It was as if the in-laws had decided on New Year’s Eve that it would be fun to come for an unannounced visit. Volatility. It is part of the family experience in any investment strategy and, like the parents-in-law, volatility is never far away but the average investor feels so much more comfortable when it is out of sight. Well, in the first days of 2016, volatility was all over the place, but made itself noticed most strongly in China where the Shanghai Composite Index fell almost 12 percent from 3,540 points on December 31 to 3,125 points on January 7.
Perhaps it is no wonder, then, that an often-quoted January 8 research note by the Royal Bank of Scotland contained warnings like “history tells us that a United States downturn may be nearer than you think”, bullet-points that vacillated from thrice bearish outlooks for China, commodities and oil, to widening output gaps and predictions (almost certainly computer assisted) that automation is on its sneaky way to destroy up to half of all jobs in developed markets. “Watch out. Sell (mostly) everything” was the recommendation (emphasis original). Surveys of other economists ensued immediately showing that, although few economists agreed to the disaster scenario, many couldn’t totally dismiss it – “cataclysmic year” became the words of the hour.
Now, one lesson of the Great Recession is that any analyst or economist who could lay claim to have predicted the catastrophe became an instant celebrity. One can wager on this doomsday (DD) effect using a new economic formula where precise prediction of gloom (1), multiplied by actual cataclysmic percentage drop in world markets (X) and divided by the [accidental] number of months between the prediction and the [arbitrary] date presented in media as the actual key date of market collapse, results in the lucky DD effect number (YN). A high positive YN acts as multiplier of book sales and social-network followers, better speaking opportunities on television and YouTube and elimination of the awkwardness factor when starting conversations with “I am an economist…”. As a bonus, the risk of a negative YN appears to be negligible because the information markets tend to quickly forget erroneous predictions due to their sheer volume, even ignoring it when outlooks for, let’s say, key commodity prices turn out to be egregiously wrong by 30 percent or more.
Nonetheless, 2016 began with many interesting questions. The impact of the Federal Reserve’s December interest-rate hike, analyses showing a stealth bear market in the US, the dichotomies between monetary policies in the US and in the Eurozone, the China syndrome, the Brazilian crisis, Russia’s conundrum, capital outflows from emerging markets, the inverted oil shock and the economic troubles of oil producers in the Gulf Cooperation Council and weaknesses of their stock markets; there was much to think and talk about. What would the implications be for Lebanese investors? Keeping all the vagaries of the outlook business in mind, Executive sat down with a selection of Beirut-based private bankers and wealth management experts to learn of their views on the state of markets and advice for 2016.
Investors will do best if they lower their expectations, recommends Toufic Aouad, general manager at Bank Audi Private Bank. Noting that the start of 2016 appeared internationally to be “the worst in the past 84 years, since 1932,” Aouad perceives the theme of 2016 to be low growth, low inflation and high volatility, leaving no ground to anticipate high returns. “For the same risk profiles, [investors] should expect that returns will be lower. This is not very good news to share with investors but that is really the situation today,” he explains.
Neither he nor his colleagues in the Lebanese private-banking realm see the writing on the wall to be prophesizing doom. “I don’t think 2016 will be dramatic,” says Georges Abboud, global head of private banking at BLOM Bank Group. He thinks that investors will have to change their behavior in selection of equities to favor stock-pickers over investing in passive funds but believes that there is also money to be made this year.
“Some people talk of the financial meltdown, but we don’t think so,” says John Dagher, the chief executive officer of Julius Baer (Lebanon), a unit of the Swiss private bank by the same name. “We believe that it is going to be a challenging year but we also believe that central banks will continue to be a major factor in the markets and will continue to have adaptive policies. A lot of industries are under pressure, so you have to be selective and you have to diversify, but there is always somewhere in this world where you could employ some money. Interest rates are still going to be on a slow tone and the correction in prices will also reach a place from where on you could see some buoyancy,” he elaborates.
For Nadim Kabbara, who is head of research and manager of several funds at FFA Private Bank, the general outlook is for more uncertainty, also when adding in factors such as a possible exit of the United Kingdom from the European Union, the migration issues in Europe and the presidential elections in the US. “There is a lot of uncertainty and one thing that brokers are convinced about is that there will be more volatility this year. That is why we advise our clients to invest into more balanced portfolios,” he says.
Scenarios on the United States
The US markets are in many ways still not to be scoffed at, says Youssef Dib, general manager of private and investment banking at Near East Commercial Bank, part of Saradar Group. “Our view on the US is that it is still benefiting from strong fundamentals – the economy is supported by growth,” he explains. He points to positives of low unemployment and interest rates that are still low even as the Federal Reserve has embarked on their normalization at the end of 2015, to strong consumer sentiment and to corporate profits that have been sufficiently attractive on downward revised sentiments. For negatives, Dib lists the unattractively high equity valuations, the suffering of the investment sector, high corporate debt levels and the general toll that the strong US dollar is taking on corporate profits. “Overall, what we can say about the US market is that it is resilient but it is not our favorite because of the rate increases by the Fed. But the resilience of the US market is a mitigating factor against possibly adverse developments,” he tells Executive.
Pointing to the impact of the Fed’s interest rate tightening, Audi’s Aouad sees the US dollar as the probable first winner of this decision, despite the fact that the appreciation has already previously been priced in on the currency markets. Given that the Fed has started intervening rather late when compared with previous rate liftoffs, it is hard to use historic reactions in any attempt to predict market reactions this time, he notes. Audi Private Bank is selective on US markets, seeing financial companies for example as stocks that are likely to benefit directly from rate hikes. “We can say today that the US bull market is entering its last phase, where we usually witness narrow market breadth and high volatility,” he says.
In addressing the interest rate issue, Dagher also describes the approach of Julius Baer’s researchers as one of digging through historic records on interest rate hike impacts and trying to see what could happen under today’s circumstances. The bank does, however, anticipate little further movement on interest rates in the near future. Dagher says that Julius Baer expects to see no or “perhaps one more” quarterly increase in the US interest rate in 2016. (note: all interviews for this story were conducted more than a week before the January 27 announcement by the Federal Open Market Committee that it would keep the federal funds rate steady at this time). Given the hidden bears and expected end of the historic bull-run on Wall Street, he adds: “Diversification becomes very important. Although some people have been writing that diversification is not going to achieve much in this huge globalization, it still will help you when you diversify into different markets and different industries.”
Drifts in Europe
When looking over various very recent European predictions that the Eurozone might be on the verge of collapse or reading speculations that the EU is sitting on a precipice above the abyss that is about to open, it may be useful to recall that pundits with a personal interest in currency markets told Lebanese audiences of an impending euro meltdown. That was in early 2010, just after Greece in 2009 started to suffer from confidence losses because of its lying over debt levels.
Construction of similar narratives seems to be a cyclical habit in some otherwise elusive European psyche, as perhaps best exemplified by the centenary propensity for predicting the end of their civilization as the end of all worthwhile civilization. The seminal European work representative of this cultural pessimism, and counter piece to some neocon American writings, is Oswald Spengler’s “Untergang des Abendlandes”; known in English as “The Downfall of the Occident” or “The Decline of the West”, it was written just about a century ago.
But the continent’s love for self-doubt notwithstanding, Europe in 2016 does not look that bad a place for investors seeking a bit of extra diversification. “If we look at Europe, we see that stocks trade at price to equity (P/E) ratios of 12 to 13. This is below peak levels and when you look at the profit margins of European companies, they are also 20 percent off their peaks. There is space for European companies to improve their margins,” reasons Abboud. Considering that the quantitative easing (QE) program by the European Central Bank (ECB) is supposed to stay in place at least until some time in 2017, he adds: “All these factors show that there is some potential for [stock prices in] Europe to grow. I am sure if you dig in, you will find value stocks, with good dividends and good fundamentals.”
For Aouad, European stocks – amidst overall expectations that returns will not be high in 2016 – appear better positioned than those in the US to deliver high single-digit returns. “The Eurozone is recovering, you can see it by profit margins or the credit cycle. You have some tailwinds, which are the weak euro for exporters and the low oil prices,” he says. Within the European space, Bank Audi Private prefers companies that are domestically focused for being not as vulnerable as some exporters to eventual disruptive developments in emerging markets. “Among exporters, we prefer those who trade with the US as the exchange rate will be to their advantage. High-dividend domestic names in continental Europe are also to be considered. We like mainly financial and mid-class [stocks],” he explains.
In Kabbara’s perspective, it is prudent to use opposing strategies in Europe and the United States, namely to look at small cap and domestically focused companies in the US, and at exporters or companies whose input costs are in euros in Europe.
Dagher characterizes Europe as a region that retains trust of investors and will remain a very important market. Outside of market issues, he notes that points for necessary consideration in 2016 include terrorism threats, immigration controversies and matters of external relations such as the Turkish-Iranian issue. The bank’s researchers expect no big changes in the euro-US dollar currency relations, and Dagher cites indications that the currency pair will move this year in either a narrow range of 1 euro to $1.07 – $1.10 or at most shift into a wider range of $1.05 – $1.15. On the monetary side, he agrees that the ECB’s task is less easy than the Fed’s in decision-making terms. Overall he sees potentials on both sides of the Atlantic. “Valuations in European markets are perhaps a bit better than American ones; [but] this doesn’t mean that there are no US equities that you can move into after the last correction,” he says.
Dib sounds almost Europe-bullish. “The economic picture in Europe looks rather good and it is our favorite equity market. Even the euro might appreciate by yearend. If the market goes up and the euro as well, it would even be a plus-plus,” he says. From a Lebanese perspective the dollar strength results in European buying opportunities, such as apartments that look 25 percent cheaper than two years ago, but cautions that he would still avoid southern Europe and Greece as well as the UK because of it giving the impression that it is taking a course of its own.
Emerging markets and China
As to the, in comparison with developed economies, even more enigmatic markets, Dib sees no specific dangers. “The reasons why we are not positive on emerging markets are that sentiment on them is still very negative and that a lot of them have problems politically. Valuations, however, are very compelling. Valuations in emerging markets have gone down 50 percent and that puts a floor on any further downside that could happen,” he comments.
Aouad highlights that emerging market equities have been broadly the subject of severe risk-aversion by investors, which materialized in net outflows especially in the second half of 2015. “Within this asset class, country selection is very important. We are very cautious on emerging markets and when we say we are country specific, we don’t like to name countries. [However], we look more at India and Mexico rather than the rest in the spectrum of emerging markets,” he says.
China, the current top enigma within the enigma of emerging markets, remains a big uncertainty, Aouad admits. “The question is whether the Asian giant will be able to succeed in his shift to a consumer and services based economy while dealing with lower investments and huge debt burden,” he posits. While he agrees that “China is obviously the big scare” of today, Abboud offers the view that there may be mitigating factors as well as over-emphases of risk potentials when it comes to the Chinese economy in a global context. “As a whole we think the market will continue to be volatile in China, but so far we are giving credit to the Chinese government to be able to guide the soft landing,” he says. That an oversupply of analyst fears have been projected onto the country’s economy, and that the Chinese deserve to be given time to manage their challenges, appears to be a majority view among the private bankers who talked with Executive.
The GCC and oil: still the fateful pairing
Forget any notion of decoupling. The start of 2016 must have reinforced the perception that Arab markets, especially the countries of the GCC, and oil have a correlation that is as strong and fateful as ever. “For the GCC specifically, the last year was not easy and market caps in large GCC markets have certainly corrected in value since oil prices started coming down a year and a half ago. The oil price has been front and center for GCC equities but we want to remind investors that markets have been pricing in a lot of that downside in oil. P/E multiples [of companies traded on GCC stock exchanges] are today more in line with emerging markets. Also, dividend yields are quite appetizing now versus developed markets and even versus other emerging markets,” explains FFA Private Bank’s Kabbara.
Having a dedicated exposure to markets in the Middle East and North Africa (MENA), FFA Private Bank has noteworthy views on regional equities. According to Kabbara, the bank’s regional investment approach is to concentrate on companies with growing market shares and which have strong balance sheets, good management and pay dividends. “Our outlook for 2016 in MENA is cautiously optimistic and we are trying to manage the [correlation of corporate valuations with the oil price] by focusing more on countries that are diversified away from oil,” he says. Kabbara then adds: “From the macro perspective, there are no changes in why we are invested in MENA; we benefit from the demographics that you find in emerging markets but not elsewhere, from the income growth, from the young population, from governments that continue to invest in their economies and from the peg that until now links local currencies and the US dollar, which you don’t see elsewhere in emerging markets.”
Dagher, who has decades of experience working in financial markets around the Gulf, confirms that GCC economies face major changes because of the oil situation but emphasizes that the bank does little in research on the GCC and that his comments are based on his personal observations. “The mere fact of thinking about an initial public offering of Aramco means that there is a huge change in that GCC economic decision makers are looking at shifting risk of oil as the main business from the state into private hands, at least for a part of the risk,” he says. Since changes in the GCC also involve introductions of value-added taxes and removal of subsidies, or possible withdrawals from full dollar-pegs, “it is a very interesting period to see how those things will materialize,” he says.
That the magnitude of the challenge for change and adaptation of companies in Saudi Arabia and other GCC economies extends into the non-oil sector was demonstrated last month by top dairy manufacturer Almarai and food and consumer conglomerate Savola Group. The two Saudi companies were hit by the removal of energy subsidies but also, in Almarai’s case, by a government decision to phase out domestic production of alfalfa and animal forage because of high water consumption; the transition to sourcing forage abroad is going to cost it $53 million in 2016 alone, Almarai estimated in a disclosure in January. The stock lost almost 30 percent of its value in the first three weeks of January before recovering about half of the lost ground in the fourth week. Savola, which owns part of Almarai, fell even more, by about 40 percent, before coming back to a one-month loss of 18 percent on January 28.
There are clearly more things to be known about GCC equities than some far-away analyst’s notes on emerging markets can cover. As Dagher corroborates, many factors besides oil are at play in the GCC markets. “It will always be rewarding to be in the GCC markets,” he says.
Not for conclusions
As January drew to its close, major Arab stock indices closed the month’s last trading week on positive notes. All markets in the Gulf Cooperation Council gained a bit on January 28 but for the year to date (ytd), the region’s major bourses were all still bleeding, at ytd drops of more than 9 percent in Dubai and Abu Dhabi, around 11 percent in Kuwait and Qatar, and 14.5 and 14.9 percent in Egypt and Saudi Arabia.
In the wider world, China ended the month with investor distrust, as the Shanghai Composite Index was down 25 percent between January 1 and January 26. The Fed met expectations that it would not venture into another rate hike and adjusted its coded communication to tell markets that they should not consider upcoming decisions as foregone conclusions. The trend to issue wildly alarmist analyst notes seems to have abated to some degree but it seems that uncertainty could be even deeper than one would like to assume. The concept of economic predictability was certainly not helped when the World Bank was compelled last month to lower its forecast for 2016 crude oil prices to $37 per barrel. The astounding 28 percent downward variance from the $51 forecast issued in the previous commodities outlook in October 2015 cannot be regarded as reassurance of any person’s or any institution’s ability to give accurate predictions for the global economy in 2016.
Doom or just volatility? Maybe the anonymous interstellar power that left us the Mayan calendar had a special sense of humor and moved the doomsday notch one leap year into the past – so that 2016 is the real 2012. Or perhaps, by way of other wholly uneconomic and unscientific but entertaining mind games, all the blood moon, harvest moon and blood-harvest moon occurrences of last September were warnings for wealth owners to repent, divest of all assets, distribute everything to the needy by [insert date of personal preference] and start rebuilding private wealth in a new cycle of global enterprise to get wealthier than ever before in the coming period of [insert lucky number] years. We will never be able to guess right.