Approximately 74% of MENA stocks gained quarter-on-quarter during Q2 and only 22% of the names are up on a year-to-date basis by the end of the quarter.
Yazan Abdeen, CEO and portfolio manager at AD Investment Management said that the stock price rally over the second quarter seemed unsustainable in many instances, as the full economic impact of the pandemic and its lockdown remains partially understood and several stocks are presently pricing a very minor impact.
Last quarter witnessed a continuation of a rebound that began at the end of Q1. The S&P Pan Arab Composite Index gained +12.6% while regional markets rallied in varying degrees with Dubai’s DFMGI being the best performer at +16.6% quarter-on-quarter.
However, as the lockdown is expected to weigh on 2020 earnings, all GCC equity indexes were still down year-to-date.
ADIM has shifted their investment focus on stocks with higher cash flow visibility and certainty.
‘From our perspective as MENA domiciled investors, the European and particularly German markets seem rather promising—barring the financial sector—both as a currency diversifier and as potential revival of demand for industrial machinery improves global supply chains are likely to be shortened,’ said George Hanna, CIO and portfolio manager.
Dividend suspensions across some sectors are an indicator of continued operational uncertainty and cash flow risk in the near term, said Abdeen, suggesting that lofty valuations may be jumping well ahead of what corporate results will reflect in the coming quarters.
‘We expect select sectors to continue being rewarded for defensive cash flows, such as consumer staples, utilities and select healthcare and pharma names. We would expect the market to continue to reward beneficiaries that have emerged from the current environment, be it due to new regulations or new business channels.’
A persisting strain can be seen across the board. ADIM expects to see continued pressure on profits for banks in the second half as the economic fallout from job losses and weaker tourism materializes, despite the observed boost in provisioning.
In other parts of MENA, fiscal expenditure which represents the bulk of economic activity and a key driver of growth in the financial, consumer and cement sectors, has also been scaled back due to weaker oil prices.
On the flipside, consumer staples have seen significant benefits, reflected in the sector’s stock prices. The materials sector which is naturally impacted by low petrochemicals prices have also seen their share prices reflect a quicker return to normal levels than expected. Similarly, telecom providers have also largely been immune.
The high correlation between oil prices and GCC equity market performances adds to the diversifying feature of these markets within a global or emerging market portfolio.
However, as oil prices are likely to remain muted for the foreseeable future, Abdeen expects the added pressure on fiscal balances across regional governments to result in an increased resolve towards becoming less dependent on oil.
‘Banks are expected to suffer the most given the low interest rate environment, reduced government spending and deteriorating asset quality. We therefore remain largely underweight the sector with the exception of a handful of names on valuation,’ Abdeen said.
However, ADIM expects to see a recovery in Q3. The gradual reopening of economies will likely reflect improvement in corporate earnings, especially since several support measures announced in Q2 which were detrimental to earnings will have generally expired by Q3.
As cross border travel remains largely muted, Hanna said that there could be a year-on-year pickup in consumer-led economic activity in the GCC region against the seasonal summer net outflow of residents and visitors.
While this is a net positive for most of the GCC, it could also partially mitigate the negative effect of the VAT spike in Saudi Arabia. For the same reasons he expects a continuation of the above-average trading activity on several regional exchanges that was witnessed in Q2 given confinement requirements.
Sharing his views on the fixed income market, the CIO added that the concerted global monetary and fiscal stimuli, coupled with probable shortening of supply chains are forces that will more likely prove inflationary within a few short years.
‘While we remain on the lookout for dislocated valuations and thus remain selective on underlying names and sectors, we prefer a gradual shift to lower duration,’ he said.