt Overweight

Long standing conviction intact. The recent broad sell-off due to country specificrisks do not warrant for the significant divergence in EM spreads to their long-term averages. Proactive EM central banks policy adjustment and fiscalconsolidation further cements our call.

Overweight

Exhibit 10: Positioning and Strategy

Tactical RationaleStrategic

Yie

ld to

wor

st %

US Treasuries Global Investment Grade Global High Yield Emerging Market Debt

0123456789

10

Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Mar-18 Sep-18

6.36

5.993.11

2.98




Fixed Income Strategy

Bonds

Glb Developed Sov (Loc)

GCC Credit

Global High yield

USD Emerging Market

US Government

USD Corp Inv Grade

BBG EUR Aggr Corp (Loc)

USD EM Sovereign

USD EM Corporate

Local EM Sovereign

Yield Spread 1 day YTD Duration

1.54% – 0.0% 0.5% 7.9

4.43% 155 0.0% 0.4% 6.5

5.86% 340 0.0% 1.9% 4.0

5.82% 285 0.0% -2.3% 5.9

2.95% – 0.0% -1.7% 6.1

4.07% 106 0.0% -2.3% 7.4

1.22% 101 0.2% -0.9% 6.0

6.38% 336 -0.2% -3.5% 7.3

5.98% 305 0.1% -1.8% 4.5

5.27% 53 0.1% -5.8% 6.0

UST 10Y FED Funds rate

0

1

2

3

4

5

6

7

1

2

3

4

5

6

7

2000 2004 2006 2008 2010 2012 2014 2016 2018

Rates %

Yie

ld %

Exhibit 11: Yields and rates do not moveproportionately

Exhibit 15: Fixed Income segments YTD performance


Fed Funds rate 3M Libor6M Libor 12M Libor

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Nov-15

Jan-16 M

ar-16

May-16

Jul-16

Sep-16

Nov-16

Jan-17 M

ar-17

May-17

Jul-17

Sep-17

Nov-17

Jan-18 M

ar-18

May-18

Jul-18

Sep-18

Exhibit 12: Libor has been the main casualty ofFED’s actions


Hourly Earnings PCE COREUS 5Y5Y Forward Breakeven

1.0%

1.5%

2.0%

2.5%

3.0%

2012 2013 2014 2015 2016 2017 2018

Exhibit 13: FED’s most preferred inflation measure(PCE) compared to hourly earnings andmarket implied inflation expectations (5Y5Y)


Source: Bloomberg as of 01 Oct 2018

Turkey Argentina IndiaBrazil Indonesia China

-8%

-6%

-4%

-2%

0%

2%

4%

2013 2014 2015 2016 2017 2018

0.53

-0.67-1.88

-2.36

-5.17

-6.53

Exhibit 14: Be selective on EM, Fundamentalsmatter


Interbank rates have been more vulnerable to risinginterest rates. The Libor rates are the key benchmarkfor global funding and hedging costs that are creatingtighter liquidity constraints.

It’s a fact, inflation has been -and still isbenign.

Let us not get complacent with inflation. Inflation isbenign amidst all these years of cheap stimulus andabundant liquidity. Markets have got excited over themicroeconomics data on wages. The forward breakevensand PCE core are showcasing divergence in economics.



GCC Bonds – a Unique and Promising Proposition

The GCC is adapting to changing global economicconditions. However, challenges remain, such asrelatively high local unemployment in certain sovereignnations leading to a heavy reliance on expatriateworkers, and the government sector to drive growth.The logical solution is to stimulate the private sector,which is a general trend across the region.

Overall, the GCC’s GDP is expected to grow to 2.4% in2018, 0.1% higher than last year. The trend is expectedto accelerate in 2019, as the Organization of thePetroleum Exporting Countries (OPEC) phases out itsoutput cut, providing a boost to oil exporting countriesand the region.

The successful and smooth implementation of thevalue-added tax (VAT) by most of the GCC nations isemblematic of the current transformations –consequences of a tough period of low oil prices.Policymakers have successfully focused on fiscalconsolidation.

From the start of this year, the economic outlook hadbeen revised upwards with significant growth witnessedin the construction industry. The rise in oil price and itsfavourable outlook –with limited spare capacity- haveboosted both sentiment and demand. Theannouncement of new megaprojects by Saudi Arabia(Vision 2030 transformation agenda), and by the UAEhave boosted the broader regional outlook. In the UAE,over 23 Expo 2020 related construction contracts worthmore than USD 2.5bn are expected to be awarded bythe end of this year. The country is set to be a topperforming economy again in 2018.

The financial sector has demonstrated strong growthand profitability. With the commitment on the currencypeg to the US dollar, the sector has benefitted from therate hikes implemented by the Fed, as interest rateshave been rising in parallel.

The volume of GCC sovereign bond issuance hasgrown exponentially in the last three years, initially dueto increasing funding needs by governments with loweroil prices as a backdrop. As the market continues togrow, international investors have been drawn to theregion bringing a great amount of liquidity, mainly fromAsia. Having said that, the risk premium has remainedsignificant, as it is logical in a context of dependency onexternal capital funding. It is worth noting that on arelative value basis, GCC sovereigns haveoutperformed EM peers, such as Indonesia, Malaysia,Korea, Poland, Brazil, or Mexico.

The potential inclusion of many regional bond issuers(both Sovereign and Corporate) into global indices isalso a key support. We estimate that internationalbenchmark aware investors have been particularlyactive in the 5 to 10Y maturity bucket as well as in thelong-dated maturities, where most of the spreadcompression is visible. The shorter maturities aretypically sought after by regional investors both on alevered and non-levered basis, whereas banks havealways been bidding for short-dated securities.

˃ GCC bond markets have evolved both in terms of depth and breadth

˃ Regional reforms are driving sustainable recovery

˃ GCC bonds are undervalued relative to their fundamentals and their volatility

˃ Higher oil prices and current bond valuations should attract global investors

˃ GCC issuers are progressively included into global EM indices

˃ Sovereigns bonds are our preference

˃ In Financials, we favour Tier-1 hybrid securities

˃ In Corporates, our preferred sectors are Oil & Gas, Utilities, Telecoms & Logistics

The announcement ofnew megaprojects bySaudi Arabia and theUAE have boosted the

broader regional outlook




In a recent announcement, JP Morgan highlighted thatit would add Saudi Arabia, UAE, Bahrain, Kuwait andQatar Sovereign bonds to their Emerging Marketsbond indices starting 31 January of next year. Thenew countries, which will be included in EMBI GlobalDiversified (EMBIGD), EMBI Global as well as theEURO-EMBIG series, will represent around 11.2% ofthe index, with Saudi Arabia at 3.1%, and the UAE at2.6%. Qatar, Bahrain and Kuwait will respectivelyweigh 2.6%, 2.1% and 0.8%.

GCC corporate issuers have been supported by theirrarity, especially on the primary market. We believe that

this is linked to banks being very active lenders tocorporate, reducing the relative attractiveness of bondissuance. What we have witnessed is a growing needfor project related bonds where various structures havebeen tested with regional investors. Despite beingprimarily designed to target institutional asset owners,they have also been welcomed by individual investorsand promoted by wealth managers, sometimes with alevered component. In addition, the credit quality ofsuch project bonds has remained strong, as there aregenerally links between the issuing corporate entity andthe governments. This feature has driven comfort andsponsorship from the investors community.

2015 2016 2017 2018F 2019F 2015 2016 2017 2018F 2019F

3.80 3.00 0.50 2.20 3.90 357.95 348.74 377.44 414.80 434.20

4.10 1.70 -0.70 1.50 2.70 654.27 644.94 683.83 758.00 785.00

4.70 1.80 -0.30 2.60 3.60 68.91 66.82 74.27 84.10 87.70

2.90 3.20 3.20 2.90 3.40 31.13 32.18 34.90 37.70 39.80

-1.00 2.20 -2.50 1.80 3.00 114.61 110.87 120.35 135.30 141.40

3.70 2.40 0.10 2.00 3.30 433.00 427.00 452.00 500.00 518.00

Source: Emirates NBD and IMF data

Exhibit 16: GCC key macro indicators

United Arab Emirates

Saudi Arabia

Oman

Bahrain

Kuwait

GCC

2015 2016 2017 2018F 2019F 2015 2016 2017 2018F 2019F

4.90 1.40 4.70 6.60 5.50 -3.37 -2.48 -1.80 -0.20 1.90

-8.70 -3.70 2.70 8.70 6.40 -15.84 -17.20 -8.97 -4.30 -4.90

-15.90 -18.40 -11.50 -0.40 -2.40 -15.95 -21.30 -11.43 -6.40 -6.10

-2.40 -4.60 -3.90 -2.30 -1.80 -13.00 -13.50 -11.40 -8.60 -8.70

3.50 -4.50 2.00 8.50 7.40 5.59 0.63 3.96 -1.60 -2.50

-2.40 -3.10 2.40 7.10 5.90 -10.80 -10.70 -7.00 -3.10 -2.90

Current Account (% of GDP) Budget Balance (% of GDP)

United Arab Emirates

Saudi Arabia

Oman

Bahrain

Kuwait

GCC

Real GDP % Normal GDP USD bn




UAE (AA)

0

800

900

600

700

400

500

200

100

300

Malaysia (A-)

Oman (BBB-)

India (BBB-)

Bahrain (BB-)

Argentina (B+)

China (A+)

Brazil (BB-)

South Africa (BB)Russia (BBB-)

Indonesia (BBB-)

Kuwait (AA)

Saudi Arabia (A+)


Exhibit 17: CDS, S&P rating

US

D M

n

2012 2013 2014 2015 2016 2017 Current2018

0

60,000

50,000

40,000

30,000

20,000

10,000

Corporate Financial Sovereign

Source: Bloomberg as of Oct 2018

Exhibit 18: Record borrowing from GCC debt issuers



Asset Allocation Outlook

Although clouds are gathering on the outlook over thelonger-term horizon, we still see above trend growthsupporting risk assets in the more immediate future.Investors have come to terms with the fact that growthpeaked at the turn of the year, as well with a number oflingering risks, rising trade conflicts the chief swingfactor amongst them. Market exuberance is no longerat extreme levels, and some pockets of opportunitiescan be identified in oversold assets. To be sure, as thecycle lingers in its late stages, volatility will graduallygrind higher which warrants some buffer cash levels torespond to positive or negative shocks.

The above view supports a tactical overweight onequities versus government bonds, as long as countryselection is carefully taken care of due to diverginggrowth patterns in different areas. A more hostileenvironment of peaking growth and liquidity alsorequires that investors rely more on active positioningthan passive beta exposure.

The US economy remains the lynchpin of global growth(Exhibit 19), expected to expand at a roughly 3% ratethis year, versus a longer run average estimated at1.8%. The effects of tax cuts are going to fade onlysometime in 2019, activity momentum is currentlystrong, hence we hold an overweight stance on USequities. Large-cap US stocks offer quality anddefensiveness versus other markets. Fed policy isexpected to become restrictive not before late next year,and rates to progress gradually higher alongside growthin activity.

We have advocated for a recovery in the DM countriesoutside of the US for some time now, which thus far hasfailed to materialise. Currently, the best indicator of thehealth of the major DM nations is wage growth, hittingcyclical highs in the US, Europe, UK and Japan (Exhibit20), providing support for consumption, which in turnshould extend to manufacturing, languishing since thebeginning of the year. We are carefully watchingEuropean macroeconomic data, as well as the relativeperformance of US cyclical equities to non-US cyclicalstocks, to spot signs of an upturn outside of the US andconsider additional positioning on other equity markets.

˃ Global activity remains strong, although mainly US-led

˃ We expect a cyclical improvement in late 2018

˃ We are tactically positioned on high-quality-US and oversold-EM assets

˃ The after-effects of populism – US trade tariffs and Italian spendthriftiness

US Japan Europe EM

99.5

100.0

100.5

101.0

101.5

102.0

Jan-17 May-17 Sep-17 Jan-18 May-18 Sep-18

Exhibit 19: JPMorgan Forecast RevisionIndices, US versus rest of world

Source: Bloomberg, PB-CIO Office, as of Sep 2018

DM Wages y/y - Euro area US UK Japan RHS

-1.5

-1.0

-0.5

0.0

0.5

1.0

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

10 11 12 13 14 15 16 17 18

Exhibit 20: Wage growth in the major DMcountries at cyclical highs

Source: JPMorgan Research, as per latest available reading

The US economyremains the lynchpin ofglobal growth, expectedto expand at a roughly

3% rate this year




Recent market dislocations driven by escalating tradeconflicts have created buy opportunities in EM assets.EM equities, bonds, and FX in particular, have bornethe brunt of Mr Trump’s ‘America First’ stance,dropping on fear that higher trade tariffs will add to theexisting woes of a stronger Dollar and higher Fedrates. EM equities have undershot global growth,becoming quite oversold versus the JPM GlobalManufacturing PMI Index, an important gauge ofbusiness confidence (Exhibit 21). This points to a highrisk premium built into the asset class. At the sametime, stimulus measures undertaken by China shouldcushion the trade blow and support, in our view,alongside favourable EM equity valuations, the casefor some risk taking. Our EM FX Risk AppetiteIndicator is oversold, pointing to a likely stabilisationof developing nation currencies. We have recentlyinitiated a tactical overweight on EM equities.

We see value in EM bonds as well, with carry atattractive levels in absolute and relative terms. Inparticular, the current yield on EM hard-currency bondsis in line with its 15-year historical average, andappealing in risk-adjusted terms (Exhibit 22). At theopposite end of the spectrum, US high-yielding credit isquite expensive against very high levels of historicalvolatility. Investors are advised to adopt a very selectiveapproach and avoid EM countries with excessiveinternal and external imbalances.

Risks to our view are posed by escalating tradeconflicts, the growing gap between strong US andmore subdued global growth, and shocks to theEurozone economy both from Brexit and loose Italianbudget rules.

Challenges to the medium-term outlook becomeobvious when one considers that the extension of UStariffs to all Chinese imports next year is no longer afar-fetched scenario, which according to some studieswould shave up to 1% off Chinese growth in 2019.Although the Chinese authorities could still cushion theblow via additional monetary and fiscal stimulus,higher uncertainty would come alongside bouts ofvolatility.

MSCI EM Index (YoY, Normlsd) Global Mfg PMI (Normalsd)

Dev

iatio

ns fr

om th

e M

ean

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2012 2013 2014 2015 2016 2017 2018

Exhibit 21: EM equities too depressed versuscurrent levels of global activity


Current Max/Min Average

0

5

10

15

20

25

EM SovUSD

EM SovLoc

EM Corp US Try US IG US HY

YTM

%

Exhibit 22: Current yield on EM Dollar bonds isappealing


Gold Risk Appetite Gold Spot

1000

1200

1400

1600

-2

-1

0

1

2

2014 2015 2016 2017 2018

Gold S

pot

Inde

x

Exhibit 23: Pessimism on gold seems to beexcessive, according to our GoldRisk Appetite Indicator

Source: PB-CIO Office, as of Sep 2018. Gold Risk Appetite Index: aggregate of momentum,positioning, volatility, skew and US real rates




Mr Trump’s ‘America First’ policy is borne out of thatpopulist anger which has triggered both the ‘Brexit’event, and the renewed spendthriftiness of the Italianauthorities. One can argue that while a hard Brexit, withdamaging effects to the Eurozone via hampered traderelations with the UK, is most likely a tail risk, theprospect of a fiscally irresponsible Italy is alreadysending shockwaves through markets. We would ratherhold the view that Italian fiscal profligacy, to translateinto a 2.4% budget deficit planned for 2019, ismanageable until the European economy is resilient.

We are looking to buy gold, a hedge to risk assets,especially at the currently depressed levels (Exhibit 23).Its year-to-date dismal performance, -8.6%, is explainedby the strength of the US economy, which has so farboosted US real rates and the Dollar. Investors tend toneglect the yellow metal when competitive assets offerattractive yields.

We hold the view that 2019 should see a moresupportive macroeconomic backdrop for gold. USeconomic growth rates are expected to drop from above-trend towards trend, as the effects of tax cuts start tofade and inflation, a late-stage variable, continues toclimb gradually. The combination of lower expansionrates and moderately higher inflation should not keepthe Federal Reserve on the hawkish side, providingfurther reason to warm up to the asset class. In the shortterm positioning on the yellow metal is at record-bearishlevels, raising the odds of a short-squeeze, We areconjecturing that a bottom should unfold by year end,unless our assumptions of moderating US growth andtame inflation do not come to pass.

While against risk-assets US Treasuries do not offervalue, given the outlook for higher Fed rates, within abond-only portfolio they are starting to offer acompetitive yield for relatively low volatility.

The Federal Reserve is expected to raise rates threemore times in 2019 according to Fed officials’projections, turning policy restrictive by the end of nextyear. In an environment marked by rising yields andinflation, we think equities would be offering moreattractive returns. Yet, within a fixed income portfolio,investors seeking capital preservation are advised toinvest in long-dated US Treasuries. The spreadbetween US 10-year Treasury and German Bund yieldsis at all-time highs (Exhibit 24), and the current yieldabove 3% takes now into account some inflation risk.

-1%

0%

1%

2%

3%

1998 2002 2006 2010 2014 2018

Exhibit 24: : Difference between US 10-YearTreasury and German Bund Yield atall-time highs


2019 should seea more supportivemacroeconomicbackdrop for gold



Oil Outlook

For the last five months oil prices have kept to a narrowrange, buffeted by concerns that a trade war betweenthe US and China could wreak havoc on the globaleconomy but supported by emerging supply constraints.As we look ahead to 2019 we don’t see either of thesedynamics resolving themselves and it’s more likely theywill intensify. The market is having to adjust to managingscarcity of supply after several years of being awash intoo much oil while demand, which had been taken forgranted in the last few years, is at risk of disappointing.As we examine these issues in more detail we begin tohave more of a conviction view on the trajectory forprices in 2019.

Oil supply is now emerging as one of the major upsiderisks for prices. After spending 2014-17 coping with aglut of oil from unconventional production in the US,market share-targeting OPEC volumes and risingoffshore and oil sands production in Brazil and Canada,the near term outlook for oil supply growth is moreuncertain. The IEA projects that in 2019 non-OPECsupply growth will rise by 1.8mn b/d compared with 2mnb/d estimated for 2018. That is still an elevated pace ofgrowth but constraints are emerging that could put adampener on output.

Tough times in TexasIn the US a shortage of takeaway capacity in the keyproducing state of Texas is acting as a brake ondevelopment. The EIA recently lowered its projection forUS oil supply growth to less than 1mn b/d in 2019compared with 1.3mn b/d for 2018 specifically oninsufficient pipeline capacity to absorb the high volumesof output. The upcoming survey of energy firms from theDallas Federal Reserve will give a clearer view on thepipeline issue as at the start of Q3 more than 50% offirms surveyed said lack of crude pipeline capacitywould limit supply growth. As we have outlined inprevious reports, the shortage of pipeline capacity iscontributing to a significant discount for WTI at Midlandin the Permian basin. In mid-August the wide discountpushed WTI Midland below USD 50/b, its lowest levelsince October 2017. At these levels there is littleheadroom for producers to operate profitably, even ifthey are prepared to pay the cost of transiting by truckor train to seaborne export terminals to take advantageof higher prices. Some relief will come in 2019 whenseveral new oil pipelines and expanded export terminalsalong the Gulf coast of Texas begin operating.

The most immediate supply risks, however, come fromOPEC. Venezuela’s oil production appears to be in nearperpetual decline with few signs on the horizon of anyrecovery. So far the US government has been reticent toimpose direct sanctions on Venezuela’s oil sector for fearof worsening market tightness. But on Iran the US is

taking a much more hardline stance and is activelypushing importers of Iranian crude to cut their levels tozero once energy related sanctions come into effect inNovember. Recent market surveys of Iranian output showa sharp decline in production in August—down by 150kb/d according to Reuters—and an even larger slump inexports. Shipments fell by more than 430k b/d last month,according to data from Reuters, accelerating a downwardtrend that has been in place since April 2018. The degreeof compliance with US sanctions already appears to behigh with major consumers such as India or South Koreacutting imports heavily. Considering the US is offeringimporters little leeway on Iran we expect the disruption tosupply will now be larger than our initial estimates and seeproduction falling at least 750k b/d in 2019 and believethere is a risk of an even larger decline.

Iran’s production starting to dropOPEC’s efforts to unwind some of the ‘overcompliance’with its 2017 production cut agreement has compressedthe producer bloc’s spare capacity, weakening anotherone of the market’s abilities to respond to price shocks.Since its June meeting OPEC production has increasedwith the bulk of the increase provided by Saudi Arabia,Iraq, the UAE and Kuwait. However, the increase hasmeant that collective spare capacity among thesecountries has fallen from nearly 3mn b/d at the end of2017 to less than 2.3mn b/d. We expect that the higherlevels from key OPEC members mean that collectivespare capacity will narrow further in 2019 and thatOPEC will be producing at more than 93% of totalcapacity by end-2019.

Commentary from Saudi Arabia oil market officialssuggests to us that the kingdom will be much moreresponsive in setting production levels going forward.After hitting a 2018 high of 10.6mn b/d in June (Reutersdata) production has edged downward as Saudi isn’tprepared to flood the market with excessive crude. This

WTI

(US

D/b

)

WTI Midland

30

40

50

60

70

80

Jan-17 May-17 Sep-17 Jan-18 May-18 Sep-18

Exhibit 25:

Source: EIKON, Emirates NBD Research



Oil Outlook

will be a shift in Saudi oil policy which previously hadbeen to keep output reasonably stable over a six-monthto one year time frame. We expect there will be morevariance in production levels going forward, respondingto near term market signals, particularly demand.

Mixed outlook for demand in 2019The outlook for demand in 2019 is more mixed. Amongthe major forecasting agencies only the IEA is expectingdemand growth will accelerate next year, from 1.4mnb/d to 1.5mn b/d. OPEC is expecting a much sharperslowdown while the EIA is becoming increasinglypessimistic. A healthy pace of US oil demand can’t betaken for granted as the economic cycle is in a highlymature phase and the one-off factor of lower corporatetax rates fades next year. A recession in the economyremains unlikely but the brisk pace of economic growththis year looks unlikely to be repeated.

More concern though lies in the performance ofemerging markets. The recent rapid sell-off in emergingassets is providing another negative risk for commoditiesin the near term, compounding fears of what a trade warbetween the US and China could have on overallcommodity demand. Where the financial market painhas been most acute, however, is in relatively small oilconsumers: Turkey and Argentina represent just 1% and0.7% of global oil demand respectively. The outlook forChina and India is far more critical. Economicfundamentals still appear good enough to support ahealthy level of demand growth in 2019 and neither hasseen as sharp increase in the cost of imported oil as themore stressed EMs. But the escalating trade warbetween China and the US does pose a seriousdownside risk for trade and oil demand in 2019.

In terms of oil market balances a swing into surplus inQ1 will be temporary and overall the market will beroughly balanced next year. The decline in OECDinventories—both in absolute level and measuredagainst demand—means the market has lost anadditional shock absorber which will allow prices toremain elevated.

Emirates NBD Research oil price views With these supply (price positive) and demand (pricenegative) conditions to be reinforced in 2019 we arebuilding more of a conviction view for the outlook onprices next year. We expect Brent futures will record anaverage of USD 73/b and don’t discount sustainedperiods above USD 80/b as the market reacts to ashortage of Iranian barrels. The trajectory for WTI islower, particularly in H1 2019 until the pipelineconstraints are overcome. We expect WTI futures willaverage USD 66/b with the spread between the twobenchmarks remaining wide for most of the year.

Production m/m (m b/d) Exports m/m (m b/d)

Jan-17Feb-17M

ar-17A

pr-17M

ay-17Jun-17Jul-17A

ug-17S

ep-17O

ct-17N

ov-17D

ec-17Jan-18Feb-18M

ar-18A

pr-18M

ay-18Jun-18Jul-18A

ug-18

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

Exhibit 26:


2018

(m b

/d)

2019

OPEC IEA EIA1.25

1.35

1.45

1.55

1.65 1.62

1.41 1.40

1.50

1.58

1.47

Exhibit 27:

Source: OPEC, IEA, EIA, Emirates NBD Research

WTI USD/b (avg) Brent USD/b (avg)

Jan-15A

pr-15Jul-15O

ct-15Jan-16A

pr-16Jul-16O

ct-16Jan-17A

pr-17Jul-17O

ct-17Jan-18A

pr-18Jul-18O

ct-18Jan-19A

pr-19Jul-19O

ct-19

20

30

40

50

60

70

80

Exhibit 28:




UK Real Estate

The UK’s impending withdrawal from the EuropeanUnion (the so-called “Brexit”) continues to dominatepolitics with negotiations between the UK governmentand EU representatives continuing to drag on withoutany firm outcomes. With the March 2019 deadline fastapproaching, there has yet to be any clarity on what thefuture relationship will look like between the UK and theEU on a number of key items including trade, regulationand immigration. Without any answers on these (andmany other) topics, both individuals and businessescannot currently predict what consequences Brexit willhave for them. This period of intense uncertainty ishaving a mixed effect on UK property.

Commercial property has, to date, been largely unfazedby the ongoing political turbulence with investmenttransactions and rents relatively buoyant (with thenotable exception of the retail sector) and it hasoutperformed all other UK asset classes so far this year.The key factors driving this outperformance have beena weak GBP encouraging overseas investment (a‘positive’ Brexit side effect from their perspective),returns from the industrial sector due to the rise ofecommerce and the ongoing search for yield in a lowinterest-rate environment.

˃ Brexit deadline in March 2019 fast approaching with little clarity on key items but impact mixed for UKproperty

˃ Commercial property largely unfazed due to overseas investment, industrial/logistics sectorperformance and ongoing search for yield

˃ Concerns about market reaching its cyclical peak with limited upside and mounting risks. Alternativereal estate sectors more resilient to Brexit turmoil

˃ Tax reform has been the principal driver for residential property over the past few years but Brexitstarting to have impact now and poor sentiment is widespread but GFC-style price crash unlikely. Primeresidential a value opportunity for overseas investors and potentially now bottoming out

˃ Government reforms a tailwind for new residential investment opportunities

UK Property Market Review Q4 2018 – Brexit Impact Mixed

Commercial propertyhas, to date, been largelyunfazed by the ongoingpolitical turbulence withinvestment transactions



UK Real Estate

Exhibit 29: Top 10 Property Transactions YTD 2018

Arches Portfolio UK-Wide Mixed 1,460.0 Network Rail (UK)

City of London Office 1,160.0

5 Broadgate, EC2 City of London Office 1,000.0

Starwood Hotel Portfolio UK-Wide Hotel 858.0

Ropemaker Place, EC2 City of London Office 650.0

Get Living Portfolio UK-Wide Residential 600.0

Central London Office 550.0

Enigma Portfolio UK-Wide Student 520.0

10 Bressenden Place, SW1 London West End Office 460.0

SACO Portfolio UK-Wide Serviced Apt 420.0

Building / Transaction Name Location Sector Price

GBPmVendor(nationality)

Purchaser(nationality)

Source: Propertydata, 2018. Data from 01 Jan 2018 to 30 Sep 2018.

JV: Telereal Trillium(UK) / BlackstoneReal Estate (USA)

Goldman Sachs (USA) NPS (S Korea)Goldman Sachs HQ,Plumtree Court, EC4

JV: GIC Real Estate(Singapore) / British Landplc (UK)

Starwood Capital (USA)

AXA IM (France) /Gingko Tree (China) /HanWha Life (S Korea)

Delancey (UK)

CK AssetHoldings Ltd (HK)

Blackstone Real Estate(USA)1-11 John Adam Street, WC2

Curlew Student Trust (UK)

PonteGadeaImmobilaria(Spain)

Oaktree Capital (USA)Brookfield AssetManagement(Canada)

PSP Investments(Canada) / TishmanSpeyer Properties (USA)

Brookfield AssetManagement(Canada)

DEKA Immobilien(Germany)

Fonciere DesRegions (France)

Ho Bee Land(Singapore)

JV: Delancey (UK)/ Oxford Properties(Canada)



UK Real Estate

However, after a long ‘bull’ run, we believe that UKcommercial property is either at or near its cyclical peakand wider weakness stemming from Brexit uncertaintyand rising rates is being masked by a small number of‘mega transactions’ from overseas investors capitalisingon currency. This is largely reflected in investorsentiment on publicly listed real estate companies whichare pricing in a correction for both office and retailassets. Even if this thesis is incorrect, there is certainlylimited upside from this point onwards given themounting risks. We consider that it is better to bepositioned in more defensive alternative sectors, suchas long income, student accommodation, real estatedebt and healthcare (amongst others) which are moreresilient to the current Brexit turmoil.

Residential property is driven by a different set of factorsto commercial property. The UK residential market hasbeen far more volatile than its commercial counterpartdue to both Brexit and successive changes to the UKtaxation regime. The market has split along two mainlines: between owner occupiers and buy-to-let investorsand between high and low value properties.

A number of successive changes to property taxationsince March 2013 have, until recently, had a greaterimpact on market performance than Brexit. Thesechanges have broadly had two effects: 1) to raise thetax burden on higher value (“prime”) and buy-to-letproperties, thus discouraging those buyers anddampening prices whilst 2) lowering the tax burden forlower value, owner-occupied property thusencouraging those buyers and supporting prices.These reforms have had a disproportionally greatereffect on Central London due to a larger volume andconcentration of both prime properties and overseasinvestors. To compound matters, a number of areas inCentral London have experienced localisedoversupply issues.

However, the imminent Brexit deadline along with risinginterest rates is now the dominant factor affectingsentiment (across all segments of the market). A highlevel of uncertainty and affordability concerns arecausing home movers or home buyers to either delayor cancel transactions. Recent high-profile commentsfrom the Governor of the Bank of England regarding apotential global financial crisis-style crash have alsoadded to the general pessimism.

Despite this period of poor sentiment, a dramatic 2008-style price crash seems unlikely. Irresponsibleborrowing (and lending) were key catalysts a decadeago. Even in a worst case ‘no deal’ Brexit scenario, weare in a markedly different credit environment today,lending standards have increased dramatically andunderlying property fundamentals remain robust with noshortage of demand. Instead, a volatile period endingwith a modest correction seems more likely. In CentralLondon, prime property has, like its commercialcounterparts, presented a value opportunity in USD orEUR terms and there are tentative signs of stabilisationin these markets.

Underlying all of this, there has been a fundamentalshift over the past few years with UK government policydetermined to provide more housing to its citizens,reform outdated laws and raise professionalism in whathas traditionally been a fragmented and poorlymanaged sector. Private capital has a key role to playin these reforms and more attractive returns areavailable, in our opinion, from supporting the emerging‘multifamily’ sector and providing more social housingacross the UK.

Successive changes toproperty taxation since March2013 have, until recently, hada greater impact on marketperformance than Brexit



UK Real Estate

UKREITs

UKCommercial

Property

UKEquities

GBP CorpBonds

5-10Yrs

UK Gilts5-10yrs

-4%

-2%

0%

2%

4%

6%

8%

-1.68%

5.69%

YTD

Tot

al R

etur

n

0.16%

-0.25%-0.87%

Exhibit 30: UK Commercial Property YTD 2018 TotalReturn vs UK Equities, Bonds & Gilts

Source: Morningstar, MSCI, 2018

Yie

ld %

01

2

3

4

5

67

8

Feb-05 Feb-07 Feb-09 Feb-11 Feb-13 Feb-15 Feb-17FTSE All Share Div Yield FT Gilts 5-15yrs Redmp YieldIPD All Property Initial Yield UK Base Rate

Exhibit 32: UK Commercial Property Yield vsEquities and Gilts & UK Interest Rates

Source: MSCI, BoE, DMO, Morningstar, 2018

Inde

x, J

an-0

8 =

100

Net Mortgage Lending (RHS) ALL UK House Prices (LHS) Prime Central London Prices (LHS)

-1 0 1 2 3 4 5 6 7 8 9

75

85

95

105

115

125

135

145

Jan-08 Jul-10 Jan-13 Jul-15 Jan-18

Net M

ortgage Lending GB

Pbn

Mar-13: Start of UKresidential tax reforms

Exhibit 34: Prime Central London vs. UKResidential & Net Mortgage Lending

Source: PropertyData, 2018

Jan-08 Jul-09

% o

f All

UK

Ret

ailin

g

Jan-11 Jul-12 Jan-14 Jul-15 Jan-17 Jul-180

2

4

6

810

12

14

16

1820

Exhibit 31: UK Internet Sales as Proportion ofAll Retailing

Source: ONS, 2018

Avg

. Dea

l Siz

e G

BP

m

20

40

60

80

100

120

140

Sep-13

Jan-14

May-14

Sep-14

Jan-15

May-15

Sep-15

Jan-16

May-16

Sep-16

Jan-17

May-17

Sep-17

Jan-18

May-18

Sep-18

Exhibit 33: Average Transaction Size, CentralLondon Offices

Source: PropertyData, 2018

New

Rat

io: m

edia

n pr

ice

/m

edia

n gr

oss

earn

ings

Existing

199719981999200020012002200320042005200620072008200920102011201220132014201520162017

0

2

4

6

8

10

12

Exhibit 35: Housing Affordability Ratio England &Wales

Source: ONS, 2018



Contributors

Maurice Gravier – Chief Investment Officer

Tel: +971 (0)4 609 3739 Email: [email protected]

Anita Gupta – Head of Equity Strategy


Syed Yahya Sultan – Head of Fixed Income Strategy


Giorgio Borelli – Head of Asset Allocation and Quantitative Strategies


Muna Alawadhi – Fixed Income Analyst


Nawaf Fahad Ali Mousa AlNaqbi – Equity Analyst


Budour Al Fahim – Equity Analyst


Edward Bell – Director Commodity Research


Nigel Burton – Director Real Estate




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