Weak oil prices fail to hit GCC outlook for this year

Despite weak oil prices in the recent past, outlook for the GCC remains "optimistic", according to a report by Bank Sarasin.

Much of its growth forecast was predicated on the oil price, which the report expects to range from $75 to $85 per barrel in the first half of 2010 as the current global recovery fuels demand for oil. However, the report expected oil price to drop "slightly" in the second half of the year due to the global cooling towards the end of 2010.

The report anticipated some capital outflows due to a rise in risk aversion, which will be partly offset by the oil price jump. The impact of any geopolitical eruption in the region will be limited, it added.

"Macro and micro risks within GCC may dampen investor's risk appetite for the region in 2010. Sarasin is cautious for emerging markets as a whole and think that the potential for stock markets in the GCC is limited," according to Global View, published by Bank Sarasin's Research team for Q1 2010.

"The heavy weighting of the financial sector is a clear negative for the region. However, a consolidation for equity markets in 2010 may set the stage for a more broad based and sustainable recovery in 2011," it added.

Overall, it said 2010 will be a decisive year for the global economy as this year will determines whether or not the upswing is sustainable.

"Despite the fact that we confidently expect a positive answer to this question in 2011, we are still a long way from seeing a positive economic trend with the power to sustain itself without external assistance," Jan Amrit Poser, said Head of Research and Chief Economist at Bank Sarasin.

The possibility that the industrialised countries will follow the same path taken by Japan over the past 20 years – a deflationary development, coupled with rising debt and weak growth – cannot be completely ruled out.

"We expect the economic recovery to falter in H2 2010 and a sustained recovery to set in only in 2011. Given the low level of capacity utilisation, deflationary risks will prevail over the next two years," it added.

Against this backdrop, Bank Sarasin expects equities, commodities and corporate bonds to post a positive performance in Q1 2010. However, the risk of setbacks will increase as the year progresses.

The report, therefore, does not predict a significant rally in equity markets over the full year and anticipates marked regional differences, particularly in Europe.

"With companies facing economic uncertainty, skillful stock picking will be crucial for investment success in 2010," it said.

"We expect a good first quarter, so we are starting 2010 overweight in equities. But the stock market rally is likely to run out of steam quite quickly," said Philipp E Baertschi, Chief Strategist at Bank Sarasin.

The bank thus preferred shares in companies from industrialised nations, which have a strong presence in emerging markets. As well as on well-capitalised blue chips that offer a high dividend yield and higher than average growth. "Bonds offer only limited opportunities for returns because of low interest rates, although they will become more attractive over the course of the year," it said.

With the economy likely to slow in Q2 2010, central banks should maintain expansionary monetary policies through existing interest rates, the report said. And it will likely be the case because the leading central banks affirmed their commitment in the fourth quarter of 2009 to maintain an expansionary monetary policy, it added.

Low interest rate policies

"We expect central banks to maintain a regime of low interest rates over the next 12 months because there is a danger of the economy weakening again in the second half of the year," the report said. "The rise in interest rates which started to emerge towards the end of last year is likely to continue in the first quarter of 2010, however. Interest rates are then expected to fall sharply over the course of the year."

This suggests a switch from short- to long-duration bonds. In 2009 the correction of the credit market anomalies caused by the collapse of Lehman Brothers was the main driver for the corporate bond market. Now that the credit market is stabilising, the focus is shifting back to fundamental data such as expected default rates.

As the economy recovers, credit conditions become less restrictive and corporate earnings improve, Bank Sarasin expects the default rate to ease slightly. This decline promises some upside potential for corporate bonds in the first half of the year. Based on positive corporate profits and generous liquidity combined with lower interest rates, stock markets should also rally in the short term. This is likely to tail off again from the second quarter onwards. There will be no dominant trend during 2010. It is therefore important to review asset allocation continuously in a critical light. In their regional and sector allocation, equity investors should take a defensive stance and avoid high individual risks. The dominant theme of the first half of 2010 will be differing regional expectations about the future tightening of monetary policy.

With key US interest rates predicted to rise, fears of the US dollar turning into a currency for financing carry trades will start to ease. This development is likely to be detrimental to the Japanese yen, as it is perceived to be the ideal credit currency for interest rate bets.

Since the stability of the Swiss franc makes it particularly sought after, the threat of currency intervention by the SNB will persist through 2010, it said.

The key question at the end of the year, it added, is whether the current dollar rally will prove to be sustainable. The trend reversal was triggered by the positive US labour market report for the month of November.

The upward trajectory of the US dollar has also been boosted by doubts surrounding the creditworthiness of Greece and its implications for European Monetary Union.

But the lower euro/dollar exchange rate is not solely down to the weakness of the euro. The Greenback has gained ground even against the Japanese yen and the cyclical commodity-related currencies, including the Australian dollar. The report said the correlation between US dollar and equities is easing.

In its past quarterly report, the bank said that the negative correlation between the US dollar and the US stock market index S&P 500 poses something of a threat.

If equity markets continue to rally, the US dollar could temporarily fall below the level justified by the fundamentals. It said: "Our calculations of the historical correlations show there is still a negative link between the US currency and stock market performance. Even so, it has weakened since the positive surprise of the US labour market report. This first step towards normalisation indicates that the dollar will in future be less influenced by the daily mood swings of equity markets."

Equity: Risk of a setback rises

Equity prices at the beginning of 2010 should initially receive a tailwind from the surprisingly positive macro data and corporate results. Moreover, equities should profit from a further decline in risk aversion. Many investors, who invested their money in assets with a zero return, will gradually switch into more risky assets with higher yield opportunities. But since economic growth in the US is likely to weaken in the second half of 2010, the risk of a setback will increase during the year.

"We expect European equities to put in the best relative performance in 2010," it said. "Emerging market equities are likely to suffer the most during a correction of risk assets. We favour the stocks of companies from the industrialised nations with a strong presence in the emerging markets. With respect to stock selection, we focus on large cap quality stocks, which offer a high dividend yield or above-average growth."

The cyclical upswing would actually justify a tighter monetary policy. Several observers assume that the central banks will discontinue the zero interest rate policy in 2010.

"We think this is premature, however," the report said. "As the sentiment indicators are likely to point to another downturn from Q2, the major central banks will set aside interest rate measures and stick to their low interest rate policy. We expect to see an interim rise in long-term interest rates, which could already peak in Q1, however. The yield curve should flatten in the second half of the year and by the end of the year, long-term interest rates will be below the present level."

Given the expected slowdown of growth in H2, the outlook for commodities appears subdued. Commodity prices should pick up slightly at the beginning of the year, but they could already peak in Q1. "Whereas we anticipate a slight decline in metals prices in 2010, we expect en-energy prices to stabilise. After prices of real estate investments staged a strong recovery in 2009, they are likely to move sideways in 2010," it said.


Ten surprises for 2010

- Surprise 1: Stocks perform much better than expected this year. Although chronic structural problems retard the recovery of the G4 economies, stocks boom particularly in dividend- and growth-rich sectors such as infrastructure, renewable energy, water and sustainable real estate.

- Surprise 2: Growth disparities and political differences turn up the pressure on the US dollar peg in Asia, which is stoking inflation and discontent. Asian currencies appreciate broadly for the first time.

- Surprise 3: The gold price climbs higher to a peak of up to $1,500 per ounce.

- Surprise 4: Instead of further writedowns, some commercial banks revalue their loan portfolios upward on the back of fewer borrower defaults.

- Surprise 5: Asia and Latin America exhibit the highest growth rates worldwide fuelled by surging domestic demand, unabated infrastructure expansion and robust exports. Africa also grows strongly.

- Surprise 6: A structural increase in demand for government bonds in the G4 countries leads to flatter yield curves at a low market-interest-rate level. Deflation concerns spark a frantic search for income-producing investments. 

- Surprise 7: Major countries plan a hike in the retirement age for the first time. Since such a development sustainably increases economic growth potential, stock markets react positively to the news. 

- Surprise 8: While prices for fossil fuels fall as a result of a global improvement in energy efficiency, prices for agricultural goods hit new record highs. 

- Surprise 9: Africa ranks among the year's winners not just on the football field, but also on the stock market. 

- Surprise 10: A popular uprising in Iran overthrows the government. The chance of a new beginning inspires political and economic hopes far beyond central Asia.

List compiled by Burkhard Varnholt, CIO and Member of the Executive Committee, Bank Sarasin

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