Raging bull
Last year witnessed divergent global performances. Many asset classes were in bull territory led by US Equities, as NASDAQ advanced +53.8%, and Bitcoin, which jumped by more than +150%. All the while, visible weaknesses persisted in commodities including oil and emerging markets including the GCC. Tadawul was surprisingly up 14.2% while Brent was down nearly 11%.
Similar divergences are visible since the Gaza war. An armed conflict in this part of the world would typically yield stock market weakness, with oil and gold overshooting. Regional stock markets fell after the war broke out, but oil weakness persisted as the world brushed off the conflict, and gold mostly rebounded from earlier weakness. We closed the year with US indices near their all-time highs while emerging markets lagged stubbornly and showed further divergences within.
A new world order
Looking at the current state of the world, we find that global GDP is still growing below trend. Developing economies show relative economic strength but are pulled down by a slowing China, a fighting Russia and forex woes in many other places from Argentina to Pakistan. Sticky inflation is down but remains relatively elevated with consumer spending sustained and labour markets tight. Monetary policy is easing, but all indications are for a new world order, where interest rates are sustainably higher.
The market now expects a soft landing with a more than 100bps decrease in the Fed Fund rates, which itself spells out the uncertainty. Why do market operators anticipate so many rate cuts if we are gently slowing down? The yield curve remains inverted but, in a departure from long-term history, the market also assumes that there should be no consequential recession this time, because this time is different.
In a nutshell, we live in a world of uncertainty, as expressed by the many divergences. When asked, every economist and strategist will point to the difficulty of mapping the current environment. Even the Fed – especially the Fed – does not seem to know. Last November, both Equities and Bonds clocked record performances, in a world where nothing is certain but positive sentiment is undeterred and “every asset goes up”.
To us, this new world looks like one where investment risks and rewards are balanced. A world where the worst, such as the regionalisation of the Gaza war or the annexation of Taiwan, and the best, such as a new AI-Tech-Crypto bonanza, could both happen. A world where questions abound, and some investment opportunities remain.
The UAE haven
The GCC remain a global haven for economic growth in this context, with relatively strong earnings, still supportive oil prices, unleashed government spending and a dizzying “all out” infrastructure upgrade in many countries of the Arab peninsula. The Gaza shock was short-lived, with financial markets now brushing it off as non-existent, even in the face of a catastrophic humanitarian crisis and one of the heaviest demonstrations of raw military force since the second world war.
In the UAE, with some of the best regional fundamentals, DFM did very well last year while ADX lagged. IPOs added some AED 300bn in fresh market capitalisation last year and their momentum is promising for 2024. Stock market valuations, as expressed by earnings multiple, are still attractive and much below what we find in the US. The UAE trades at an aggregate P/E of 14.5x according to Refinitiv, with ADX near 16x and DFM around 10x. Very compelling value indeed, considering the buoyant fundamentals.
In this context, what are the risks? What could go right, or wrong? On the downside, four main eventualities keep us on our toes. The geopolitical situation could tilt the balance if it persists into a drawn-out war, escalates into a regional conflict, or widens to Taiwan or Korea. A potential recession would also change the cards, especially since it is not widely expected. Dollar strength and oil weakness are also on our minds for potential risks impacting regional financial market performances.
On the upside, we find that better governance of UAE listed companies, more index inclusions, the confirmation of a soft-landing scenario, a resolution of the geopolitical tensions, further dollar weakness and oil strength and a pursuit of the IPO bonanza, all make for further potential positive catalysts for the local stock market. Overall, we find that the static positions of the DFM and ADX since last fall, with the markets treading water in anemic volumes, should change to a clearer direction in 2024. The next leg could be up or down, but the odds favor the upside scenario in our view.
A balanced view for 2024
We held a defensive UAE investment strategy from August to December 2023, which yielded positive absolute and relative performances even as the markets paused for breath. This consisted in being equally weighted in cash, stocks and bonds – one third each in any given portfolio. We changed our stance in mid-December to a more balanced view, in line with our current analysis.
To reflect this balanced view, we recommend that UAE portfolios should now hold less cash (20%), with the rest equally weighted between stocks and bonds (40% each). Within stocks, and all else being equal, Emerging Markets are due to catch up, with the GCC a winning contender, the UAE a regional favorite and the DFM a clear value play. By asset class, higher rates have titled the game in favor of fixed income, which currently offers equity-like returns with significantly lower risk.
Finally, as a cornerstone of our strategy, we introduced a UAE index target for the first time, with an aggregate expected upside of +15% by year-end 2024. This translates into an anticipated index level of 10,850 for ADX and 4,500 for DFM. At the time of writing, we are already up by a blended +4.3%, which means that we have already cleared nearly one third of the expected upside in less than one month. We just might be on the right path to another lucrative stock market year, in 2024.
