• Volatility has not badly diminished year-to-date performance of GCC equities
• New GCC credit issuance continues to be the focus of bond investors
• We visit some themes

GCC markets retain top position as best performers globally despite summer volatility

Over a one year period the UAE and Qatar remain among the best performing equity markets globally. Since these markets were included in the MSCI emerging markets index in May this year, fears of FIFA reviewing its decision to stage the football World Cup in Qatar in 2022 and concerns about the mounting turmoil in Iraq have acted as a dampener on these markets.

In consequence, the DSM – the Qatari equities Index – has been moving steadily downwards (in June 2014, down -14%), with all stocks in the index declining. However the index dividend yield is at 4.4%, among the highest globally, and price to earnings is at 11.6X2014E, making the Qatari market very attractive on a year-ahead view. Earnings growth is in double digits and infrastructure build will continue regardless of any decision on FIFA 2022. Ooredoo, Qatar National Bank, Doha Bank and Industries Qatar (the worst performers YTD) offer the maximum upside, as they are trading on low valuations and have high dividend yields. We expect Qatari markets to recover post summer, as the long-term macro-economic picture remains positive, with 2015 GDP growth forecast to run at 6.3%.

UAE markets experienced sharp volatility this month with the Dubai Index, the DFMGI, dropping -6.7% on 24th June and recovering almost completely the next day. The DFMGI is down -20%, since the peak in mid-May. The selloff has been broad-based, triggered by market news on management changes, investors being hit by margin calls and the seasonal pattern that repeats itself every year, with investors booking profits before Ramadan. The 3 month annualized volatility for the DFMGI is above 50% and is the highest in the last 4 years. Dubai is still the best performing market globally on a one year basis; its price-earnings ratio valuations are in line with the GCC’s and cheaper than for most global and emerging markets.  The ADSMI (Abu Dhabi) index also had sharp swings in June and is down about 14% since the end-of-May peak.

Saudi equity markets remained stable as the large-cap petrochemicals outperformed – Saudi Industrial Investment Group, Yansab, Advanced Petrochemicals Co and SABIC – along with the consumer companies Savola and Almarai, all remain on our focus list for the GCC.

Focus for bond investors remains on new issuance pipeline

Regional credit and bond markets were well supported throughout the week – US Treasuries rallied to 2.51% – with marginal weakness only towards the end of last week.  Primary issuance slowed down with Al Hilal bank being the only issuer, to print their USD 500 MM tier 1 perpetual sukuk at 5.5 % (initial guidance 6 %). Dubai 5 year CDS edged higher to close at 150.  Abu Dhabi’s IPIC (International Petroleum Investment Company) bonds outperformed, on the back of reports that the company was considering selling its stake in the Austrian oil & gas producer OMV (29.4% Stake). We continue to prefer bonds in the 7 to 10 year maturity segment in both USD and EUR denominated debt, as they offer a decent spread over their equivalent benchmarks in the high-grade space. We added Emaar Malls Group 10-year Sukuk as our high-conviction trade idea to our preferred list, on the expectation of potential spread compression for this blue-chip UAE corporate.

Additionally, there was a deluge of bond supply last week from various emerging market (EM) issuers.

In Turkey bonds traded weaker, given the new issuance led by state-owned Ziraat Bankasi and Al Barakla Turk.  On Friday Fitch Ratings downgraded the Long-term Foreign (FC) and Local Currency (LC) Issuer Default Ratings (IDRs) of Turkiye Is Bankasi (Isbank), Turkiye Garanti Bankasi (Garanti) and Akbank to 'BBB-' from 'BBB'.  Fitch also revised Yapi ve Kredi Bankasi's (YKB) outlook to negative from stable. Republic of Bulgaria priced a €1.49 BN, 10-year sovereign bond at a coupon of 2.95 %, the lowest ever the country has achieved for Eurobonds.  Sberbank, Russia’s largest bank, priced a €1bn of their loan participation notes (5.5 years maturity) at + 260 bps over benchmark (coupon of 3.3524%). Gazprombank followed suit, issuing a €1bn 5-year bond at a coupon of 4% (+ 334.9 over benchmark).

Cyclical sectors will prevail for thematic investing in 2H2014

The US large-cap market continues to trade close to all time-highs on economic optimism and bank stimulus.  Cyclical sectors - technology and energy of late - are leading the rally, which appears to be on a firm footing. This seems indeed to be an ideal backdrop for renewed equity strength.  We continue to expect new market highs in the second half of the year, as US consumption and investment trends are very supportive and thus advise investors to adopt a 'buy the dip' strategy.

US industrials have high operational leverage and as such stand to benefit most from the US recovery. On top of this competitive labor costs, infrastructure investments which can no longer be delayed, low energy costs from shale-oil, historically low fixed investments to GDP in the US and high corporate cash levels are all stacking up in favor of positive investment trends.  An index tracker is an efficient and cost-effective way to invest in US industrials.

US technology stocks display above average earnings growth and valuations – after the recent correction – in line with benchmarks’ multiples.  As an alternative to an index tracker, we have selected a basket of stocks based on sub-sector diversification, strong annual double digit earnings growth for the next three years, giving average upside of more than 20% based on Bloomberg consensus, 12-month target prices (proposed in the Investment Solutions Weekly).

We are positive on US energy and hence on global oil stocks – the MSCI Energy Sector index has a 60% skew towards US equities.  Oil stocks are deep cyclicals and geared to the US and global recovery, thus offering a dividend yield slightly above market average, combined with below-market valuations.  Although in the long run the oil price is expected to normalize towards USD100 or below, shorter term economic expansion and geopolitical risks should support crude and hence the whole sector.