The Quarterly Investment View - ADCB · 2015. 1. 11. · The Quarterly Investment View January 2015 Asset Management |[email protected] 3 and/or corporate bonds over and on

The Quarterly Investment View January 2015

Asset Management |[email protected] 1

Index

1. The oil factor mitigates the incipient global slowdown Page – 2 & 3

2. Executive Summary, Market Outlook, and Portfolio Positioning Page – 4 & 5

3. United States: Fed to remain prudent amidst global growth concerns Page – 6

4. Euro-zone: the old issues are still there, the euro is still too strong Page – 7

5. Japan: concerns over success of “Abenomics” creeping in Page – 8

6. China: central bank turns more dovish as manufacturing slowdown accelerates Page – 9

7. India: reform path progresses but capex cycle needs revival for growth to accelerate Page – 10

8. GCC: low debt and high reserve levels allow to mitigate growth impact of oil price drop Page – 11

9. Appendix: forecast and valuation Page – 12-16

10. Sources and Disclaimer Page – 17

Please refer to the disclaimer at the end of the attached publication

mailto:[email protected]



The oil factor mitigates the incipient global slowdown

More than six years after the 2008 Global Financial Crisis (GFC) the global economy has given only

little signs of a broad-based and sustained pick-up in aggregate spending. The only large advanced

economy that has seen a significant and continuous pick-up in job creation is the US. Yet, even in

this lonely so-called “champion of growth”, and notwithstanding such protracted employment

growth, salary growth and capital spending (except until very recently energy capital spending)

have remained subdued, telling us something deeper bout the inherent fragility of its very recovery.

Little wonder if consensus growth forecasts from 2011 to 2014 have been systematically, year over

year, revised downward. And little wonder if – come 2015 – with the Eurozone slipping into deflation

and China’s export growth model increasingly unable to perform in a world of excess capacity, there

were many good reasons to expect again a year of less rather than more growth. We were thus

approaching 2015 with a sense of heightened concern, also because equity valuations have

become increasingly unattractive and a lasting equity correction still has the potential of removing

the positive QE-induced wealth effect from the US recovery. From our point of view the increase in

equity market volatility has little to do with rate hikes, much more with global growth concerns.

Yet, and in spite of such growth concerns, the sharp oil price correction of the last months seems to

us still mostly supply, rather than demand driven. As such, it should have a significantly positive

impact on global economic growth. It allows low income households across the globe to stabilize, if

not increase, their consumption spending. It makes it easier for many governments to reduce their

deficits. It also reduces – at least temporarily - inflationary expectations thereby further dampening

yields and making it easier for governments to service their debts without adding fiscal drag.

To be sure, we were sceptical about the consensus forecasts for 2015 and we are certainly not

advocating a return to the high growth rates we were used to before the GFC. Yet, whilst we still

have serious doubts about the consensus 2015 US growth rate at 3%, we are now more confident a

repeat of the 2014 2% performance is possible. China and the Eurozone are still unlikely to reach

respectively 7% and 1% growth in 2015, but the former might now be able to avoid a signification

reduction towards the 5% level, and the latter might be able to avoid outright recession. No little

difference from the viewpoint of financial markets.

Federal Reserve adjusting to the global environment

The US dollar index (the greenback’s exchange rate based on the trade weights of the US’ main

trading partners) is now up 15% versus its average of the last 5 years. Even for a relatively large

and closed economy such as the US this should have a tangibly negative impact on growth and an

already low level of inflation. If one adds to that the (at least initially) disinflationary impact of the

lower oil price, it becomes very hard to see how the Fed could hike rates in 2015 to a significant

extent. We have long argued that the upcoming rate hikes will not alter the basic fact that US

monetary policy will remain largely accommodative, simply because the end of additional QE does

not imply that the Fed will allow its balance sheet to shrink in any meaningful manner. Recently we

have been considering to replace our “not so relevant rate hike” scenario with the hypothesis of “no

rate hike at all”. If anything, some minor rate hikes would be relevant in that they would finally signal

a return to normal monetary policy, thereby boosting confidence into the economic system. But

even small rate hikes seriously risk exacerbating the appreciation of the US dollar. And that’s

precisely why the Federal Reserve might ultimately decide to pass in 2015.

Other central banks picking up the baton of QE and Greece unlikely to exit the

Euro-zone

Bank of Japan Governor Kuroda has - politically alone – little choice but to pursue his very

expansionary monetary policy stance. Given the country’s still very strong external credit position,

as well as the fact that most debt is domestically held, this is for the moment unlikely to destabilize

the Japanese bond market. Now that the ECB’s sole mandate of price stability is in concrete peril,

President Draghi is likely to cook up some scheme for the acquisition of sovereign, supranational

Luciano Jannelli, Ph.D., CFA Head Investment Strategy [email protected] Rahmatullah Khan Economist Investment Strategy Team [email protected]





and/or corporate bonds over and on top of the ECB’s already existing buy programs. Rumors to the

contrary notwithstanding, Germany is unlikely to allow Greece to exit the single currency. Germany,

in fact, remains the single largest beneficiary of the monetary union and the benefits that it derives

from the euro are significantly larger than all the money put up (and which it still owns) to help bail

out the various periphery economies. Why would the ever so prudent German government wish to

put such wonderful and advantageous trade-off at an immediate risk by allowing an unprecedented

euro exit, which could then be only the first domino to fall in a longer series of such exits?

Yields to remain low, but equities to remain volatile

Sluggish growth will keep yields at bay. Low yields and moderate growth are still positive for

equities but volatility is very unlikely to abate. The rise in the US dollar is a headwind for US equities

in particular. Amongst advanced markets German, and more in general European export-oriented,

equities might be the most attractive in terms of valuation, and in consideration of the fact that the

euro has lost a significant part of the gains it had made earlier in the year against the yen. Amongst

emerging markets we look favorably to equities and bonds of energy-dependent markets such as

India, Turkey and Indonesia. When the oil price will stabilize we expect a consolidation and pick-up

of equity markets in the Gulf Cooperation countries.

Index Snapshot (World Indices)

Index Latest Quarterly change % (Q4-2014)

Change in 2014 (%)

S&P 500 2,002.6 4.4 11.4

Dow Jones 17,371.6 4.6 7.5

Nasdaq 4,592.7 5.4 13.4

DAX 40 9,586.9 3.5 2.7

Nikkei 225 16,885.3 7.9 7.1

FTSE 100 6,437.9 -0.9 -2.7

Sensex 26,908.8 3.3 29.9

Hang Seng 23681.3 2.9 1.3

Regional Markets (Sunday to Thursday)

ADX 4424.6 -11.3 5.6

DFM 3600.3 -25.2 12.0

Tadawul 8175.4 -23.2 -2.4

DSM 11898.2 -10.5 18.4

MSM30 6204.12 -15.2 -7.2

BHSE 1425.2 -3.3 14.2

KWSE 6423.2 -14.2 -13.4

MSCI

MSCI World 1,654.4 0.7 2.9

MSCI EM 934.7 -4.9 -4.6

Global Commodities, Currencies and Rates

Commodity Latest Quarterly change % (Q4-2014)

Change in 2014 (%)

ICE Brent USD/bbl 51.5 -39.4 -48.3

Nymex WTI USD/bbl 48.49 -41.6 -45.9

OPEC Basket USD/bbl 46.7 -44.8 -51.8

Gold USD/t. oz 1213.9 -2.0 -1.4

Platinum USD/t oz 1220.0 -7.1 -11.9

Copper USD/MT 276.15 -6.1 -16.8

Aluminium 1762 -5.2 4.1

Currencies

EURUSD 1.1850 -4.2 -12.0

GBPUSD 1.5138 -3.9 -5.9

USDJPY 119.08 9.2 13.7

USDCHF 1.0135 4.1 11.4

Rates

USD Libor 3m 0.2536 8.7 3.9

USD Libor 12m 0.6338 8.7 7.8

UAE Eibor 3m 0.6771 -4.8 -16.7

UAE Eibor 12m 1.0157 -2.3 -14.2

US 3m Bills 0.0203 -42.0 -46.2

US 10yr Treasury 1.9729 -12.8 -28.3

.

Past quarter global markets’ performance




Executive Summary

Federal Reserve will remain very accommodative even after starting to gradually hike rates, ECB to become increasingly

supportive through 2015, BoJ likely to continue quantitative easing.

US growth to remain steady and moderate, likely to pull Europe and Emerging markets

Advanced economies equities have still some upside given accommodative monetary policies

China’s reform, and growth, problems will remain with us for a longer period

Commodity exporting emerging markets such as Brazil, Russia and South Africa will suffer

Emerging markets which are not exposed to commodity prices and where the reform process seems to be more promising,

such as India, are more likely to take advantage of the decline in commodity and energy prices

Selectively emerging markets hard currency bonds offer good value, whereas local currency bonds remain subject to a

scenario of continuing exchange rate volatility

Energy prices are expected to stabilize, and at some point recover from current lows

Industrial metals have still more downside given the ongoing transformation of China’s economy

Precious metals upside to be capped by continuing global disinflation, as well as the permanent shrinkage of emerging

markets trade surpluses.

Market Outlook and Portfolio Positioning

Fixed Income

Duration Avoid the intermediate section of the yield curve

Federal Reserve will only very gradually start hiking rates in 2015. Long-term yields remains capped by secular disinflation.

Advanced economy corporate bonds

Underweight Credit spreads have widened again towards the end of the last year. Widening has come on the back of lower grade corp yield moving up while high grade corp yield has largely trended downward.

EM bonds Selectively overweight Among Emerging Markets we differentiate between commodity exporters and importers, favoring the latter. Commodity exports not only face growth issues but they seem to be prone to currency volatility. In commodity importer country’s bonds, we still prefer USD bonds rather than local currency bonds primarily of continuing currency volatility.

Equity Markets

US Moderately overweight We have so far been confirmed in our call for more accommodative monetary policy for longer and the recommendation to stay overweight in US equities. As growth and policy will remain accommodative, we stay moderately overweight, yet we now expect less upside because of increasingly stretched valuations.

Eurozone Moderately overweight Periphery equities' valuation-based catch-up has now petered out. Growth will pick-up moderately as the ECB enhances support and exports to the US increase. In real terms Eurozone equities are expected to perform in line with US equities.




Japan Moderately overweight US recovery and very accommodative monetary policy is still supportive to our constructive view on Japanese equities. However, gains are likely to be limited as compared to the last two years primarily due to disappointing growth and inflation performance.

Emerging Markets Selectively overweight Emerging equity markets remain a mixed bag. We are overweight those emerging markets that are more reform prone and less dependent on commodities, such as India and some Eastern European and Asian economies, such as Turkey and Indonesia.

Energy and Commodity Prices

Energy Neutral The recent sharp decline in prices seem to have undershot. Yet, volatility is to remain high as long as the direction of US production remains unclear. For the moment we expect as sideward price movement.

Industrial Metals Underweight The full implications of the China transformation story will determine a further reduction in the commodity- intensity of its economy. There may be some recurring technical rebounds in specific metal prices, but globally deflationary downward pressures are likely to continue in this commodity space.

Precious Metals Underweight As most advanced economies maintain their deleveraging course, the USD and Euro in particular are likely to remain strong versus emerging market currencies. Thus the risks of investing in precious metals remain quite elevated.

Currencies

EUR Down A diverging monetary cycle in the two economic regions supports further US dollar strengthening in coming quarters. A more dovish Fed might to some extent mitigate this development, yet not alter its basic thrust.

GBP Down Weakening growth momentum in the UK and anaemic economic environment in the neighbouring Eurozone has negatively affected cable in recent months. We expect this to continue in coming quarters. However, we expect only a marginal depreciation of the pound sterling versus the US dollar as both Fed and BoE rate hikes are expected to be muted.

JPY Down Japanese yen is expected to remain in depreciating trend as the BoJ will continue to inject large amount of money into the system. But the yen being a carry trade currency, it should see temporary rebounds during global risk aversion phases.




US recovery to remain modest

Whilst it is true that the economic recovery in the US has

broadened its base, it remains inherently fragile as can be

observed from the fact that wage growth is stalling in spite of

continuing job creation. Normally, at this stage of the cycle,

the declining slack in the labor market should already have

boosted workers’ earnings growth, thereby further enhancing

consumption growth. There is one silver lining in that the

lower oil price raises households’ real income. As such, it

should provide – together with improved household balance

sheets - structural support to continuing consumption growth.

However, even if we expect US real growth to remain decent

(say around 2% annual real GDP growth), we do not expect a

major break-out away from the lower growth rates that have

emerged since the 2008 Global Financial Crisis. A lot of this

has to do with the simple fact that overall household and

government debt stocks remain at historically high levels, and

that the rest of the world continues to struggle to shake of

very strong deflationary pressures.

The US economy is not an island

The US economy, in fact, is not immune of the struggling

Eurozone, recessionary Japan and slowing emerging

economies. This can be very easily observed from below

chart which shows that periods of stronger dollar coincide

with net export dragging GDP growth lower.

We believe that there remains room for further appreciation of

the US dollar and – as such – an additional drag on US

growth.

Federal Reserve to remain very prudent

The strength of the US dollar has not only a negative impact

on growth, it also has a disinflationary impact on the economy

to an equivalent extent as the rise in interest rates (through

the reduction of prices of imported goods). This reinforces the

economy’s disinflationary trend which is already very strong

in view of still significant deleveraging, very well contained

wage pressures, the continuous slide in commodity prices

and – recently – the sharp drop in energy prices.

The short- versus long term implications of the oil price

drop and the Federal Reserve’s patience

First and foremost it is important to note that the overall

stance of US monetary policy will remain accommodative

through 2015 because the Federal Reserve – whilst not

adding additional liquidity in the system – will not reduce the

size of its balance sheet either. Thus the largely

accommodative stance will not be altered by what we have

long expected to be a moderate increase of the Federal

Reserve Funds rate in 2015. The Federal Reserve has now

an additional motive to be prudent since in the short-term the

drop in the oil price is not only deflationary, but possibly also

recessionary because for sure it will reduce energy capital

expenditures (which are the bulk of US capital expenditures).

Over the longer period the drop in oil prices is reflationary

since it increases consumers’ real income by liberating

resources for the acquisition of discretionary items, thereby

also promoting capital expenditure in other sectors of the

economy. As these second order effects need time to work

out, and given also the strong US dollar, the Federal Reserve

will want to err on the side of prudence and raise rates only

moderately, in the order of say 50 basis points, in 2015. A no

rate hike at all scenario is becoming more likely. The overall

yield curve should thus remain contained which is good for

US equities.

5

7

9

11

-200

0

200

400

600

Feb-10

May-1

0Au

g-10

Nov-1

0Feb

-11Ma

y-11

Aug-1

1No

v-11

Feb-12

May-1

2Au

g-12

Nov-1

2Feb

-13Ma

y-13

Aug-1

3No

v-13

Feb-14

May-1

4Au

g-14

Nov-1

4

(Per cent)('000)

A solid improvement in labor market to support consumption further

Change in nonfarm payroll Unemployment rate - rhsSource: Bloomberg

020406080100120140160

-5

0

5

1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014

(Index)(Per cent)

Fed is likely to be mindful of dollar strength that affects net export contribution to the GDP growth

Net export contribution to GDP growth (q-o-q, annualized)Trade weighted dollar index - rhs

Source: Bloomberg

0.0

1.0

2.0

3.0

4.0

Nov-1

0

Mar-1

1

Jul-11

Nov-1

1

Mar-1

2

Jul-12

Nov-1

2

Mar-1

3

Jul-13

Nov-1

3

Mar-1

4

Jul-14

Nov-1

4

(Per cent)Inflationary pressure remains subdued

Core PCE, y-o-y Core PPI, y-o-y Average hourly earnings

Source: Bloomberg

United States: Fed to remain prudent amidst global growth concerns




Draghi’s balance sheet battle

It is probably important to stress that even if Mr. Draghi

succeeds in increasing the ECB’s balance sheet from 2tn to

3tn euros, overall annual real GDP growth in the Eurozone

will remain subdued at the 1% level. Thus the “mere”

purpose of the expansion of the ECB’s balance sheet is to

prevent the monetary union to slide into a deflationary

recession across all its member-states. In order to bring the

balance sheet as quickly as possible at the desired level – or

more importantly convince the markets immediately that the

3tn euro size is feasible by the end of 2015 – Mr. Draghi will

most likely have to add the acquisition of approximately

500bn corporate, supranational (EIB) and sovereign bonds

to existing buy and lending programs.

Euro deprecation as the key QE reflation lever

Critically the further compression of Euro-zone bond yields

as well as the reduction of periphery spreads will take stress

of the banks’ balance sheets and thereby facilitate lending.

Yet, given the lack of credit demand, and the entrenchment

of the credit crunch in periphery economies, one should not

expect miracles when it comes to increasing lending.

Thus the most effective way by which QE can directly reflate

the Eurozone’s economy is by promoting a further

devaluation of the euro which promotes exports, and makes

the Eurozone’ assets cheaper for foreigners.

A depreciation of the euro will also (through an increase in

the price of imported goods) determine the necessary

increase in inflation, thereby preventing the credit crunch

from morphing into an outright aggregate demand crunch.

Deflation entrenchment and Greece are the key risks

Whilst we believe that Mr. Draghi will succeed in his 2015

balance sheet target, we are not convinced that that will be

sufficient to defuse the entrenchment of deflationary

expectations over the next six months, especially if the euro

does not depreciate further in a significant manner (in this

respect we note that deflation continues to plague Japan in

spite of the significant expansion of the Bank of Japan’s

balance sheet). Uncertainties are compounded by the risk of

Greece having an anti-euro government by January 25 which

would demand a renegotiation of its outstanding debt, as

well as the austerity policies.

-4-202468

1012

Apr-0

4

Dec-0

4

Aug-0

5

Apr-0

6

Dec-0

6

Aug-0

7

Apr-0

8

Dec-0

8

Aug-0

9

Apr-1

0

Dec-1

0

Aug-1

1

Apr-1

2De

c-12

Aug-1

3

Apr-1

4

(Per cent)

Lending to remain modest in euro

Loans to private sector, y-o-y chg.

Source: Thomson Reuters

1.001.051.101.151.201.251.301.351.401.451.501,800

2,000

2,200

2,400

2,600

2,800

3,000

3,200

Dec-0

9

May-1

0

Oct-1

0

Mar-1

1

Aug-1

1

Jan-12

Jun-12

Nov-1

2

Apr-1

3

Sep-13

Feb-14

Jul-14

Dec-1

4

(EUR/USD)(EUR Bn)

ECB balancesheet needs to expand in order to devalue Euro

ECB balancesheet EUR/USD - rhs

Source: Bloomberg

-2-10123456

Dec-9

7De

c-98

Dec-9

9De

c-00

Dec-0

1De

c-02

Dec-0

3De

c-04

Dec-0

5De

c-06

Dec-0

7De

c-08

Dec-0

9De

c-10

Dec-1

1De

c-12

Dec-1

3De

c-14

(Per cent)

Inflation is down in all Eurozone countries

Germany CPI Italy CPI Spain CPI France CPI

Source: Bloomberg

Eurozone: the old issues are still there, the euro is still too strong




Growth disappoints, again

The economic recovery has remained elusive following the

April sales tax hike as the economy went into a recession

with declining real GDP in two consecutive quarters. As

economic indicators – both industrial production and the

Tankan producers confidence index – have disappointed in

October and November, there is now a concrete risk that

fourth quarter growth could even disappoint the modest

expectation of 2.8% (QoQ annualized) from the already low

third quarter base. Market consensus expects real GDP

growth to be modest at 1% in 2015 on the back of an

estimated meagre growth of 0.3% in 2014.

Abenomics fails?

While growth is disappointing, the recent downward trend in

inflation is questioning the very success of “Abenomics”, a

policy that is entirely centered on the idea of creating inflation

through quantitative easing so as to induce wage growth that

in turn would sustain domestic demand. In fact, the tax-

induced inflation created early this year seems to be petering

out and the decline in wages in November (year-over-year

basis) confirms how serious the policy failure risk is.

Authorities increasing “Abenomics” measures

Realising the weakness in growth momentum and the

anaemic internal price dynamics, the Bank of Japan (BoJ)

announced a slew of additional quantitative easing measures

in October to support the equity market and further

depreciate the Japanese yen. Whilst, these new measures

have effectively boosted equity prices and depreciated the

currency further, it is not clear yet that they will have the

desired impact on inflation and real growth.

Prime Minister Abe’s recently announced fiscal stimulus

worth of JPY 3.5tn (c.USD 29bn) is for sure unlikely to have

any meaningful impact on economic activity. Moreover, more

significant fiscal stimulus is not an option for the government

as the deficit is already running above 8% of GDP and public

debt is in excess of 225% of GDP.

Continuous policy failure warrants caution

If “Abenomics” would fail in promoting economic growth, it

would inevitably raise questions about the sustainability of the

countries’ growth in public debt. Not surprisingly, foreign

inflows in the equity market were “only” around USD 7.5bn in

2014, down by 94% as compared to 2013.

Thus even if the BoJ measures would continue to support

gains in the equity market as the currency depreciation

boosts the earnings for Japanese companies, those gains are

likely to be limited as compared to the last two years. Finally,

any further fiscal stimulus that would shoot the sovereign

debt significantly up could at some point become negative for

sovereign bonds.

-8-6-4-202468

Dec-1

1

Mar-1

2

Jun-12

Sep-12

Dec-1

2

Mar-1

3

Jun-13

Sep-13

Dec-1

3

Mar-1

4

Jun-14

Sep-14

(Per cent)

Both private demand as well as public demand are weak

Real GDP, q-o-q annualized Real Pvt demand, y-o-yReal Public demand, y-o-y

Source: Bloomberg

-5-3-11357

Jan-10

May-1

0

Sep-10

Jan-11

May-1

1

Sep-11

Jan-12

May-1

2

Sep-12

Jan-13

May-1

3

Sep-13

Jan-14

May-1

4

Sep-14

(Per cent)

After a brief jump in inflation downward trend resumed

CPI, y-o-y Producers' input cost, y-o-y Wage growth, y-o-y

Source: Bloomberg

90

95

100

105

110

115

120

125

13,000

14,000

15,000

16,000

17,000

18,000

Oct-1

3

Nov-1

3De

c-13

Jan-14

Feb-14

Mar-1

4

Apr-1

4Ma

y-14

Jun-14

Jul-14

Aug-1

4

Sep-14

Oct-1

4

Nov-1

4De

c-14

(USD/JPY)(Index)

Currency depreciation and rally in stock market do not seem to be adequate for sustainable economic recovery

Nikkei 225 USD/JPY - rhs

Source: Bloomberg

Japan: concerns over success of “Abenomics” creeping in




Growth slowdown continuing

The ongoing economic transition in China from investment

led growth, which heavily relied on infrastructure spending

and exports, to domestic consumption driven growth is likely

to continue to weigh on the economic outlook. The sluggish

global economic conditions have weighed on exports while

the curtailment of investments has slowed down

manufacturing, and inevitably also consumption.

The chart below shows how both the secondary (industrial)

sector (which is almost half of GDP) and the tertiary

(services) sector have not managed to keep up with the

growth rates before the 2008 Global Financial Crisis (GFC).

Likewise, the external sector is no longer the support it once

provided to the Chinese economy. Also because of the

Renminbi’s peg to the US dollar, exports are unlikely to

repeat their 2010-11 or pre-GFC performance.

On the domestic side, the recent trend in economic releases

- especially related to the manufacturing sector - confirm the

growth going even further down. All in all the probability of

sub-7% growth in 2015 has risen.

People’s Bank of China more dovish, for now

Slower growth has pushed the People’s Bank of China

(PBoC) to act by reducing, after more than two years, the

one year deposit rate by 40 bps to 5.6%. The market is now

expecting another rate cut in 2015. Another policy

consideration for the central bank would be a lower

exchange rate as the renminbi is scaling new highs in real

terms (REER basis) due to its soft peg with the US dollar.

Therefore, we believe that the central bank could well take

easing action through currency depreciation and liquidity

injection.

Careful with Chinese equities

The local equity market rallied significantly over the last two

months. A most important factor for the sharp rally was likely

the undervaluation of the market, as well as the reform

linking the Shanghai and Honk Kong exchanges. This

created optimism among investors for a further opening up

the financial market. Sentiment got an additional boost from

the surprise rate cut by the PBoC. Going forward further

upside seems to be largely based upon speculation of the

further opening of what remains a very opaque market.

0

5

10

15

20

Mar-0

4

Nov-0

4

Jul-05

Mar-0

6

Nov-0

6

Jul-07

Mar-0

8

Nov-0

8

Jul-09

Mar-1

0

Nov-1

0

Jul-11

Mar-1

2

Nov-1

2

Jul-13

Mar-1

4

(Per cent)

Growth slowdown coming from transition process from secondary to tertiary

Secondary sector growth, y-o-y Tertiary sector growth, y-o-yReal GDP growth, y-o-y

Source: Bloomberg

-25

-5

15

35

55

75

Feb-10

Jun-10

Oct-1

0

Feb-11

Jun-11

Oct-1

1

Feb-12

Jun-12

Oct-1

2

Feb-13

Jun-13

Oct-1

3

Feb-14

Jun-14

Oct-1

4

(Per cent)Foreign trade clearly in a lower trajectory

Exports ImportsSource: Bloomberg

10

15

20

25

30

68

101214161820

Mar-1

0

Jul-10

Nov-1

0

Mar-1

1

Jul-11

Nov-1

1

Mar-1

2

Jul-12

Nov-1

2

Mar-1

3

Jul-13

Nov-1

3

Mar-1

4

Jul-14

Nov-1

4

(Per cent)(Per cent)

Industrial side of the economy to continue to trend down

Industrial production, y-o-y Fixed asset investment, y-o-y - rhs

Source: Bloomberg

5.65.86.06.26.46.66.87.090

95100105110115120125

Jan-10

May-1

0

Sep-10

Jan-11

May-1

1

Sep-11

Jan-12

May-1

2

Sep-12

Jan-13

May-1

3

Sep-13

Jan-14

May-1

4

Sep-14

(USD/CNY)(Index)

On REER basis CNY continues to touch new highs in recent years

REER USD/CNY-rhsSource: Bloomberg

China: central bank turns more dovish as manufacturing slowdown accelerates




Capital spending must recover

The upswing in consumer and business sentiments is yet to

be followed by an effective improvement in real economic

data. It is worth noting that the significant downturn in

corporate capital spending – a decline of 8.5% in 2011-12

and a tepid revival of 1.3% in the succeeding year – had

been caused by the combination of domestic policy paralysis

and anemic global growth. Thus the prospect of more

incisive policy action bodes well for at least some structural

pick-up in capital spending, even if global growth would not

accelerate. Also the main cause of low household capital

spending – i.e. a high inflationary environment which

ultimately resulted in a crash in household capital spending

growth from 38.6% in 2011-12 to 5.1% in 2012-13 – seems

now likely to have vanished.

Policy measures must lead the way

The recent liberalization of the Land Acquisition Bill and the

increase of the FDI limit in the insurance sector from 26% to

49% confirm the government’s intention to expedite the

reform process and attract investments. However, one needs

to be cautious as these ordinances have yet to pass through

both houses of parliament where the ruling coalition does not

have a majority in the upper house. To look for a revival in

the corporate capex cycle, we are amongst others closely

monitoring credit growth. The downtrend in credit growth;

however, has yet to reverse. A significant pick-up in credit

off-take is usually a precursor for a turnaround in the capex

cycle and industrial growth.

But fundamental economic factors have already

improved

Whilst growth has not yet picked up sufficiently, very

important structural factors, such as the high current account

deficit, the high fiscal deficit and persistently high inflation

have improved remarkably over the last months and

quarters. The current account deficit has declined as low as

1.1% of GDP in the second quarter of 2014 and the

government remains credibly committed to the targeted fiscal

deficit of 4.2% of GDP in the fiscal year 2014-15, helped also

by the recent slump in oil prices. The decline in commodity

prices has also significantly helped in cooling off inflation.

Indeed, inflation is expected to undershoot the Reserve Bank

of India target of 6% in March, inducing the central bank’s

Governor, Raghuram Rajan, to adopt a more dovish stance.

Many market participants expect a rate cut as early as in

January. However, the governor could wait for fiscal budget

announcements before he takes a call on the policy rate. In

this respect it is worth noting that the high level of inflation

over the last few years has had its toll on the real effective

exchange rate, and thus the country’s competitiveness. This

warrants some more depreciation which – however – is

inflationary in nature.

Moderately positive on equities

The still very good growth prospects warrant a positive

stance on equities which is somehow mitigated in the short

term by the stretched implicit earnings expectations.

(40) (20) - 20 40 60

- 5

10 15 20 25

2005-0

6

2006-0

7

2007-0

8

2008-0

9

2009-1

0

2010-1

1

2011-1

2

2012-1

3

2013-1

4

(Per cent)(Per cent)

Investment cycle to pick up for growth to accelerate

Total capital formation, y-o-yReal GDP growth, y-o-y

Source: CSO

-100

10203040

May-0

6No

v-06

May-0

7No

v-07

May-0

8No

v-08

May-0

9No

v-09

May-1

0No

v-10

May-1

1No

v-11

May-1

2No

v-12

May-1

3No

v-13

May-1

4No

v-14

(Per cent)

Industrial production and credit growth yet to show turnaround

Credit growth, y-o-y Industrial growth, y-o-ySource: Bloomberg

90

95

100

105

110

115

Jun-05

Dec-0

5Jun

-06De

c-06

Jun-07

Dec-0

7Jun

-08De

c-08

Jun-09

Dec-0

9Jun

-10De

c-10

Jun-11

Dec-1

1Jun

-12De

c-12

Jun-13

Dec-1

3Jun

-14De

c-14

(Index)Rupee remains over valued on REER basis

Trade weighted Real Effective Exchange RateSource: Bloomberg

India: reform path progresses but capex cycle needs revival for growth to accelerate




Sound fiscal management allows GCC to rationalize

government spending so as to mitigate growth impact

Since government spending is still the main driver of

economic growth in the Gulf Cooperation Council countries,

the recent sharp decline in oil prices has created concerns

about its sustainability in the medium term. It is worthwhile to

note that government spending had risen sharply since 2008-

09 as governments in the region undertook a countercyclical

fiscal policy in the wake of Global Financial Crisis, embarking

on rapid infrastructure development. This has significantly

increased the fiscal break-even oil price for countries in the

region.

The current oil price is lower than the fiscal break-even price

for almost all countries in the GCC. This means that if the

average oil price remains around the same level in the

coming quarters, each member country will have a fiscal

deficit. As a result, many market participants expect cuts in

government spending which will have a negative impact on

the growth outlook in the region. We believe that the impact

of current lower prices would not be significant in the medium

term primarily for the following reasons.

First, the oil prices might well have undershot which could

determine a rebound later in the year as the supply outlook

gets clearer and demand gets support from the recent lower

prices.

Second, member economies except Bahrain enjoy a strong

fiscal environment as reflected by an extremely low level of

public debt and high levels of reserve assets. Gross public

debt in Saudi Arabia (which alone constitutes roughly half of

the GCC countries’ economic size) is less than 2% of GDP

while it is less than 12% of GDP in the UAE.

Saudi Arabia in its budget for 2015 has indicated that the

current low level of oil prices will not affect its spending plans

in the medium term. Even after an estimated deficit of USD

14.4bn in 2014, it announced a budget with an intention of

increasing spending, though modestly, in 2015. A budgeted

deficit of USD 39bn or higher actual deficit could be easily

managed by the government having around USD 427bn

deposits with the central bank and around USD 750bn as

foreign reserve assets. Oman increased its spending plan by

4.5% to USD 36.6bn for 2015 despite a widening of the

deficit. The country expects to manage this from state

reserves, previous years’ surpluses and international grants

& loans. Dubai also revealed an increase in its expenditure

plans by 9%. Despite the rise in planned expenditures, the

Emirate expects the budget to be balanced this year on an

expected rise in revenues. This reflects confidence that

Dubai’s economy, largely driven by trade and tourism, will be

unaffected.

Given our belief that the recent dip in oil prices should not

have in 2015 a very strong impact on government spending,

the growth outlook, especially for the non-oil sector remains

stable. Stable or slightly lower crude production could have

some moderating impact on headline GDP growth numbers

for 2015. Moreover, lower oil prices will result into lower

nominal GDP.

Moderately cautious on equities

We are cautiously positive on local equity markets, as

participants will realize that overall economic growth should

remain stable. We do see downside risks to our expectations

as long as the oil price does not fully stabilize. Equity

markets could also be affected by the potential rate hikes by

the Fed, which regional central banks will have to follow due

to the currency peg.

020406080100120140

020406080

100120140

Bahrain Saudi Arabia UAE Kuwait Qatar

(US$/bl)(US$/bl)

Fiscal break-even oil prices have shotup over the last few years

2008 2014ESource: CEIC, Thomson Reuters Datastream, IMF

0

20

40

60

80

0

10

20

30

40

50

Bahrain Kuwait Oman Qatar Saudi Arabia United ArabEmirates

(USD Bn)(Per cent)

Low level of public debt can sustain fiscal deficit in the medium term

Govt gross debt (% of GDP) Gross public debt - rhs

Source: IMF, October 2014

GCC: low debt and high reserve levels allow to mitigate growth impact of oil price drop




Bond Market Spreads

GDP forecast 2014 CPI forecast 2014

Estimates Consensus ADCB Consensus ADCB YoY Estimates Consensus ADCB Consensus ADCB

US 2.30% 3.0% 2.8% US 1.70% 1.5% 2.2%

Eurozone 0.80% 1.1% 1.5% Eurozone 0.44% 0.6% 1.3%

Japan 0.20% 1.0% 1.4% Japan 2.80% 1.5% 1.5%

China 7.40% 7.0% 6.7% China 2.10% 2.0% 2.5%

India 5.20% 5.5% 6.3% India 6.40% 6.7% 6.1%

2015 2016 2015 2016

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Dec-0

7

Dec-0

8

Dec-0

9

Dec-1

0

Dec-1

1

Dec-1

2

Dec-1

3

Dec-1

4

(Per cent)

EM IG corporates v/s US Treasury 10yrs

ML USD Investment Grade EM Corp.-US Treasury 10 yrs spread


-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Dec-9

9

Dec-0

0

Dec-0

1

Dec-0

2

Dec-0

3

Dec-0

4

Dec-0

5

Dec-0

6

Dec-0

7

Dec-0

8

Dec-0

9

Dec-1

0

Dec-1

1

Dec-1

2

Dec-1

3

Dec-1

4

(Per cent)

World large corporates v/s US Treasury 10yrs

City World BIG Corporate, AA-US Treasury 10 yrs spread


0.01.02.03.04.05.06.07.0

Dec-0

6

Dec-0

7

Dec-0

8

Dec-0

9

Dec-1

0

Dec-1

1

Dec-1

2

Dec-1

3

Dec-1

4

(Per cent)

ML Global HY corporates v/s US Treasury 10yrs

ML Global Broad Market Corp. & HY Index-US Treasury 10 yrs spread


0.02.04.06.08.0

10.012.014.016.018.0

Dec-0

0

Dec-0

1

Dec-0

2

Dec-0

3

Dec-0

4

Dec-0

5

Dec-0

6

Dec-0

7

Dec-0

8

Dec-0

9

Dec-1

0

Dec-1

1

Dec-1

2

Dec-1

3

Dec-1

4

(Per cent)

ML EM corporate plus index v/s US 10yr Treasury

ML EM Corporate Plus Index-US Treasury 10 yrs spread


Appendix

in agreement

expect moderately less

expect moderately more

expect significantly less

expect significantly more

Source: Bloomberg Source: Bloomberg




Equity Market Valuations

0

10

20

30

40

50

Dec-6

0

Dec-6

6

Dec-7

2

Dec-7

8

Dec-8

4

Dec-9

0

Dec-9

6

Dec-0

2

Dec-0

8

Dec-1

4

(X)

Absolute valuation US equities

Shiller S&P 500 PE ratio

Source: multpl.com

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

Dec-8

0De

c-82

Dec-8

4De

c-86

Dec-8

8De

c-90

Dec-9

2De

c-94

Dec-9

6De

c-98

Dec-0

0De

c-02

Dec-0

4De

c-06

Dec-0

8De

c-10

Dec-1

2De

c-14

(Per cent)

Relative valuation US equities v/s US 10yr Treasury

Fed Model - (Earning yield-Bond yield)

Source: Thomson Reuters, multpl.com

6789

10111213141516

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)Euro Stoxx 12m forward PE

12m forward PE Average

Source: Bloomberg

-6

-5

-4

-3

-2

-1

0

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1No

v-11

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)

Euro Stoxx 12m forward PE - S&P 500 12m forward PE

Discount from S&P 500 12M forward PE Average

Source: Bloomberg

6

11

16

21

26

31

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)Nikkei 225 12m forward PE


Source: Bloomberg

-12-10-8-6-4-202

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)

Nikkei 225 12m forward PE - S&P 500 12m forward PE


Source: Bloomberg




6789

10111213141516

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)FTSE 100 12m forward PE

12m forward PE AverageSource: Bloomberg

-9-8-7-6-5-4-3-2-10

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)

FTSE 100 12m forward PE - S&P 500 12m forward PE


Source: Bloomberg

6

8

10

12

14

16

18

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)DAX 12m forward PE


Source: Bloomberg

-4.5-4.0-3.5-3.0-2.5-2.0-1.5-1.0-0.50.0

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)

DAX 12m forward PE - S&P 500 12m forward PE


Source: Bloomberg

68

1012141618202224

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)Nifty 12m forward PE


Source: Bloomberg

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)

Nifty 12m forward PE - S&P 500 12m forward PE


Source: Bloomberg




61116212631364146

Dec-0

5

Jul-06

Feb-07

Sep-07

Apr-0

8

Nov-0

8

Jun-09

Jan-10

Aug-1

0

Mar-1

1

Oct-1

1

May-1

2

Dec-1

2

Jul-13

Feb-14

Sep-14

(X)

Shanghai Composite 12m forward PE


Source: Bloomberg

-15.0-10.0-5.00.05.0

10.015.020.025.030.0

Dec-0

5

Jul-06

Feb-07

Sep-07

Apr-0

8

Nov-0

8

Jun-09

Jan-10

Aug-1

0

Mar-1

1

Oct-1

1

May-1

2

Dec-1

2

Jul-13

Feb-14

Sep-14

(X)

Shanghai Composite 12m forward PE - S&P 500 12m forward PE


Source: Bloomberg

6

8

10

12

14

16

18

20

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)Jakarta Composite 12m forward PE


Source: Bloomberg

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)

Jakarta Composite 12m forward PE - S&P 500 12m forward PE


Source: Bloomberg

6

11

16

21

26

31

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)

Taiwan stock exchnage 12m forward PE


Source: Bloomberg

-10.0

-5.0

0.0

5.0

10.0

15.0

Jun-05

Jan-06

Aug-0

6

Mar-0

7

Oct-0

7

May-0

8

Dec-0

8

Jul-09

Feb-10

Sep-10

Apr-1

1

Nov-1

1

Jun-12

Jan-13

Aug-1

3

Mar-1

4

Oct-1

4

(X)

Taiwan stock exchnage 12m forward PE - S&P 500 12m forward PE


Source: Bloomberg




5

7

9

11

13

15

17

Dec-0

5

Jul-06

Feb-07

Sep-07

Apr-0

8

Nov-0

8

Jun-09

Jan-10

Aug-1

0

Mar-1

1

Oct-1

1

May-1

2

Dec-1

2

Jul-13

Feb-14

Sep-14

(X)Istnabul stock exchnage 12m forward PE


-8.0-7.0-6.0-5.0-4.0-3.0-2.0-1.00.0

Dec-0

5

Jul-06

Feb-07

Sep-07

Apr-0

8

Nov-0

8

Jun-09

Jan-10

Aug-1

0

Mar-1

1

Oct-1

1

May-1

2

Dec-1

2

Jul-13

Feb-14

Sep-14

(X)

Istnabul stock exchnage 12m forward PE - S&P 500 12m forward PE


Source: Bloomberg

579

111315171921

Dec-0

6

Jun-07

Dec-0

7

Jun-08

Dec-0

8

Jun-09

Dec-0

9

Jun-10

Dec-1

0

Jun-11

Dec-1

1

Jun-12

Dec-1

2

Jun-13

Dec-1

3

Jun-14

Dec-1

4

(X)Bovespa 12m forward PE


-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

Dec-0

6

Jun-07

Dec-0

7

Jun-08

Dec-0

8

Jun-09

Dec-0

9

Jun-10

Dec-1

0

Jun-11

Dec-1

1

Jun-12

Dec-1

2

Jun-13

Dec-1

3

Jun-14

Dec-1

4

(X)

Bovespa 12m forward PE - S&P 500 12m forward PE


Source: Bloomberg




Sources

All information in this report has been obtained from the following sources except where indicated otherwise:

1. Bloomberg

2. Wall Street Journal

3. RTTNews

4. Reuters

5. Gulfbase

6. Zawya

Disclaimer

This publication is intended for general information purposes only. It should not be construed as an offer, recommendation or

solicitation to purchase or dispose of any securities or to enter in any transaction or adopt any hedging, trading or investment

strategy. Neither this publication nor anything contained herein shall form the basis of any contract or commitment whatsoever.

Distribution of this publication does not oblige Abu Dhabi Commercial Bank PJSC (“ADCB”) to enter into any transaction.

The content of this publication should not be considered legal, regulatory, credit, tax or accounting advice. Anyone proposing to

rely on or use the information contained in the publication should independently verify and check the accuracy, completeness,

reliability and suitability of the information and should obtain independent and specific advice from appropriate professionals or

experts regarding information contained in this publication.

Information contained herein is based on various sources, including but not limited to public information, annual reports and

statistical data that ADCB considers accurate and reliable. However, ADCB makes no representation or warranty as to the

accuracy or completeness of any statement made in or in connection with this publication and accepts no responsibility whatsoever

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publication is intended for qualified customers of ADCB.

Charts, graphs and related data or information provided in this publication are intended to serve for illustrative purposes only. The

information contained in this publication is prepared as of a particular date and time and will not reflect subsequent changes in the

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accurate. ADCB expressly disclaims any obligation to update or revise any forward looking statements to reflect new information,

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The Quarterly Investment View - ADCB · 2015. 1. 11. · The Quarterly Investment View January 2015 Asset Management |[email protected] 3 and/or corporate bonds over and on