The potential for a global economic slowdown and US recession has left UAE investors facing tough choices over where to invest their money in 2008.
With the shockwaves of the sub-prime crisis still being felt in markets around the world, and the US economy expected to be weak through the first half of 2008 – and possibly for most of the year – investors would be forgiven for being somewhat defensive.
Those who have stakes in global markets must assess which regions will best insulate their investments from the fallout of a possible recession, and on a local level, decide if the construction and oil boom in the UAE still provide a safe haven against a global economic tumble.
Over the past year UAE-based investors have been exposed to an increasing number of attractive investment opportunities, including a host of initial public offerings, and Gulf markets, which have generated arguably the highest profitability rates of all emerging markets.
Investors are now faced with the challenge of picking sectors and stocks that are likely to perform well in the region, and at the same time side-stepping the effects of a tumbling dollar and a weak US economy.
The advise to those with existing global investments is to shift money to a place where the US economy cannot hurt your returns, and seriously consider emerging markets, especially the Middle East and Africa (MEA).
Corporate earnings in 2008 in the GCC are likely to be higher than that of MEA, with the aggregate profit for GCC establishments expected to grow by 12 per cent in 2008, up from five per cent in 2007.
Among the four largest GCC countries, Qatar is expected to maintain its attractiveness as the fastest growing country in the region in 2008, with an estimated earnings per share (EPS) growth of 29 per cent.
Aalaeddine Chahbi, a hedge fund manager for Evolvence Capital, said: “Globally there are only a couple of regions with growth rates of more than 15-20 per cent, and they are usually in the Middle East or Africa. For example, Angola has an expected GDP growth of around 25 per cent, which is outstanding by any standards historically.
“From a risk-management point of view, I would definitely avoid the US market, and all the markets that are correlated with it because whether the talk about a recession is justified or not, there is still the general feeling there, which is enough to cause a recession.
In Europe, earlier in the week, fears of a recession hit shares of companies such as metals producers, technology providers and construction firms. The losses offset strong gains for companies in sectors that are less attuned to economic cycles, including healthcare, utilities and telecommunications.
The expectations for 2008 “are too high in our view, and we advise to start the year with a defensive portfolio structure”, said Societe Generale’s European equity strategists.
They prefer consumer staples, including pharmaceutical and utility firms.
Investment veteran Jim Rogers pointed this week to agricultural commodities as a possible tool to immunise global investments against markets shifts. Rogers said the US economy is headed for its roughest recession in years, counselling investors to opt for commodities and to avoid a dollar he expects will be under pressure for “years to come”.
Commodities, a traditional inflation-sensitive investment, are a good play for 2008, and in the event of a global recession, agricultural commodities would be an outstanding defensive investment, he said.
Christopher Wyke, commodity product manager at Schroders, said strong demand for natural resources – particularly from developing economies – will remain a key support of rising energy, metals and agriculture prices in 2008.
“On the supply side, many inventories are at, or close to, record lows. Furthermore, the quantity of the world’s arable land continues to decline steadily due to issues such as desertification and urbanisation in developing countries.
“In sharp contrast to the turbulence witnessed in the equity and bond markets, many commodities performed strongly when the sub-prime mortgage market woes were at their peak during the summer,” Wyke added.
On a local level, investors in the UAE and other GCC states can take solace in reports that economies in the Middle East are set for sustained growth, and will outstrip other emerging markets in 2008.
A recent Goldman Sachs report said: “The GCC economy by 2050 could be comparable in size to Germany or Italy using relatively conservative assumptions. Under more aggressive assumptions of high population growth, better use of technology and improving education, the region’s economy could overtake that of the United Kingdom, and GDP could equal that of the G7 over the same period.”
Evolvence Capital’s Chahbi, however, issued a note of caution for those looking for gains in the UAE property market. “With local property you can’t be naive anymore; at one point of time all you had to do was buy any kind of property and the price would appreciate.
“Now you have to do your due diligence and consider prime locations in Dubai, which you know will appreciate for offer and demand reasons,” he said.
“In the UAE there will be a balance between offer and demand during 2008 and 2009, which will then turn in favour of demand – which means the prices are likely to go up again.
The message, therefore, is keep investing in local property but you should be more careful and selective and look at prime locations or particular properties such as commercial property in the DIFC or in growing cities such as Abu Dhabi.”
For those without current investments in the UAE or the wider GCC region, the challenge in 2008 will be whether to bet on one of the IPOs likely to be launched.
Countries such as Saudi Arabia have tight capital controls on its markets, limiting the reach of foreign investors, and therefore insulating the economy from a possible recession to some extent. IPOs in the UAE will be able to ward off side effects from foreign market turbulence since the majority of the seed money is from local sources.
“Markets in this region have low correlations with global markets and economies, so I don’t think this potential recession will impact equity and IPO markets here. Saudi Arabia has a capital control system in place, so if you want to purchase a pitch in Saudi you have to be a national, giving the market insulation – especially in the IPO market – from international investors,” said Chahbi.
“The UAE is less insulated. But for the types of markets that are more or less open, so far most of the IPO money is local. Most of the money going into the equity markets is from the GCC region. And they are offering less risk in this case,” he added.
Investors looking at global markets would be wise to be aware of Goldman Sachs recent move to change its rating and price targets on several US retailers. The recent weakening in the labour market and further slowing in consumption could send the US into a mild recession during mid-fiscal 2008.
The brokerage said a second half-margin recovery could be at risk if retailers do not plan inventory levels prudently enough.
“The department stores’ sales and margins get hit the hardest due to their highly discretionary sales mix and season-driven inventory positions, and apparel manufacturers are second in line,” said Goldman.
With consumer trends set to soften further, Goldman said it would continue to advise investors to maintain a defensive investing posture through the first half of fiscal 2008 at a minimum.
Meanwhile, property markets in Eastern Europe look like a safe bet and are seen as a chance to generate sturdy returns throughout the year.
Chahbi: “Markets such as Croatia and Bulgaria and countries on the Mediterranean will not necessarily be hit by what’s happening in the global economy in the real estate sector because of high local demand.”
Gold: the great insulator
Historically, gold has always been a good bet against inflation, or a hedge against inflation. So whenever you start to see inflation the hedging instrument is typically gold. People start buying gold because they no longer trust their currency and, therefore, the price of gold appreciates. Gold will not only be somewhat immune to a recession but it will also profit from it because it has a hedge value – all the more if the dollar keeps depreciating.
This is evidenced in recent news that gold futures rose above $900 an ounce for the first time. High oil prices, a weak dollar and fears of a US recession led uneasy investors to keep buying the metal.
An ounce of gold for February delivery on the New York Mercantile Exchange jumped $6.50 to $900.1 in early trading, an all-time high and a psychologically important milestone. Gold later slipped to $898.70 an ounce but remained in record territory.
“It’s a reflection of market sentiment: gold is a hedge against uncertainty and right now it’s the best bet,” said Carlos Sanchez, a precious metals analyst at CPM Group in New York. “None of the other investment options look that great and gold does.”