FAB Global Investment Outlook 2018

Global
Investment
Outlook 2018
Going from strength
to strength
Global
Investment
Outlook 2018
Going from strength
to strength
Contents
09
2017: THE YEAR THAT WAS
13
THE ECONOMIC & INVESTMENT OUTLOOK FOR 2018: SUMMARY
19
THE GLOBAL MACRO ECONOMIC OUTLOOK FOR 2018; A GROWTH TILT TOWARDS ASIA-PACIFIC (EX-JAPAN)
29
THE OIL MARKET
35
THE MENA REGION
45
GLOBAL FIXED INCOME – DEVELOPED MARKETS
51
MENA BOND & SUKUK MARKETS
55
ASIA BOND MARKETS
59
G4 FX
65
MENA FX OUTLOOK
71
ASIA FX
79
EUROPEAN (EX-UK) EQUITIES: A POSITIVE OUTLOOK
85
JAPANESE EQUITIES: THE INVESTMENT CONUNDRUM OF OUR TIME?
97
MENA EQUITIES
107
UAE BANKING
117
REAL ESTATE AS AN ASSET CLASS
123
RISK CONTROL FOUNDATIONS IN GLOBAL PORTFOLIO MANAGEMENT
129
AN INTRODUCTION TO BITCOIN, BLOCKCHAIN AND THE FUTURE OF MONEY
141
‘UNIVERSAL BASIC INCOME’ – A SOLUTION TO THE THIRD INDUSTRIAL REVOLUTION?
147
Appendix: VALUE ADDED TAX
Foreword
FAB GLOBAL
INVESTMENT
OUTLOOK 2018
Welcome to First Abu Dhabi Bank’s events. Here in the Middle East, it has
Global Investment Outlook 2018. certainly been an interesting year. The
As Group Head of Personal Banking price of crude oil stabilized, finishing
it gives me great pleasure that we the year strongly. Despite the region’s
are publishing our inaugural annual political developments, the local equity
investment outlook, following the markets began to see renewed IPO
establishment of our newly-merged activity. There is also the possibility of a
bank that brought together two great positive announcement regarding Saudi
brands, National Bank of Abu Dhabi and Arabia being accorded MSCI emerging
First Gulf Bank, to create the Middle market status (from frontier) enabling
East’s largest bank. The new entity it to join the UAE in the coveted group.
created in April last year is the only
regional bank rated ‘AA-’ by Standard & As FAB approaches its second
Poor’s, the rating agency - and we are year of existence, although our
growing stronger as we enter 2018. DNA originated in Abu Dhabi, our
business and investment activities
Most of us would agree that last year are continuing to expand regionally
was one of considerable change, and beyond. Whether it is our asset
although one that was more positive for management services, or investment
HANA AL-ROSTAMANI investors than 2016. Good returns were advisory offering, we have investment
Group Head of Personal Banking achieved in markets despite geopolitical professionals to cater for all our
clients’ needs, whether they are embraced change; in short, one plus one clients have been dealing with the
locally or internationally-based. has equaled more than two. lower oil price environment, and our
analysts remain relatively optimistic.
The ‘Economic & Investment Outlook’ Work done by Professor Danny We are entering a period in which the
section of this book summarizes FAB’s Quah, when he was at the London diversification away from fossil fuels will
investment strategy team’s view of School of Economics a few years ago, accelerate. The UAE is already diversified
the world. They and their colleagues suggested that Abu Dhabi’s longitude economically, and this is set to continue.
across the bank (many of whom have approximates the centre of global
contributed to this book) possess many economic gravity. Thinking along I now hand you over to the investment
years of combined experience. They these lines, you, our clients, can benefit experts that have put together this
expect good returns in 2018, but with from our geographic position and the informative publication. We hope
greater volatility. With this volatility will lines of communication it affords. In you will thoroughly enjoy reading our
come investment opportunities. Above addition, FAB continues to be one of Outlook for 2018.
all, our clients will continue to need the safest institutions to bank with in
sufficient portfolio diversification, which the continuing uncertain world we live
generally leads to more sustainable long in today.
term investment returns.
Macro-economic management, of Yours sincerely,
FAB continues to build on its core both fiscal and monetary policy, has Hana Al-Rostamani.
strengths, post the merger. As our continued to be exceptional here in
teams have come together, they have the UAE. The government and our
08 2017: THE YEAR THAT WAS
FAB GLOBAL INVESTMENT OUTLOOK 2018

2017: THE YEAR THAT WAS 09
2017: THE YEAR THAT WAS

2017: THE YEAR

THAT WAS
GLOBAL GROWTH GAINED

MOMENTUM IN AN EXCELLENT
YEAR FOR MOST RISK ASSETS
POLITICS: Trump was inaugurated

as US president in January. Initial
fears of right-wing politicians coming
to power in Europe did not come to
pass. Progress in Brexit was very slow
GLOBAL CENTRAL BANKS: The

US Federal Reserve continued to
‘normalize’ rates, and to reduce its
balance sheet MENA BONDS: Returned 4.8%, ASIA-PACIFIC EQUITIES (EX-
hurt by geopolitics, and needing JAPAN): This sub-sector rose
US TREASURIES: Underperformed yet more evidence of a better by 38.7% (in US dollars); China
most other asset classes, rising 2.3% oil market performed solidly
in a ‘risk-on’ environment
S&P500: Rose an impressive 19.4%, MENA EQUITIES: Disappointing
US INVESTMENT GRADE without any correction of note, year, up 4.6% on the MSCI Arabian
CORPORATE BONDS: Returned 6.4%, with earnings growth the key Equities index, with geopolitics
again reflecting risk-on elsewhere overshadowing oil
STOXX EUROPE 600 EQUITIES: GOLD: Returned 13.7%, mainly
US HIGH YIELD BONDS: Returned Disappointing, at a 6.5% return, due to USD weakness; little hedge
7.9%; fine for much of the year, then burdened by politics and a demand was required last year
reflected rising short-term rates strong euro
INDUSTRIAL METALS: 31.1%
EMERGING MARKET USD BONDS: A JAPANESE EQUITIES: 19.4% higher ahead, driven by reduced
respectable 10.3% return, helped by over the year, a performance that Chinese capacity, and production
improving EM economic metrics caught many investors by surprise interruptions elsewhere
EMERGING MARKET LOCAL EMERGING MARKET EQUITIES: HEDGE FUNDS: Generated 6.0%
CURRENCY BONDS: Returned a Came almost top of the class, on average, with wide dispersion;
very good 15.2%, helped also by US at 37.3%, in the second year of few good performers manage to
dollar weakness earnings recovery sustain it.

2017: THE YEAR THAT WAS 11
COMMENTARY: 2017 began with performance that hardly stopped discussed more fully under ‘G4 FX’).
confidence as Donald Trump for a breather for the rest of the In monetary policy, the European
took the helm as America’s 45th year. Trump’s attempt at healthcare Central Bank enacted what the
President. His agenda of growth reform had a setback after it was markets called a ‘dovish taper’,
revival and economic expansion, rejected by a majority of fellow whereby the monthly amount of QE
to be accelerated by corporate Republican Party members. He had was reduced, but the time horizon
tax cuts, helped fuel one of the wanted to get healthcare reform for it to come to an end was pushed
most stable stock market rallies out of the way before moving further out. Having said that, the
seen for a number of years. The US onto tax reform. This was the first ECB is expected to begin to move
Federal Reserve continued raising significant test for the president, into the ‘gradual tightening’ club
rates in line with its thesis of rate who as we know has a ‘can do’ during 2018.
‘normalization’, and gradually attitude. Markets continued their
reducing its balance sheet, upward trend even as criticism In October it was announced by
previously expanded substantially grew about his ability to deliver on President Trump that Janet Yellen
via quantitative easing (QE) to avert other important campaign pledges, would be replaced this year as
a depression in the aftermath of including infrastructure spending Governor of the US Federal Reserve
the Great Recession of 2008/09. - and especially tax reform – and by Republican Jerome Powell, to
Inflation on the basis of the Fed’s also as some early White House officially take effect in February. Mr.
preferred ‘core’ PCE data (excluding appointees were shown the door, as Powell is known as a centrist, rather
food & energy) continued to be well as an investigation of whether than a hawk or a dove.
restrained, ending November at the Trump camp colluded with
1.5% year-on-year, and still below Russian officials to influence the In the UK, very slow and clearly
the Fed’s target of 2.0%. US growth result of the 2016 general election. painful Brexit deliberations
continued at moderately good continued, reaching an interim
levels for much of the year, and In Europe, there was a trend earlier conclusion in December regarding
this along with still historically in the year of Far Right candidates the ultimate financial divorce
low interest rates provided almost beginning to look more electable settlement, enabling discussions
perfect conditions for investors to than previously, the best example to proceed to trade during the next
put cash to work in so-called ‘risk’ being Marine Le Pen in France. The round. Meanwhile, Brexit hardliners
assets (led by equities) around the election of Mr. Macron as French continued to challenge British Prime
world. As discussed in our ‘Global president was a landmark event, Minister, Theresa May, to reach a
Macro Economic Outlook’ article, although some of the reforms ‘better deal’ than was being offered.
the IMF and others upgraded their he wants to achieve (especially Deep political divisions in the UK
growth forecasts during the year, in labour markets) go against had resulted in Mrs. May calling
as we suggested they would at this established norms going back many June’s ‘snap’ general election. It
time last year, with the point being years. Elsewhere in Europe it became was a gamble that didn’t pay off,
that for many years analysts started clear an economic recovery had causing her Conservative Party
with optimistic forecasts, only to begun in Greece, and the country to lose its majority in parliament,
then lower them during the rest of was able to exit the emergency and as a result having to enter into
the year. Last year was different. liquidity assistance programme. In negotiations with Northern Ireland’s
Spain, the question of Catalonian UDP to cobble together a working
In March came what turned out to separatism became quite serious, coalition. Mrs. May’s political life
be only a small hiccup in an S&P500 and is still unresolved (this is continued to be fraught, and in

the background there was always beliefs are now fully-enshrined in US tax reform was a major
Boris Johnson, who many suspect the Chinese constitution. China is win for Trump, when he most
would like to replace Mrs. May and discussed in more detail elsewhere in needed it.
run the country. Nonetheless, the this publication.
achievement of the financial divorce
(and some dollar weakness) was The Trump Administration secured does appear to be re-balancing as we
sufficient for a close of just above a major political win in the form of move into 2018.
$1.35, reaching our target of $1.35- the passing of its tax reform bill in
1.40 envisaged at this time last year. December - one of the cornerstones Although pleased that we were very
of the Trump policy agenda. broadly correct in our ‘risk on’ call
In Japan, Prime Minster Shinzo Corporation tax will be reduced in equities for 2017 (especially in
Abe was caught up in two political from a central rate of 35%, to 21%, US and Indian equities, the latter of
scandals, which damaged his ratings. and this together with foreign which performed particularly well,
However, seeing the opportunity in repatriation tax incentives bolstered closing up almost 28%), our bullish
the second half of the year he called US equities through the year-end. view on the US dollar was proven
a ‘snap’ general election, which he There was criticism that (also incorrect, with the dollar closing
won by a landslide, winning a ‘super- referring to changes in income tax 9.9% lower on its index (DXY) over
majority’ for his LDP party. He called bands) this was a set of measures 2017. This was mainly because
the election more than a year earlier disproportionately benefiting market participants remained more
than constitutionally necessary, the wealthy. concerned with Trump’s various
on the platform of revising Japan’s tribulations (staff turnover, Russia
pacifist constitution, and almost Here in the MENA region, with the allegations, and lack of policy
certainly benefitted from the rebalancing of crude oil continuing - execution) during many months of
Japanese people being worried and ahead of the anticipated partial the year, rather than with interest
about two missiles fired by North floatation of Saudi Aramco during rate differentials.
Korea over the island of Hokkaido in the next year or so - local market
September, 2017 (Japan is discussed interest was sparked with the first
in more detail in a separate article equity IPOs in the UAE for more
elsewhere in this book). than a few years. More are expected
in 2018. Additionally, MENA bond
In China, the event looming issuance in both conventional
largest on the calendar was the and sukuk forms is expected to
important 19th Party Congress be healthy.
later in the year. The authorities
- and further benefitting from Crude oil prices remained almost
President Xi Jinping’s very much fully within our forecast range
strengthened position after that of $45-$60/barrel forecast at
Congress - continued with reforms, this time last year. The OPEC and
and against the background of a ‘NOPEC’ producers are believed
self-imposed credit squeeze, to to have achieved close to a 85% ALAIN MARCKUS
bring about better quality economic rate of compliance on their agreed Head of Investment Strategy,
growth (i.e. better balanced) than production restraints dating back Products & Services - Wealth &
in the past. President Xi and his to November, 2016. The oil market Private Banking

ECONOMIC & INVESTMENT OUTLOOK SUMMARY 13
ECONOMIC & INVESTMENT

OUTLOOK SUMMARY

14 ECONOMIC & INVESTMENT OUTLOOK SUMMARY
THE ECONOMIC & INVESTMENT

OUTLOOK FOR 2018: SUMMARY
THE POLITICAL BACKGROUND: Brexit negotiations remain tough, as towards 3.5% (or even a bit more)
Europe continues to take a hard line; into 2019.
Although global geopolitical it is as yet unclear exactly what kind
concerns remain, world growth of a trade deal can be reached. If US growth falters in 2018 it
continues to gather pace in the should be a pause, not a sign of
relative absence of inflation. We expect adverse Middle East impending recession. In the words
geopolitics to abate, leading to of Warren Buffet, “The US has the
In the US, tax reform is a major renewed interest in the region’s secret sauce”.
success for the Republicans to build capital markets, helped by oil.
upon, but healthcare reform will The ECB recently revised its
continue to be challenging. THE ECONOMIC BACKGROUND: Eurozone growth forecast up,
to 2.3% for 2018 (from 1.8%),
Last year’s passing of a ‘watered The current global economic cycle vindicating our positive European
down’ budget of $1.1 trillion sets was elongated by QE, and the main equities stance.
the stage for more Trump-led policy feature was low growth – reforms
initiatives in 2018. should now help lengthen the Japan’s monetary policy should
cycle further. remain more accommodative than
The Republican majority in the the FX depreciation ‘competition’;
Senate remains slim, and could be We expect world growth forecasts even here growth is improving.
reversed if the mid-term elections to be revised upwards again, to 4.0%
in November go badly. for 2018 (from the IMF’s 3.7%), led China’s forecast GDP growth (at
initially by the developed nations. 6.5% for 2018) looks a bit too
Trump’s presidency will high; 6.0-6.2% looks more realistic,
continue to be judged by policy The IMF recently had US growth although would still be very good.
implementation rather than at 2.3% for 2018 (vs. a current
manifesto pledges. run-rate of 3%+) - corporate Asia-Pacific (ex-Japan) should see
tax reform will see this revised, the best regional growth for the
In China, President Xi Jinping now perhaps to above 3%. medium-to-long term; the IMF
has much more leeway to clean up expects 5.2% growth for its ‘Asean-5’
its political and economic systems – The IMF will revise its US growth for 2018.
all of which is positive. forecast sooner rather than later;
the passage of US tax reform had World trade should move to a more
Although the Eurozone faces Italian not been fully factored in. bi-lateral basis, inspired by Trump.
elections in April, and Angela Merkel China will appease Trump with more
is still trying to build a coalition Tax reform and some extra FDI, as Japan already has done.
in Germany, Brexit looks the only infrastructure spending has the
serious issue. potential to increase US growth The ‘normalization’ of interest

rates will continue to be US-led; 2019 with the momentum “The world is on a better
rates there should go to 1% above carrying it into 2020 – the longest growth path than for many
inflation (not 2% as historically). for generations. years.”
Central banks will move towards THE INVESTMENT BACKGROUND:

shrinking their balance sheets,
although this will be gradual We continue to favour risk assets like they will be able to buy the
– they don’t want to impede equities for 2018, but expect more sector cheaply – they will likely
global growth. volatility; sharp corrections should be be mistaken.
bought into.
Central bank tightening should The FAANGs (including Apple and
not affect emerging economies as A positive effect on US corporate Microsoft) look highly-valued, but
before; EM growth should continue earnings from lower taxes will follow deservedly so (excluding Netflix)
to exceed developed countries. as the actual realized average rate of as they produce significant
26% falls towards 21%. free cashflow.
The ECB will only very gradually
reduce its QE, and we expect We expect US corporate capital This is not a ‘dot-com’ bubble when
limited rate increases if at expenditures to jump this year, as looking at current valuations - Big
all, to keep the euro low, thus companies were clearly holding back Data and innovation in the sector is
sustaining growth. until they had the new details. driving prices.
Expect fiscal policy to take the In global equities, ‘value’ sectors …as is AI (artificial intelligence),
baton from monetary policy. such as Banks and Energy should while the original understanding
do well. of ‘convergence’ is taking
Digitization, and increased on a massively different and
productivity through sustained US financial regulation will be exciting meaning.
innovation should continue to keep greatly eased; a more simplified tax
global inflation in check. system along with rising interest Industry giant, Microsoft has
rates will benefit the financial sector reinvented itself (via cloud
It is increasingly likely that the computing), and semiconductors
thesis of secular stagnation put …accordingly, banks will lend more are in a structural growth phase, and
forward by Larry Summers and freely; in addition, the slackening less cyclical.
others will be replaced by very of Dodd-Frank will be bullish for the Markets are nowhere near the
solid growth. sector – and for the whole market. euphoria necessary to bring about a
lasting reversal; the last third of gains
After a major crisis, investors should We remain overweight in IT, usually arrives in the final phase.
double perceptions of duration which should outperform
of market cycles; so seven years further over the year as a We don’t expect Fed funds to go
becomes 14 years and we are nine whole, driven by a multitude of above about 3%, and therefore
years in. growth possibilities. don’t see the risk of equities being
adversely impacted.
The current US economic cycle The majority of US mutual funds
will be further extended into are underweight in IT, thinking Incoming Fed Chair Powell should

“The fundamentals of investors who were long take some respectively (but 3.9% looks far
Information Technology look profits, enabling others to enter. too low).
very exciting.” Into 2018, estimated 2019 earnings A good selection of mainland
should be the focus; it shouldn’t be Chinese stocks should work well
until late this year that investors this year – ignoring uninformed
worry about flatter earnings comment that China is about
in 2020. to crash.
continue the normalization path We like European (ex-UK) equities, We think it helpful that Asia-Pacific
in 2018 – rate rises will be kept in which is more of a ‘value’ play, (ex-Japan) includes Australia, a
check as government debt in the US and a hedge against the IT/Growth classic ‘late-cycle’ commodity play;
remains high. overweight in the US and Asia- Australia is only now breaking-out.
Pacific (ex-Japan).
As interest rates rise there will be an In Emerging Markets we are looking
increasing rotation to higher-quality The STOXX 600 is on a P/E of 14.2x for opportunities in commodity
investments - hedge funds should for 2018 and 12.7x for 2019; the producers, while still favouring
start to increase short positions in latter compares very well indeed with commodity-consuming economies.
lower-quality ones. improved earnings growth of 11.7%
Since 2013’s ‘taper tantrum’ the
EQUITIES: As in 2016 after the Brexit current account deficits of India and
We expect earnings estimate vote, foreign earnings-heavy Indonesia are much-improved; the
revisions to generally be very UK equities could perform if EM world is less risky than before.
positive during 2018 (they already sterling falls – but Brexit and
look good), helping to moderate May’s future are still in doubt. …and EMs are less hostage to
many valuations. In the end, Brexit concessions commodity prices than historically,
should be made by both sides, and stronger growth will
The S&P500 (at 2,743.15) is on a and the sense of its conclusion underpin valuations.
P/E of 16.9x for 2018, on consensus could trigger renewed interest in
earnings growth of 10.6% - but this UK assets. India remains a core holding for the
should improve further. longer term in our models, to take
Our largest proportionate advantage of its demographics
…and on a P/E of only 15.1x for overweight position vs. the and reforms.
2019 based on healthy earnings benchmark remains ‘Asia-Pacific (ex-
growth of 11.9% - although still with Japan) equities – ‘APEJ’ for short. We studied Japan, the key finding
analysts behind the earnings curve. being that the Tokyo ‘second
APEJ is (in weight order): China, section’ (over 2,000 small &
The cycle should be sustained by US Australia, South Korea, Hong mid-caps) is a haven for good
and non-US growth; the S&P could Kong, Taiwan, Singapore, Thailand, stock-pickers.
trade at 17.0x 2019 earnings of Indonesia & the Philippines…
181.64 i.e. 3,088 – or 12.6% higher. In MENA equities we are currently
…and is on a P/E of 13.0x for 2018, ‘neutral’ vs. the benchmark, and
Note that a correction of about 5% and 12.5x for 2019, based on will remain so until investment
should occur sometime during Q1 as earnings growth of 9.5% and 3.9% sentiment settles.

FIXED INCOME: growth, and don’t expect a recession We would caution against taking
there for a while yet. duration risk above 10 years as
Fixed income will always be a large normalization along with more
proportion of a conservative client’s Last year saw a US 10-year Treasury inflation will likely impact bonds
mandate, and rather less of a yield range of 2.04-2.60%, quite this year.
growth mandate. close to what we predicted; in 2018
we expect a range of 2.40-3.00%. Investment Grade bonds will
We are still underweight in become more appealing relative
Developed Market Government With Fed funds at a maximum of 3% to High Yield bonds, likely from
bonds, expecting three Fed rate (i.e. 2% inflation plus a normalization/ mid-2018 onwards.
hikes in 2018, and two in 2019. cushion of 1%), the US 10-year
Treasury yield could rise to 3.50% by Longer duration Investment Grade
The US Federal Reserve continues year-end 2019. bonds, along with perpetual bonds,
to be vigilant on the economy should be the domain of traders,
while the normalization of interest We remain overweight in High not investors.
rates continues. Yield bonds, consistent with an
overweight in US stocks, however we EM and MENA bonds are neutrally-
As mentioned, we are bullish on US will review this in early 2018. weighted, with the yield pickup

“Investors should not be The share of renminbi global Gold should be held as a hedge
frightened by the corrections transactions is still at a very against possible unexpected
expected” low level… it will take another risks; dollar strength would
2-5 years to begin to see hurt gold and restrain other
its internationalization. commodity prices.
vs. developed market bonds still
looking attractive. COMMODITIES; ALTERNATIVES; Real estate should have a role
REAL ESTATE: in portfolios, for reliable rental
Volatility in Investment Grade income, as a hard asset, and as
should moderate; we expect good We suggested in last year’s a volatility dampener – always
quality EM bonds to outperform Outlook that base metals should excluding one’s main residence.
developed market bonds as be bought into any dip (which
a consequence. occurred); the same applies at
these higher levels.
FOREIGN EXCHANGE:
Chinese demand (and supply)
US interest rate increases should will continue to affect copper,
finally lead to some firmness in aluminium and other metals, as
the dollar relative to other major will supply disruptions in Indonesia
currencies – interrupted from time and Chile.
to time by US politics.
Overall, the late-cycle behaviour
We expect a trading range of that we expect (linked to
approximately 91-100 in the increased infrastructure spending)
dollar index, given likely interest should benefit base metals prices.
rate differentials.
China’s credit squeeze has caused
In sterling, Brexit and Mrs. May’s base metal price volatility; the
political tenure will dominate uptrend in the LME Metals index
the outlook; a $1.25-1.40 range looks intact, however.
is expected, with a spike below
$1.25 possible. Crude oil continues to rebalance;
we expect Brent to be capped at
The euro/dollar pair is expected about $70/barrel in 2018, with $50
to trade in a $1.12-1.22 range the expected low.
during 2018.
…however supply-side issues
Emerging markets overall should (e.g. regarding Venezuela and ALAIN MARCKUS
continue to grow well in 2018, so certain Middle East producers) Head of Investment Strategy,
EM FX weakness should be limited and/or excess demand could see Products & Services - Wealth &
unless dollar strength is sustained. $70 reached. Private Banking

THE GLOBAL MACRO ECONOMIC OUTLOOK FOR 2018; A GROWTH TILT TOWARDS ASIA-PACIFIC (EX-JAPAN) 19
THE GLOBAL MACRO

ECONOMIC OUTLOOK
FOR 2018; A GROWTH TILT
TOWARDS ASIA-PACIFIC
(EX-JAPAN)

20 THE GLOBAL MACRO ECONOMIC OUTLOOK FOR 2018; A GROWTH TILT TOWARDS ASIA-PACIFIC (EX-JAPAN)
The Global Macro Economic Outlook

for 2018; A Growth Tilt towards Asia-
Pacific (ex-Japan)
PART ONE:
THE GLOBAL MACRO
ECONOMIC OUTLOOK
Last October, the IMF increased demographic factors, and still than expected - more than offset
its GDP growth forecasts for the historically-low commodity prices. downward revisions for the US and
world economy for 2017 and 2018, However, they went on to say, the UK”. They reduced their UK
to 3.6% (from 3.5% in July), and “The global upswing in economic growth forecast for 2017 by 0.3
to 3.7% (from 3.6%) respectively. activity is strengthening”, adding, percentage points (subsequently
GDP growth is estimated to have “Broad-based upward revisions in born-out by official UK forecasts),
been 3.2% in 2016. They said that the euro area, Japan, emerging while raising forecasts for Germany,
the recovery was not complete, Asia, emerging Europe, and Russia France and Italy. The forecast for
held back by low wage growth, - where growth outcomes in the China was raised to 6.8% for this
restrained productivity, adverse first half of 2017 were better year, up from its previous estimate

of 6.7% (6.8% was the year-on- by the IMF have been piecemeal, “The IMF is expected to revise
year rate for the third quarter), that was to be expected; it was the upwards it’s growth forcast
and for 2018 the forecast was direction that mattered. for the US for 2018 - possibly
raised to 6.5%, from 6.4%. The substantially”
Chinese were once again urged to Inflation remains subdued in the
rein in the expansion of credit in advanced economies. The IMF a few
their economy. months ago was carrying estimates continued low aggregate ‘realized
of 1.7% for 2017, and the same risk’ in 2018. As we go to print the
Turning to India, the forecast for for 2018, and since then the Citi BNP Political Risk index is standing
the current fiscal year (ending Inflation Surprise Index for major at -0.94 (down from a reading of
in March, 2018) was lowered to economies has been marginally 2.40 after the surprise Brexit vote
6.7% (from the 7.2% predicted in negative (i.e. coming in lower than in the UK in June, 2016). While
July); and for 2018/19 the forecast expectations). For ‘Emerging & indicators like these naturally have
was reduced to 7.4%, from the Developing’ economies, the IMF was to be interpreted cautiously –
earlier 7.7%. The report mentioned recently projecting 4.2% inflation similarly, BoA Merrill Lynch’s Global
strengthening growth across most for 2017, and 4.4% for 2018. Financial Stress indicator (at -0.15
of Asia, including for Japan, whose Similarly, the Citi Inflation Surprise at mid-December, where levels less
forecast was raised to 1.5% for the Index for emerging markets was than zero indicate less financial
current year (vs. the earlier 1.3%), continuing to come in lower than market stress than normal) – we
and 0.7% for 2018 (up from the expectations as we went to print. feel they help us see past localized
earlier estimate of 0.6%). Based on ‘The Economist’ poll of disturbances, be they regarding
inflation forecasts for 2017 for the North Korea, or in our own region.
The IMF expected the oil price to countries they track, the highest
average $50.3 a barrel this year, and emerging economy inflation rates We expect Trump to succeed with
to remain in the $50s until 2022. were: Turkey (10.8%), Argentina tax reform, and for infrastructure
In our January ‘Outlook 2017’ we (25.1%), and Egypt (26.7%). In spending to be increased
had said we expected global growth that poll, China’s inflation rate moderately. Healthcare reform
estimates to be revised upwards, was estimated to come in at in the US will be rather more
thinking especially of the forecasts 1.6% for 2017. We expect global difficult, however; it is a notoriously
from the IMF, which we use as our digitization and many other complex subject.
consensus baseline. At that time kinds of technological advances
the IMF was expecting growth of to keep production costs down Considering the baseline growth
3.4% in 2017, and 3.6% for 2018. globally, as well as what the assumption for 2017, it has become
For a number of years, investors Amazon’s of the world are doing, increasingly clear in recent weeks
had grown accustomed to growth to keep global inflation properly in that the IMF assumption of 3.6%
forecasts always being revised check – including in the EM world, for global GDP growth for last year
downwards during the year – but which has historically suffered will have to be revised upwards
we said 2017 would be different from higher inflation than in early in 2018 – perhaps by 0.2%
– and that is what happened. developed countries. percentage points, to 3.8%. At the
This was an important part of our same time we would expect the
thesis to be overweight risk assets, So what do we expect the world to IMF to revise their projection for
namely equities, during 2017. look like in 2018? Firstly, thinking 2018 upwards, from 3.7% currently,
Although the forecast revisions of global political risk, we expect to the region of 4.0% - and with

“It makes a change for ‘Wall of Worry’, and will continue December meeting. Similarly the
global growth estimates to bet against the strongest equity IMF had been at 1.9% growth for
to see upward - rather than momentum we have seen for a the Euro Area for 2018, but the
downward - revisions” number of years. And a further run-rate at the end of last year was
crucial point is surely this: the bell- already 2.2-2.5% - and the ECB just
weather indices will stoke a growing revised it’s GDP growth forecast
some of the usual caveats to cover ‘feel-good’ effect, starting in the US upwards for this year, from 1.8% to
themselves - yet they are still and rippling outwards. 2.3% (which let’s face it for the EU
likely to be behind the curve all would be impressive).
year – just as they were in 2017. Not much of the above is rocket-
Our headline assumption is that by science: the IMF was carrying a For China, the IMF was projecting
early 2019 the IMF and others will 2.3% growth projection for the US 6.5% for 2018, but they will
be talking about global growth of for 2018, yet the run-rate in late probably want to revise that
4.2% for 2018 – (up from the 3.8% 2017 was already 3%+ - and before downwards slightly.
we assume occurred in 2017). This is very few analysts had factored-
what the S&P500 is telling us today in anything positive about tax As part of this overall bullish
(at 2,776) – this is more than a reform or an even higher US equity economic background, world trade
seasonal rally. The doom-sayers will market. Also, the Fed has increased will continue to grow, and start to
continue to provide the so-called its US growth forecasts after its be more bi-lateral, with more trade

“At the worst, we are thinking

of a ‘growth recession’ in
2020”
being done within the emerging

world, especially the healthy
parts of it with excellent outlooks
i.e. SE Asia. We expect the US to
suck-in even more imports, and
for its trade balance to worsen
further, especially with China – yet
China will probably successfully
appease President Trump with large
amounts of inward FDI.
In US politics, if Trump was

impeached, at this point the voters
(and investors) probably wouldn’t expect this to remain a largely US producers, as we don’t expect
be particularly bothered, as despite phenomenon, and for the Federal a return to a commodities
a narrow Republican majority in Reserve to in effect target a Fed ‘Super-Cycle’. Commodity prices
the Senate, the economy would funds rate of 1% above inflation (especially base metals) are
by then have gained even better (rather than 2% historically). So expected to firm, but not to get
momentum. Tax reform (and at notionally a ‘real’ rate of 1% above too overblown unless growth rates
least some progress on healthcare) an inflation rate unlikely to exceed exceed those we have assumed.
should make for a better 2% might result in a Fed funds rate Emerging markets are far less
background to help Republicans of just under 3% - or three hikes dependent on commodities than
get through the mid-term elections this year, and two or three more they used to be. Having said that, a
this year. in 2019. The prospect of 3% Fed country such as Indonesia – which
funds should not scare equities; will be driven by demographic
Thinking of the economic cycle however, to do more than that growth and related factors – still
(both from a US viewpoint and would likely hurt fragile emerging stands to benefit substantially if
globally), the current economic markets – although the EM world commodity prices increase, due to
momentum should last well into will have become even stronger by its truly substantial and very broad
2019, at the end of which we 2019, and it is now much stronger range of natural resources.
would expect a ‘growth recession’, than it was at the time of 2013’s
starting in the US, and affecting taper tantrum. Globally, the Asia-Pacific region
the more fragile countries in the (excluding Japan) – Japan is a boat
emerging world. We still favour the commodity- lifted by the rising tide – is our
consuming areas of the world favourite region for growth and
Meanwhile, regarding the so-called (the Eurozone, China and India, for investment globally, as explained in
‘normalization’ of interest rates, we instance), over the commodity- the following section of this article.

PART TWO:
A GROWTH TILT TOWARDS ASIA-
PACIFIC (EX-JAPAN)
Turning specifically to Asia-Pacific growth (as do most investors). They “Chinese equities are grossly
(ex-Japan), readers will expect us to are doing all they can to (a) reduce under-represented in global
put China at the forefront of any debt in the system - or rather the equity indices - this will
discussion, so here is a re-cap on further ‘excess’ growth of it - at change”
what we believe is happening there. all levels, (b) clamp down upon
In summary, the authorities - and irresponsible wealth management
recently emboldened by President products - and ‘shadow banking’, as a reserve currency that major
Xi Jinping’s strengthened position (c) bring about an economy driven international counterparties will
after the 19th Party Congress - more by domestic consumption, be happy to trade with and invest
are continuing with reforms, and rather than industrial production, in. In late November tighter online
against the background of a self- (d) to fight pollution in all its forms, lending regulations were imposed.
imposed credit squeeze, to bring and (e) to fight corruption. The list is The authorities are serious about
about better quality economic in reality much longer, including the reducing leverage in the system, and
growth (i.e. better balanced) than establishment of China’s ‘Belt and preventing asset price bubbles (in
in the past. Communist Party Road’ Initiative (the new ‘Silk Road’), stock prices, or real estate, especially
members know this means lower and the furtherance of the renminbi in Tier 1 and 2 cities). State-Owned-

Enterprise debt has been carved-out, credit squeeze to reduce growth “We have successfully gone
and is being addressed, and related to an annualized 6.2% (or maybe against the bearish consensus
surplus industrial capacity is slowly 6.0%) in the first half of 2018, and on China for a number of
being rationalized. The foregoing to average that level during the months now”
is a gross over-simplification of year. To reiterate, at the recent
what is underway, and there are no Congress President Xi as much
easy answers - and in all fairness as promised lower growth in the
President Xi has been at pains interim when he quite forcefully
to underline the challenges that underlined the challenges China
China faces. In terms of capital faces. The good news is of course
markets, the regulators are doing that - especially for an economy of
many of the right things to make its size – viewed globally this would
Chinese ‘A’ shares (the onshore still be a very healthy growth rate.
variety) and bonds more acceptable If the debt ‘work-out’ (mainly in
to international investors, a State-Owned-Enterprises) can be
consequence of this being higher successfully achieved over the next
weightings in global tracking indices few years, continuing strength in
(such as MSCI for equities). Even retail sales (we think of between
after the latest increase in the MSCI 6-9% p.a.) should at the top-line sources of that growth towards
weighting, Chinese equities are still facilitate the significant economic consumption, and that includes
very under-represented in global transformation the government some consumption improvement
equity indices. Global investors has planned for. Sovereign debt in Japan.
have begun to smell the coffee, represents 49% of GDP, according
however, and are marshaling more to the latest IMF estimates, and Looking at the IMF’s ‘ASEAN-5
resources to make sure Chinese they expect this to rise to 59% by countries’ (i.e. Indonesia, Malaysia,
asset classes are properly assessed. 2022. The comparable numbers for the Philippines, Singapore and
Commentators all too willing to Japan are 239% currently, falling Thailand), their latest forecast
remind us about high debt levels in to 234% by the end of that period. calls for 5.2% for 2018, following
China don’t usually mention that Reviewing global growth for the the same rate for 2017. For China
the domestic savings rate is still third quarter of 2017, China and alone, the IMF had estimated 6.8%
thought to exceed 30% (compared South-East Asia were the clear growth for 2017, falling slightly
to now under 4% for the US). Our global regional leaders, year-on- to 6.5% for 2018 – and as we
summary view is that the bears of year. China’s official GDP rose suggested above - we expect both
China and its equities are likely to 6.8%, Indonesia 5.1%, Malaysia those estimates to be subject
continue to be proven wrong, and 6.3%, Singapore 4.6%, Thailand to some moderate downward
notwithstanding the occasional 4.3%, the Philippines 6.9%, with revisions, perhaps to a range of
sharp equity sell-off we expect ‘frontier’ market Vietnam at 6.4%. 6.0-6.2% for 2018 in the light of
Chinese stocks to climb their own South Korea and Hong Kong both recent economic statistics coming
‘Wall of Worry’ during 2018. achieved 3.6%, with Taiwan at in shy of forecasts.
3.1%, and Australia at 2.8%. The
We may not actually see this in Asia-Pacific region looks poised What makes us so enthusiastic
China’s official GDP numbers, but for another year of solid growth about ‘APEJ’? What will be the
we expect the latest twist of their in 2018, with a rotation in the factors really driving growth?

SUMMARY POINTS:
The essence of Asia-Pacific as we see it –
• In such a global ‘goldilocks’ • China, South Korea, Taiwan, • Indonesia has just over 260
environment, no countries and Vietnam should benefit million people, with a low
will benefit more than from better growth in the average income; there is huge
the EMs developed world potential for this to improve
• Global trade is growing; • If or when commodity • Asia-Pacific is seeing a shift

within that, EMs are trading prices recover, Australia and to domestic consumption
more between themselves, Indonesia should do very well as the middle classes grow,
especially in Asia-Pacific – a bonus! driving growth
• Our FX experts like the • After tax reform in the • Chinese consumers are moving
Singapore dollar and the US, higher infrastructure to premium brands e.g.
Thai baht, and expect less spending should benefit upgrading the quality of food
volatility than in the past commodity-producing EMs they demand
• Global growth drives • Demographics are poor in • Japanese growth is improving -

imports, boosting exporting the developed world, but are and as the world’s third largest
countries like Korea, very good in countries like economy this is good news for
Singapore and Thailand Indonesia and the Philippines A-P

• There is a good balance of corporate profits in China (vs. RISK FACTORS:

different sizes and types 80% ten years ago)
of economy (even if China • A US recession (of course)
is dominant) • The new economy in A-P is
driven forward by robotics • Australia has some entrenched
• Labour mobility in SE Asia is and AI – and President Xi has fundamental problems, and only
quite high, facilitating ongoing underlined this kicks-in cyclically
economic growth
• China’s authorities are clued- • Unexpected excessive upside in
• The world tourism industry up: they know they must the US dollar, and/or larger rate
is being transformed by increase foreign interest in its rises than we envisage
the Chinese, with A-P travel capital markets
greatly stimulated • Armed conflict in the region
• Chinese equities have been
• China fiscal policy is expected to climbing a ‘Wall of Worry’ (‘What • Weak currencies at times –
be supportive of regional growth, about all that debt?’) although even the Vietnamese
via large infrastructure projects dong now avoids major downside
• Chinese equities (and bonds)
• Growth in China’s services should increase in global indices • Demographics in China (and
sectors and retail sales (MSCI) - off a tiny base Japan, of course): slackening the
means they are on the right ‘One Child’ policy is way too late
transformation track • Which are the real gems in
this exciting region? Vietnam, • China’s debt (although as
• Information Technology-led with export growth, and also mentioned the ‘carve-out’, good
structural change is occurring – with domestic growth - also GDP growth, and the savings rate
and spread across much of A-P the Philippines are key)
• China’s Baidu, Alibaba & Tencent • And which is the nation-state

are now world leading companies gluing all these countries
– like Taiwan Semi and Hynix together, and real quality
itself?... Singapore, of course!
• Chip makers around the world
have been a major driver of • EMs around the world are
markets – and A-P stands desperate to understand how to
out here replicate what has been achieved
in Singapore
• China leads much of the CLINT DOVE
developed world in E-commerce, Investment Strategy,
social networking, and the Products & Services - Wealth &
cashless society “In terms of economic Private Banking
fundamentals, Asia-Pacific
• The ‘old economy’ is estimated ticks just about all the boxes” KEH CHUN WEI
to only account for 60% of International Banking, Singapore

28 THE OIL MARKET

THE OIL MARKET 29
THE OIL
MARKET

30 THE OIL MARKET
The Oil Market
Those of you who read our report whilst there is still some room for “Low level of CAPEX within
at the beginning of 2017 will a test of $70 we expect this next the conventional sector
already have been aware of our resistance level to hold for the time remains ‘the elephant in the
more optimistic outlook for crude being. Further out we believe that room’ ”
prices compared to the general the market in general will remain
consensus view at the time. Since supported by fundamentals, namely
then the market has staged a the on-going recovery in demand
pretty respectable recovery, with which is finally having an impact because aside from trying to ensure
Brent recording an average 2017 on global crude stocks, supported that the market rebalancing process
price of $54 per barrel, which was in part by the OPEC/NOPEC output continues, both have other specific
admittedly just below our original reduction agreement with its better key domestic reasons to support an
forecast of $57, but definitely than expected compliance rate of extension of the output cap in 2018,
healthier than the US$44 achieved over 80%, and which the signatories such as the impending IPO of Saudi
in 2016. have agreed to extend for a further Aramco and the Russian elections.
nine months past the accord’s initial It must be noted however that the
On a short-term technical basis the March, 2018, expiry date. This latest extension will be reviewed again in
move to just below $65/barrel in extension was anticipated given June this year, when certain OPEC
December last year has basically the fact that Moscow and Riyadh members have hinted they may
met our near-term target, and remain the prime drivers of the deal, reveal their exit strategy from the

THE OIL MARKET 31
agreement, depending of course on growth for crude by 2025. has also ignored the ‘elephant in the
market conditions at the time. room’, which is the dramatic fall in
Of course we cannot ignore the capital expenditure on conventional
On the global crude demand front, threat of US shale production, field development and exploration
Asia will likely remain the main noting too that it has rebounded in since 2014, a situation underlined
driver of such growth in the year line with last year’s price recovery, yet again by recent data showing
ahead, especially countries such as and will likely continue to provide that the number of newly-approved
China and India. This was underlined a cap on a sharper move higher in conventional projects are at their
in November, 2017, when China’s oil prices over the next 12 months lowest level in 60 years, and that
total oil imports rose to 9.01 million or so. However as outlined in potential fresh oil reserve discoveries
barrels/day, their second-highest our early 2017 piece we believe last year totalled just 2.4 billion
level on record. Meanwhile, the IEA this particular sector has been barrels, compared to a historical
predicts that China’s consumption somewhat over-hyped, particularly annual average of 9 billion barrels.
of transport-related fuels will with regards to its actual percentage For us this is something that might
continue to expand by 3.3% per contribution to total oil supply, create another crude supply crunch
annum over the next 12 years, and its questionable long-term within the next 3-5 years.
although adding that India will geological sustainability, the latter
probably overtake it and become being too detailed a discussion to Renewables is another topic that
the world’s largest source of demand enter into here. This narrow focus continues to receive plenty of media

32 THE OIL MARKET
coverage, and we agree that this will still comes from fossil fuels, and at the current global geopolitical
be the primary game-changer for even bio-fuel production in the environment the risk of other
the market in the long-term, but its US appears to be running into surprise events taking place this year
actual impact on the demand for oil headwinds, highlighted by Du Pont’s appears to be growing. Venezuela,
remains very limited for now, and decision recently to shut the world’s a country with the world’s largest
this will only change once the vast largest cellulosic ethanol plant in proven oil reserves is still undergoing
network of infrastructure required Iowa just two years after it opened. a social and economic meltdown,
to support such alternative sources which in turn continues to reduce
of energy is in place. Electric cars still Finally there are the imponderables both the quality and quantity of
only makeup just 2% of the global (or aptly-named ‘black swan’ events) Venezuela’s crude output. In Africa,
market, and such vehicles are still which are difficult to predict but on-going militant activity in Libya,
extremely pricey compared to their continue to occur, an issue that was and the potential for a resumption
internal combustion compatriots, highlighted as recently as last month of similar activity and/or protests
with domestic subsidies generally by the sudden surprise shutdown in Nigeria’s oil-rich Niger delta
providing support to their overall of a major North Sea pipeline for could threaten supplies, while in
sales performance. Meanwhile, over repairs, and threats by oil workers Washington much-promised changes
80% of global energy consumption in Nigeria to go on strike. Looking to US energy policies have yet to

THE OIL MARKET 33
even be drafted, with tax reform, CONCLUSION:

NAFTA, the Russia investigation and We remain positive in our outlook
Obamacare the primary domestic for crude oil prices, especially
areas of attention for the Trump further out, whilst in the interim -
administration up to now. Closer to and barring any unforeseen events
home, US moves to pressure Iran - we expect prices to hold onto the
over its missile activity and the gains made in 2017 and for the
decision by President Trump not to average price of Brent to rise to
confirm Iranian compliance with around $60/barrel over the next
the JCPOA agreement late last year 12 months, within a likely trading
may even put the nuclear accord range of $50-70.
at risk of collapse, and combined
with the consequent threat of fresh GLENN WEPENER
US sanctions this could potentially Market Insights & Strategy Group
reverse at least some of the sharp Global Markets
recovery in Iranian crude exports
*Note: FAB/IMF/WB estimates
seen during 2016/17.

34 THE MENA REGION

THE MENA REGION 35
THE MENA REGION

36 THE MENA REGION
The MENA Region
Given the global strategic crude market, and this was clearly founding in 1932. Thus bearing the
importance of the MENA region underlined by the output cut above in mind it’s likely the year
and the various geopolitical fault- agreement, a key driver behind ahead will be another eventful
lines within it, one should always last year’s oil price recovery, which one for the Middle East and North
try to anticipate the unexpected. did not collapse as a number of Africa. And so without dusting off
At the same time there are many commentators had suggested it the crystal ball we have tried to
more positive developments might. Egypt’s economic recovery, give our brief take on what 2018
going on in this part of the world reform implementation and could bring for a number of key
than the negative headlines the political stability has been solid states within the region.
24/7 news outlets appear to despite the doomsayers, the GCC
focus on. 2017 was a year where currency pegs remain in place, and “ The momentous changes
many mainstream predictions Saudi Arabia, after years of false currently underway in Saudi
and forecasts made during 2016 starts, has finally begun a crucially Arabia are set to dominate
were proven to be wrong; OPEC important reform process which regional headlines during
showed that it remains extremely could have the largest impact on it 2018.”
relevant when it comes to the and the region since the Kingdom’s

THE MENA REGION 37
Saudi Arabia
FAB Outlook: Cautiously Positive
2018 GDP Forecast: 2.00% (-0.30% in 2017)*
Saud Arabia’s social and economic to the Crown Prince’s key support
framework experienced the start of a base namely the youth, who make up
historically important shift last year, this country’s largest demographic.
and this is expected to continue in There is significant new ground
2018 driven by the lofty ambitions being broken in other areas too,
of Crown Prince Mohammed bin Saudi woman will be allowed to
Salman (often referred to as MBS). drive for the first time from June,
Meanwhile although the Saudi cinemas will begin operating again
Aramco IPO, which we expect to from March, conventional tourism
take place during the latter part of visas are set to become ‘de rigueur’
the year, will be the prime event for while more importantly MBS “Progress on economic
investors, so too will the Kingdom’s has promised to restore a more diversification is key.”
potential of being added to both “moderate and balanced” form of
the MSCI and FTSE Russell EM Islam to the Kingdom, and success
market indexes. The detention of a in this area in particular could be
number of high profile individuals in a key development in effectively in revenues (firmer oil price/levies/
November last year on allegations combatting radicalism both at home VAT etc..) and the implementation
of graft has been analyzed and and abroad. of certain domestic subsidy cuts
discussed from various viewpoints, such as those linked to fuel. Official
but for us it should be judged overall On the spending front the forecasts see the deficit falling to
as a positive step. Corruption has government recently unveiled a 7.30% of GDP this year from 8.90%
been an acknowledged problem in budget of SAR 978 billion for 2018 in 2017 and 14.20% in 2016.
Saudi Arabia for many years and this as it looks to give the economy a
specific move, although coming as a kick start after its contraction last Risks of course remain. The changes
surprise, was a way for MBS to send a year. More than 10% of this record proposed within ‘Vision 2030’ are
clear message that the old ‘business breaking budget will be directed laudable but will be extremely
as usual’ environment is ending and towards boosting exports and challenging to meet, and thus
that no-one is untouchable. It also the development of new sectors. it’s vitally important that the
allowed the government to recoup Despite this jump in expenditure, reform process both on the social
some funds that can now be directed which will include support for lower and economic fronts is not only
towards development projects as income families, and a decision to implemented swiftly, but also
well helping to further ease the extend the earlier balanced budget efficiently and sensitively. MBS has
budget deficit. A more transparent target date from 2020 to 2023, taken a lot on his relatively young
commercial climate should be the authorities still expect the shoulders, and his success or failure
attractive to investors, whilst on the overall fiscal deficit to continue to will determine the long-term future
political front such actions play well shrink, due to a predicted increase of Saudi Arabia.

38 THE MENA REGION
United Arab Emirates

FAB Outlook: Positive
2018 GDP Forecast: 3.50% (1.30% in 2017)*
The UAE remains the most is in a strong position to take “Renewed government
diversified economy within the advantage of an improving global spending set to boost
GCC with the non-oil sector now economic climate. In fact the growth.”
accounting for around 69% of GDP. government has already begun to
More recently it was the first to loosen its purse strings, and work
rein in public spending, remove has re-started on a number of
fuel subsidies, and open up new key infrastructure projects, which
sources of sustainable revenue in turn should give the domestic much watched real estate market
generation, aside from bond economy a boost. appears to be making a slow but
issuances, in response to the oil steady recovery, and activity in
price drop which began in 2014. 2018 marks the introduction of this sector is likely to pick-up as
value-added-tax and here again preparations for EXPO 2020 in
Abu Dhabi conducted the the UAE has been at the forefront Dubai gathers pace. Meanwhile
successful IPO of ADNOC’s fuel of its implementation compared to the increased development and
distribution unit at the end of its regional peers. Liquidity within adoption of new technologies,
2017. Now with crude above the banking sector has improved especially ‘Fintech,’ is an important
US$50 a barrel and the Federal markedly this past year and focus for the government and an
budget back in the black the UAE although lending is sluggish, the area to watch in the year ahead.

THE MENA REGION 39
Kuwait
FAB Outlook: Positive
2018 GDP Forecast: 3.00% (-1.50% in 2017)*
Kuwait’s overall real GDP growth

contracted during 2017, due
primarily to a drop in oil related
revenues that in turn, was caused
by the reduction in the country’s
crude production as it kept to
its relevant quota level within
the OPEC/NOPEC output cut
agreement. However the economy
is expected to rebound in 2018,
supported by continued expansion
within the non-oil sector, and
infrastructure project activity
linked to the government’s five- projects. It has also triggered a “GDP contraction in 2017
year ‘National Development Plan.’ number of dissolutions of the linked to oil output reduction
Meanwhile the domestic banking assembly, which in turn leads agreement”
sector is sound, with strong capital to yet another election (four
buffers and should benefit from have been held since 2012), and
the anticipated improvement in the formation of a new cabinet,
economic conditions next year. amplifying these delays. The has significant assets and fiscal
Elsewhere, the real estate market most recent example of this took buffers at its disposal, and has
appears to have stabilized and is place in October 2017, when the been able to weather most of the
showing some signs of upward Prime Minister resigned following internal and external economic
momentum again, albeit at a the filing of a no-confidence challenges it has faced so far,
relatively cautious pace. For us motion against two other senior including the recent extended
a possible risk to this general ministers by various opposition period of low oil prices. However
economic recovery lies within the members, and reported attempts it still relies far too heavily on
domestic political space; Kuwait’s by the opposition to block various revenue generated by its energy
parliament often sees lively government proposals including sector, thus as with certain other
debates take place, but this has in fuel price hikes. In response to this GCC economies, efforts towards
the past also led to an extended event the country’s Emir, Sheikh further diversification, combined
delay in the implementation Sabah Al Ahmad Al Sabah, was with reforms, such as the steady
of important draft bills on the recently quoted by local media removal of costly subsidies, and
economy, whether it is getting outlets calling on the assembly activation of policies aimed at
MPs to agree on certain necessary to act responsibly for the security boosting the private sector will
austerity measures, or giving the and stability of the state. Longer all need to be enacted sooner
green light on major development term, whilst Kuwait currently than later.

40 THE MENA REGION
Iraq
FAB Outlook: Uncertain
2018 GDP Forecast: 2.75% (-0.50% in 2017)*
“With the war over Iraq now

faces numerous economic &
social challenges”
autonomous region’s decision to

hold an independence referendum
last year, which was later ruled
by Iraq’s Supreme Court as being
‘unconstitutional’ and led to federal
government forces entering areas
previously controlled by the Kurds,
Following a contraction in GDP billion issuance during the second including the oil-rich province
during 2017, Iraq’s economy is half of 2018 (the budget is based on of Kirkuk.
expected to begin expanding again a conservative average forecasted
next year, driven by an increase oil price of around $46 per barrel), Meanwhile the government faces
in crude exports, the continued while the current US dollar-pegged an enormous and costly challenge
implementation of various reform exchange regime is likely to remain to rebuild those cities and towns
measures and an improvement in in place. impacted by the civil war, a process
the overall security situation. In that will need to be done as swiftly
the meantime the government Several domestic political risks and sensitively as possible. Thus all
continues to work closely with the remain and these could heat- the major political parties within
IMF, and has promised to enact up ahead of provincial and Iraq will need to find a way to work
further steps to better control and parliamentary elections due to closer together to ensure that any
streamline its future expenditure, be held in May 2018, a poll which incoming administration will be able
reduce bureaucracy and ensure debt will also determine whether or not to operate effectively. The country
sustainability. With regards to the Prime Minister Haider Al Abadi will will also require significant long-term
latter, Iraq is expected to return to serve another term. The future of financial aid and expertise to rebuild
the international debt market this Kurdistan in particular will remain its economy, not just from agencies
year with the government’s draft a highly charged issue in 2018, such as the IMF and World Bank but
budget including a proposal for a $2 especially following the semi- also from countries such as the US.

THE MENA REGION 41
Turkey
FAB Outlook: Uncertain
2018 GDP Forecast: 4.00% (5.50% in 2017)*
Turkey’s economy performed far

better than expected in 2017 due
in part to government stimulus
efforts; however our outlook for
2018 is more cautious. The political
landscape both internally and
externally remains volatile, the
latter situation highlighted by
Turkey’s continued tense relations
with the EU and the US.
On the economic front and

although growth has been strong,
there are some signs it may be
starting to overheat. For example
inflation has risen sharply this
past year and is now close to a
14-year high (12.98% y/y) but the
Central Bank has not as yet moved record this in your memory,” he “Politics may constrain future
adequately enough to counter this stated in December 2017. growth.”
expansion by aggressively raising
rates, a situation which some Meanwhile Turkey’s foreign debt
analysts suggest is due primarily position has again come under
to domestic political pressure and the spotlight with domestic banks fund its widening budget deficit)
that in turn has raised concerns currently holding an estimated reduced their holdings. While we
over the bank’s ability to retain $172 billion in external debt, do not anticipate a near-term debt
its independence. according to a recent report by the crisis, as Turkey’s banks remain
Fitch ratings agency, with a large well-managed and have decent
President Erdogan was quoted chunk of this due to mature over levels of capital reserves, the
numerous times last year claiming the next 9-12 months. All of these economy looks likely to struggle to
publically that those pushing concerns have been reflected most reach the same level of growth in
for higher rates as a solution to acutely by the recent performance 2018 that it achieved last year, and
inflation were wrong; “I am against of the local currency, the lira, although investors will probably
high interest rates, I will continue which was hammered towards the be attracted by the higher bond
to announce this. It is impossible end of 2017 as short-term foreign yields and a weaker Lira, both
for inflation to decrease in a investors in Turkish assets (which markets look set for another
country with high interest rates, the country relies heavily upon to volatile year ahead.

42 THE MENA REGION
Egypt
2018 GDP Forecast: 4.40% (4.20% in 2017)*
“The recent strong recovery

looks set to continue.”
negative reactions triggered by

the sharp devaluation of the
Egyptian pound last year, and that
consequently touched a record high
of 35.26% at one stage, is likely to
continue to ease significantly in
the months ahead; this in turn will
enable the Central Bank to begin
Egypt’s economy has rebounded Meanwhile the credit agencies cutting interest rates.
strongly since an IMF led economic also appear to also like what they
reform program was adopted and see, with S&P recently raising its Meanwhile tourism, one the
the local currency was floated outlook on Egypt from positive to country’s key employers and
back in November 2016. The more stable. We expect another year source of foreign exchange, is
transparent FX regime attracted of consolidation and expansion making a steady recovery, the
over $57 billion of foreign funds for the Egyptian economy, and giant Al Zohr gas field began
into domestic assets such as T-Bills that the government will continue operating at the end of last year
and T-Bonds, and these flows also to implement reforms, albeit at and has the potential to eventually
helped boost Egypt’s FX reserves perhaps a slightly slower pace, make Egypt self-sufficient in terms
to their highest level since 2010. taking into account the near-term of its domestic natural gas needs,
The IMF conducted a review of the impact all of these harsh, but whilst on the political front, the
government’s reform performance necessary measures have had on Sisi administration appears stable.
towards the end of last year the poorer sections of Egyptian (You can read our more detailed
and said it was pleased with the society. In this regard inflation, outlook for the Egyptian market
progress made thus far. which was one of the primary on page 92).

THE MENA REGION 43
Morocco
2018 GDP Forecast: 4.50% (4.40% in 2017)*
Morocco was again the star in duration.

performer in North Africa last
year, with the economy supported Despite its successes, further
by healthy tourism numbers actions such as those mentioned
and a rebound in agricultural above are imperative if Morocco
production following the end of expects to reduce its stubbornly
a serious drought. Progress has high unemployment level of
also been made on economic 21% and achieve sustainable
diversification with a strong focus long-term economic growth. One
on developing the manufacturing specific area of concern are the
sector, while the banking sector ongoing protests in the north of
remains robust with more than the country, where demonstrators
adequate capital buffers. Other have been calling for better
good news is that inflation education, healthcare and job “North Africa’s star performer
continues to ease whilst the opportunities in their region. but room for improvement.”
government has promised to work Political will in Rabat is therefore
towards reducing the fiscal gap important in order for progress to
further, making the tax system be made on these issues where
more efficient and introducing there are still some hurdles to
a more flexible exchange rate overcome. The current coalition
regime. Implementation of the government was only formed
latter would help boost exports almost six months after elections
and attract greater foreign had been held in October 2016,
investment, but the previously due to disagreement between
proposed July 2017 kickoff of the various parties, then in
steps towards a more flexible October 2017, the King dismissed
currency was delayed by the a number of cabinet ministers
authorities over concerns of reportedly on the back of their
potential market volatility and poor performance. Thus effectively
speculation; this was unfortunate pursuing the country’s reform
and probably unnecessary as program in 2018 will depend on
the country currently has a the Prime Minister, Saadeddine
decent level of FX reserves and El Othmani’s ability to keep the GLENN WEPENER
the changes would have been coalition together and persuade Market Insights & Strategy Group
executed slowly over a period of its representatives from all Global Markets
time, so any volatility would most six political parties to support
likely have been only short-term this initiative. *Note: FAB/IMF/WB estimates

44 GLOBAL FIXED INCOME – DEVELOPED MARKETS

GLOBAL FIXED INCOME – DEVELOPED MARKETS 45
GLOBAL FIXED INCOME –

DEVELOPED MARKETS

Global Fixed Income – Developed Markets
Donald Trump’s inauguration as other Trump policies followed, enacted, although the benefits
President of the United States opening the way for rallies in will be spread out over 2018 and
on 31st January, 2017, followed many fixed income markets and 2019. Thus more rate hikes by the
much trepidation coming into the beginning of a soft year for Fed are almost certain in 2018, the
the close of 2016. With markets the dollar. question is how many?
priced for reflation of the US
economy and associated interest The US economy has not yet The markets currently price nearly
rate normalization by the Federal been boosted by tax reforms and three hikes between now and the
Reserve (Fed), the US dollar was infrastructure spending, but then end of 2019. The median value
king and credit markets were again it hasn’t needed it. The of the latest Fed forecasts (the
nervous about the implications, economy has had a good year and so called ‘dot plot’) prices three
not least in emerging markets. at the time of writing, the fourth hikes for next year. The impact of
quarter is probably set to be the 2017’s hikes has been felt at the
The first cracks in this story came strongest quarter of the year with front-end of the US yield curve,
when it became clear that Trump growth comfortably above 3%. but it has not been so obvious for
was not going to repeal parts of Tax reform is back on the agenda longer maturities. The US 2-year
‘Obamacare’ easily. Doubts about with a serious chance of being Treasury yield has risen from just

under 1.20%, to around 1.83% as Longer maturity Treasuries have and inflation.
we go to print. In contrast, the US been helped by both stable US inflation and wages will be
30-year yield has fallen from just expectations about trend growth very important for the markets
above 3.00%, to around 2.70%. in the US, and stable views about again in 2018. Official forecasts
So the yield curve has flattened the level where the Fed might see only limited rises; the OECD,
dramatically. It could be argued eventually put rates up to. They for instance, has the CPI remaining
that if the Treasury market moves have been especially helped around 2%. This level is in line with
in line with 2017, then the US by inflation data in 2017 that market pricing of the medium
2-year yield could rise another 50 has been notably lower than term rate of just under 2% as
to 75 bps if the Fed hikes two to consensus forecasts, and wages at the end of 2017. If growth
three times in 2018. This would that have not increased while expectations are not pushed
take the yield into the 2.25% to the labour market has been much higher by tax reforms, and
2.50% range. We should add that improving. Many of you will be inflation remains stable, longer-
replacing Janet Yellen as Fed Chair aware of this issue in terms of the dated yields may increase very
with Jerome Powell is unlikely to debate about the Phillips Curve, little if the Fed hikes rates.
have a significant impact on Fed which attempts to analyze the
policy-making. trade-off between unemployment The risks to this kind of view

of US Treasury yields lie to the essentially driven by various takes is roughly right, then the ECB is
upside (i.e. lower prices), judging on late-cycle behaviour of the unlikely to be doing anything with
by market outlook commentaries economy and the Fed, then the rates in 2018. Moreover, whilst
doing the rounds. The main factors outlook for Bunds in Europe must they are reducing their purchases
driving these views are: inflation surely be for limited moves. The of assets in their QE programme,
will increase more than suggested Eurozone economy has surprised they are still buying and increasing
above, due to tight labour markets positively in 2017 with GDP growth the balance sheet, just at a slower
eventually impacting wages ending up comfortably above 2% rate. This all suggests that Bund
and therefore inflation; inflation and set to remain there in 2018. yields won’t move far from current
being under upwards pressure However, the economy still has a levels. The risks to this appear to
from the lagged effects of the considerable amount of slack with be on the upside for yields as well,
weaker dollar in 2017; the Fed unemployment rates still relatively if: fiscal policy is more stimulative
being more aggressive as financial high. Consequently inflation will than expected; political risks build
conditions continue to improve remain both low, and lower than again (watch the Italian elections);
due to firm equity markets and ECB targets, therefore closer to 1% or if the ECB begins to signal rate
as they remain concerned by the than 2%. Also, if US inflation might or QE changes for early 2019.
inappropriate risk-taking that low be pushed a little higher by lagged
interest rates supports; and the impacts of dollar weakness, then The last of the big three
impact of the Fed’s balance sheet Eurozone inflation may be pushed government bond markets is
reduction policy (i.e. winding down a little lower by lagged impacts of obviously Japan. The Japanese
quantitative easing or QE). euro strength. economy will have grown by
over 1% in 2017 and looks set to
If the outlook for US Treasuries is If this growth and inflation picture do the same in 2018, the fourth

year running when growth will be CONCLUSION:

above 1%. However, inflation is
and is forecast to remain around Given the above analysis, the
1% too, and below that on Japan’s likely trading range in the bell-
‘core’ basis, despite a very tight weather US 10-year Treasury yield
labour market. The Bank of Japan is expected to be approximately
is surely reasonably happy with 2.20-3.00% during 2018 (up from
this mix but it is not a mix that last year’s 2.15-2.60%), with the
will cause them to change policy maintained underweight position
rates or their interventions in the in developed market government
JGB market. This latter policy of bonds on the part of the FAB Asset
so-called ‘yield curve control’ keeps Allocation Committee in its model
10-year JGB yields around zero. portfolios suggesting that if there
Recent comments by the central is to be a break out of this yield
bank governor suggested that range, it will more likely be to the IAN CLARKE
this target may be reviewed and upside rather than the downside. Investment Management,
revised later in 2018, so as not to Products & Services, Wealth &
undermine returns for pension Private Banking
funds and insurance companies,
and in turn consumers. However, ALAIN MARCKUS
even if this turns out to be the Head of Investment Strategy,
case, commentators talk about 10- Products & Services - Wealth &
year JGB yields rising to 0.20%! Private Banking

50 MENA BOND & SUKUK MARKETS

MENA BOND & SUKUK MARKETS 51
MENA BOND & SUKUK

MARKETS

MENA Bond & Sukuk Markets

whether 2018 will be another year
of attractive returns. Will global
growth be good again and regional
growth pick up? Will inflation pick
up? Will the US Federal Reserve
(Fed) hike rates more - or less -
than priced into the markets?
What will oil prices do? Will Middle
East politics be surprising and
eventful again, or will the tensions
evident at the end of 2017 ease
in 2018?
Global growth forecasts from the

IMF and OECD are for 3.6% in 2017
and 3.7% in 2018. IMF forecasts
for MENA are 2.2% (the lowest
since 2009) and 3.2%. Inflation
for the developed economies
is seen stable at 1.7% for both
years, crucially with US inflation
remaining stable around 2%.
MENA bond and sukuk markets limited rate hikes from the US Growth with little inflation may be
had another good year in 2017, Federal Reserve and a soft US dollar. something of a puzzle, but it is a
following on from the rewarding The two, major drivers of returns situation that should allow the Fed
2016. Performance was broadly – credit spreads and underlying US and other central banks to tighten
in line with similarly rated bonds Treasuries – contributed equally policy gradually. Thus, global
elsewhere in global credit markets, to returns. In line with this, lower- growth should continue to support
as a combination of rising oil prices, rated bonds and sukuk with higher demand for oil, as was the case in
stable economic growth in the credit spreads generally performed 2017, which in turn should support
region (even if it wasn’t strong) best. Longer maturity bonds also the oil producing countries in the
and benign developments in the tended to perform better due to region. A growth backdrop of this
global environment helped. Of the the flatter US Treasury yield curve kind should allow credit spreads to
global factors it is worth stressing and tightening of credit spreads. either remain where they are or
that good, global growth that tighten a little further.
was accompanied by low inflation Most of these factors seem likely
allowed the major central banks to be important again for MENA A number of analysts and
to tighten policy gradually, or bonds and sukuk in 2018. Their commentators have raised
do nothing of note. Thus we saw interplay is likely to determine concerns about tight credit

MENA BOND & SUKUK MARKETS 53
spreads in MENA, but in our view exceed 10% of GDP in 2018, with remains very wide. In the GCC,
spreads in the region remain above only Kuwait and Qatar running spreads for Abu Dhabi have
measures of fair value in most surpluses. The big economies of tightened around 20 bps this year,
cases, with a favourable growth Saudi Arabia and the UAE will see whilst those for Bahrain have
outlook. Credit spreads in markets improvements, but the former will widened by a similar amount.
such as the US High Yield market still run a fairly sizeable budget 10-year spreads for these two
have tightened to the levels of a deficit. Consequently, credit sovereigns are around 100 bps and
decade ago, and at a time when ratings for issuers from a number 450 bps, so a 350 bps difference.
corporate leverage has increased, of countries are likely to remain In contrast, and highlighting the
so this is clearly food for thought. under pressure. intra-region opportunities that
However, spreads for GCC and can present themselves, although
MENA issuers have not tightened The current account balances Egypt has been a B/B- rated
quite so much relative to historical are and will be generally more credit all year, credit spreads have
levels, and still offer value as noted favourable, although there is a tightened from over 500 bps to
above in our view. Prospects for similar relative picture. According around 325 bps in 2017 as the
capital appreciation due to tighter to the IMF, the UAE will have a country has begun implementing
spreads is clearly more limited in current account surplus of just the IMF reforms and otherwise
2018. However, yield and carry still over 2% of GDP in 2017 and 2018. normalized the economy. Thus
promise reasonable returns. Saudi Arabia should have small the markets have begun to price a
surpluses in each year, following ratings upgrade in 2018.
Fiscal policy in MENA has obviously deficits of 8.7% and 4.3% of GDP
been a focal point since oil in the last two years. However, In contrast to this and the positive
prices fell into the start of 2016. current account deficits will persist ratings transitions that were seen
Subsidies have been cut and for Bahrain and Oman, around overall in credit markets globally
taxes raised, most notably the 1.5% still for Bahrain and more in 2017, there were a number of
introduction of VAT in parts of the troubling levels of 14.3% and downgrades in the region. Bahrain
GCC. These earlier adjustments 13.2% for Oman. This highlights lost its last investment grade
and higher oil prices support the that economies, credit ratings and rating in July, with S&P moving
idea that further fiscal policy market developments are likely to it down into the single Bs (B+)
adjustments will be more limited, diverge further in 2018. in December. S&P moved Oman
in line with recommendations down from investment grade to
from organizations such as the Oil prices will clearly remain BB during 2017 and there must be
IMF, and in line with the apparent important in these regards. Prices a chance that either Moody’s or
mood amongst policy makers who that remain around current Fitch move in the same direction
would like to see growth pick up. levels, as noted elsewhere in the in 2018, given that both these
However, fiscal breakeven oil prices Outlook, will give more time and agencies still have the sovereign
remain above current levels for a space for the weaker countries rated investment grade. However,
number of countries despite the to correct their trajectories. The this presents opportunities as
2017 rally. Thus fiscal deficits in spread between the strongest sovereign ratings in the region
Bahrain and Oman will continue to and weakest credits in the region now range from AA (i.e. UAE and

Kuwait) to the likes of Bahrain and the yield curve for regional issuers
then down to the B- countries (e.g. as they both included 30-year
Egypt). With spreads generally bonds in their programmes. This
above our estimates of value for follows $81 billion of issuance in
ratings, the yields associated with 2016. As per JP Morgan’s MECI
the lower ratings are welcome. (Middle East Composite Index) the
size of the market has gone from
The flip side of lower oil prices $169 billion at the end of 2015,
in recent years has been the to $221 billion in 2016 and $282
remarkable growth of MENA billion as at 30th November, 2017.
bond and sukuk markets. At the Duration of the index has gone up
time of writing and according to from 5 to 6 years over this period, IAN CLARKE
Bloomberg data, there has been in part reflecting the issuance of Investment Management,
issuance of $95.8 billion in 2017, longer-dated bonds. This increase Products & Services, Wealth &
with the governments of Saudi in the size and range of the market Private Banking
Arabia and Abu Dhabi being the has attracted regular interest from
largest issuers. These last two international investors from the IDRISSA BOLY
issuers highlight not just the US, Europe and Asia. The breadth Investment Management,
increased size of the market, but of the market and investor base Products & Services, Wealth &
also the ongoing development of will remain a feature in 2018. Private Banking

ASIA BOND MARKETS 55
ASIA BOND MARKETS

56 ASIA BOND MARKETS
Asia Bond Markets
Firstly, in considering how local Asian bond markets might perform in Unless there is a genuine shock, or
2018, these will to an extent be constrained by expected rate rises in the economic policy mis-step in the
US and perhaps by a few other developed world central banks, but in US (or China), Asian bond markets
many ways Asian regional markets should continue to see local regional should still do quite well looking at
factors driving them. the outlook to the end of 2018. Any
local rate increases that do occur
should be quite well telegraphed to
the market. Successful passage of
tax reform in the US would be good
for US growth (and hence bearish for
‘developed’ bonds), but Asian bonds
are likely to continue to see regional
demand rise to meet continued

ASIA BOND MARKETS 57
very healthy issuance. Also, we slightly during the final quarter of came from Chinese names last year,
mustn’t forget that tax reform in 2017, reflecting the deleveraging. and these are expected to continue
the US would be positive for the Having said this, our feeling is to drive the market. But will this
Asian corporate sector, helping to that Chinese officials are very maintained high volume of new
keep local regional credit spreads mindful of the impact on the issues push rates wider and higher?
tight. The base case outlook for real economy, and indeed we Not necessarily, given that Asia as a
2018 is one of continued growth have seen them add short-term region has one of the world’s largest
for the region, but slowing slightly liquidity in size whenever it has trade surpluses, so the region can
from 2017’s rate, as discussed been necessary recently. In the easily fund itself and funds will likely
elsewhere in this book. Politically latter part of last year pressure on continue to meet on-going issuance
we expect more stability in the credit spreads increased regionally head-on – a genuine structural
region, especially following the as the cost of funding positions positive for regional credit and the
overall outcome of the Chinese increased for Chinese onshore possibility of lower interest rates
Communist Party’s 19th Congress a investors. However, we mustn’t get over time. We would also note that
few months ago. Lastly, regarding too bearish as we would underline ‘Asia EM’ companies and investors
North Korea, although they might it was a calculated and self- are doing more bond business within
do some more missile tests we don’t inflicted move from government the region, with these markets
think they have any genuine desire policy designed to normalize becoming less dependent on
to enter into conflict. Overall the funding and reduce the leverage. If Developed World buyers over time.
improved political environment in we saw the 10-year sovereign yield
the Asian region should serve to rise towards the 4.30-4.50% area, So what is our trading view for fixed
maintain credit spreads at what that would be of some concern; income credit markets in 2018,
are historically tight levels. Such however, the yield has fallen based on the above background? We
is the enthusiasm for investing in back to just above 3.90%, hence expect a good start to 2018, based on
Asian bonds. regional credit markets do have new cash inflows, and more settled
a more settled and positive look onshore rates in China. While a settled
China is always the big story when about them. US bond market would clearly be a
looking at the regional economic better background for our markets
outlook in relation to credit Considering the outlook for to be operating against, as we’ve
spreads. After President Xi made issuance, we should first mention hinted we don’t assume that. Even so,
it clear in his marathon Congress that 2017 saw over $220 billion of unless international influences really
speech that the self-imposed regional bonds issued, a sizeable move against us, we do expect Asian
credit squeeze would continue, 40% or so higher than 2016 levels. credit spreads to tighten initially. In
along with the investment product Our expectation is for roughly the sovereigns we would look to enter
and shadow banking clean-up, same amount as last year but some at a Chinese 10-year yield of 4%,
the bell-weather China 10-year other market participants expect or just over, using the 4.25% level
sovereign yield traded up quite a still larger amount, maybe 5-10% as a stop-loss. In credits we would
sharply, from the 3.60% area, higher than last year, based on consider relatively high quality SOE
to 4.03% on a closing basis. This firm forecasts for corporate capital and infrastructure names. Selectivity
occurred despite growth slowing expenditure. Over 60% of new issues is clearly key, as many of these have

58 ASIA BOND MARKETS
become expensive, trading well below CONCLUSIONS:

a US Treasuries +100 basis point By the year-end we would expect
spread in a 5-year tenor, when fair to see higher outright rates, but
value is probably nearer UST’s +115 once again tighter credit spreads
basis points (of course depending for credits in the region and
as always on the issuer) – but the relative to offshore markets would
underlying demand appears very look for local fixed income to
solid. After the good expected start, outperform in what could easily be
though, we would caution that by a global rising rate environment.
the second quarter a raft of new SOE
and infrastructure issues should be
coming to market, slowing the bullish
spread performance.
What are amongst our favourite

markets for 2018? We like Hong Kong,
high-grade, low leverage counters
with good China exposure, both in the
governments and corporates. We also
expect the Chinese industry leaders
to keep getting stronger and to be
well-supported. Do make sure to avoid
the weaker ones as they are being
allowed to fail. Given the possible rate
environment it would probably be
best to keep duration quite short, at SHAUN ROBERT LYNN
3-5 years. Asia Credit Trading, Global Markets

G4 FX 59
G4 FX

60 G4 FX
G4 FX
As we move into 2018 there is Reserve were less surprising, with 2018. However, even amongst the
cautious optimism about the the former announcing a January, fundamental positives, at least
outlook for global growth, with 2018, reduction in stimulus from some geopolitical uncertainty
central banks now more prepared euro 60 billion per month, to euro remains. Angela Merkel’s inability
than they had been to remove 30 billion, and the latter continued as yet to form a coalition has
monetary stimulus, therefore its tightening by either unwinding been a shock to many, although
sending a more positive message the balance sheet, or by hiking appears to reflect the continued
regarding global economic growth interest rates as broadly predicted polarisation of German society. It
to the still somewhat sceptical by futures markets. Even the Bank seems unlikely that there will be
financial markets. of Japan has possibly come to the any reconciliation of ideals there
table, with Governor Kuroda’s term in the near future. Similarly in the
The Bank of England was probably up at the end of April, and regime case of the UK and Brexit, this has
the biggest FX surprise of 2017, in change now a bit more likely as illustrated a clear generational
terms of them hiking rates, albeit it seems he will retire after all. divide which shows no sign
just once - mainly to undo the In addition the public discussion of healing.
unnecessary post-referendum cut, of so-called ‘reversal rate theory’
while at the time being seen as has the market betting on an The US has been a fascinating
leaving the door open for further adjustment to the 10-year bond example of division over the last
moves. The ECB and the US Federal yield target in the second half of two years, with little abatement

G4 FX 61
of President Trump’s controversial who bought into Trump’s campaign would expect to see a resurrection
tweets, and with expectations rhetoric believed that trade deals of his ‘wall’ rhetoric at the very
of his diplomatic conduct so negotiated with many external least. Hopefully, Trump will avoid
lowered that a trip abroad with partners had indeed resulted in a some of the more inflammatory
no discernible hiccups is seen as a net loss for the US and its workers. kinds of comments made during
success. Within the confines of the While it may be true that the 24 his campaign, and will be cognisant
US borders it appears that Trump is year old NAFTA agreement needs of the impact that could have on
making headway in implementing to be reworked in places, the longer Mexico’s own elections; Andrew
some of his more controversial term implications of withdrawal Manual Lopez Obrador (‘Amlo’) is
campaign promises, for instance from it would not be positive the country’s foremost nationalist
with the Supreme Court passing the for the US economy, especially nominee, and it wouldn’t take
third version of his travel ban. The bearing in mind the three million much to see the electorate lean in
renegotiation of the North American workers whose jobs are supported his direction.
Free Trade Agreement (NAFTA) by exports enabled by NAFTA. In
should be watched closely in the terms of US domestic politics, with Elsewhere, the North Korea
year ahead as a portion of US GDP is the important mid-term elections situation looks no closer to being
still derived from trade with Canada coming up next November, Trump resolved. Additionally, some of
and Mexico, and disengagement cannot afford to be seen as weak America’s traditional allies in the
would prove costly. Many voters by his core supporter group, and we region have also been bruised by

62 G4 FX
some of Trump’s rhetoric (and doesn’t offer much comfort over pass the reforms was proven to
actions); for instance, Australian the next 12-18 months. Options be quite impressive, for instance
Prime Minister, Malcolm Turnbull, for Trump in dealing with Korea considering the pace with which it
although happy to fight alongside look limited, but provocations by was revised to a palatable format.
the US should the 1951 ANZUS Kim Jong Un within the region Driven by the quick win of front-
treaty be triggered, will not seem unlikely to lessen, and loading the tax cuts to boost the
commit his troops to be part of South Korea and Japan could well economy ahead of the mid-term
any move as an aggressor. The face continued missile launches elections, we were not surprised
Japanese are in much more of over their territories. President to see the corporate tax rate cut
a predicament, with its current Trump has created something from 35% to 21%, with immediate
constitution banning war as a similar to an ‘Obama/Syria’ headline-grabbing minimum wage
means of settling international conundrum through his ‘fire and increases from US corporates, as
disputes (although Prime Minister fury’ tweets. well as year-end bonuses for vast
Abe will be seeking to make numbers of employees. Whether
amendments to this). Japan is Key to US economic developments the bill does provide some relief to
now working with Washington to over the next few years will be middle and lower income families
develop a missile defence system, the US tax reform bill, which is yet to be seen and remains very
a boon for American weapons has just been signed into law by contentious. Trump will be keen
manufacturers if nothing else as President Trump. The political will to build on the momentum of this
the time frame for installation on the part of the Republicans to success especially given his slim

G4 FX 63
majority in the Senate, or face are due, and lest we forget, Brexit ECB president, has made it clear
being a lame-duck president for is not yet resolved. Europe is that he sees a gradual recovery
the rest of his term. struggling to condone Spanish in Europe and is happy with
Prime Minister Rajoy’s methods, progress. Although we think it
Although not immune to and the people of Catalonia highly unlikely the ECB will raise
adverse political developments have turned against the national its central rate during 2018,
in Washington for Trump, we government. Some investors are there seems no real rationale for
do expect a degree of US dollar concerned that without careful it to continue with quantitative
strength overall in 2018. This handling this could create further easing beyond this September.
will likely come at the expense instability in Spain and even a Meanwhile, the Fed’s hiking path
of the EUR, GBP, CAD and JPY, push towards a general election. In does appear to be set, barring
as American companies, many Italy, once again no political party any major data upsets. Also, the
of which hold earnings in local is expected to win an absolute fact that even the UK has hiked
currencies, buy dollars in order majority in parliament. The anti- supports at least a slightly more
to remit their funds back to the establishment Five Star party hawkish approach from the
US. There are expectations that has struggled in recent months, ECB. Given the possible political
as much as $4 trillion could flow having come under fire for lacking headwinds in the Eurozone,
back over the next two years. transparency and a proper internal and the anticipated US rate
US employment growth looks governance system, although it differential and dollar remittance
resilient, fulfilling one of the dual nonetheless remains a realistic factors discussed earlier, we
mandate pillars of the Federal contender to the Democratic would expect any short-term euro
Reserve, but inflation has proven Party. We expect Italian headlines strength to be capped at perhaps
trickier to predict. Wage growth to begin to impact on the single $1.22, within a likely trading
has not been sufficiently powerful currency in the first half of 2018, range of $1.12-1.22 during 2018.
to cause inflation to reach 2% compounded by continued
annualized on the Fed’s chosen pressure from Germany as Mrs. The UK curve has found support
measure, but good US real GDP Merkel struggles to pull together a of late, and this could continue to
growth should in our view facilitate stable coalition government. She be the case in the short-term as
further normalization of rates. may yet be forced to hold another participants might price-in more
We expect three 25 basis point election if the Social Democrats action from the Bank of England
increases in the Fed funds rate refuse to join in another grand on rates. The recent upside in
in 2018, followed by at least two coalition, or Merkel may lead a sterling (to $1.3558 currently)
in 2019. minority government, neither of has been despite the tumultuous
which are very palatable. political backdrop of Brexit and
One of the main ‘winners’ of dollar the daily struggle British Prime
strength and a steeper curve at the The economic recovery in the Minister Theresa May faces to
short end in the US should be the Eurozone has been slow moving hold onto her job. Partly provoked
European Union, which spent much but it does seem to be picking by the recent departure of First
of 2017 mired in political turmoil. up momentum as we continue Secretary of State, Damien Green,
As we move into 2018, Germany to see foreign investment into in disgrace, it looks likely Mrs. May
is still somewhat in disarray, the bloc, such that the ECB is will need to reshuffle her cabinet
Spain is dealing with Catalonian leaning towards being slightly early in the New Year. The British
separatism, the Italian elections less accommodative. Mr. Draghi, government appears to have been

64 G4 FX
struggling with combating the before becoming more bullish of Overall, we expect to see a stronger
EU’s timetable, agenda, and policy the Canadian dollar. We expect dollar (and a flatter US yield curve)
on Brexit progression. While it’s the NAFTA negotiations to add to during 2018. Although we would
true that sterling has held up very volatility, and to limit the scope of therefore expect to see the euro/
well over the last few months, CAD appreciation. dollar pair trade lower, the euro
against most people’s (including could be stronger on the crosses
our) expectations, we expect to CONCLUSIONS: in the second half of the year as
see an increase in volatility in some political uncertainties in the
the currency, and don’t envisage Overall we are relatively positive Eurozone get resolved.
the $1.32-1.37 range holding. about 2018 from an economic
We expect a break back below standpoint. Although as discussed Although dollar strength will likely
$1.30. The curve has already built the world will not be free of be US growth-led relative to various
in positivity from the Bank of geopolitical headwinds, we don’t other countries, the looming reality
England’s actions, but we remain expect any of these to result of the US mid-term elections are
unconvinced of UK fundamental in serious ‘realized’ conflict. As likely to limit dollar upside during
economic strength. Regarding mentioned elsewhere in this book, that period.
the possibility of another BoE world leaders will be much more
rate hike, we would need to see concerned about participating in as
higher UK wage inflation before much economic growth as possible
believing this to be likely. – making sure they get their fair
share of it. While it looks as though
Another central bank that has the world’s major central banks
joined the tapering choir is the will collectively be more inclined to
BOC (Bank of Canada), which tighten monetary policy during 2018
was one of the most transparent (vs. 2017), we only expect overall
central banks in 2017 with regards bank sheet shrinkage to proceed at a
to its rate path, indicating that very slow pace.
the hike in September, 2017, was
going to be the last. Nevertheless, The world will still have to contend
the market has taken the liberty with an unpredictable POTUS in 2018,
of pricing in more hikes for 2018, and this, together with elements of
finding further support with the European political uncertainty, as
OPEC extension of cuts which well as the ongoing unprecedented
should help to sustain higher oil Brexit drama, FX market volatility ALISON HIGGINS
prices. As always there is data- can only increase. While as a trading FX & Rates Products,
dependency here, and we would desk we naturally welcome this, Global Markets
need to see stronger performance this wouldn’t necessarily be bad for
from inflation and households to investors or corporates, as it should NOURAH ALZAHMI
sustain the solid economic growth produce opportunities for them to FX & Rates Products,
that Canada has been enjoying trade and/or hedge. Global Markets

MENA FX OUTLOOK 65
MENA FX
OUTLOOK

66 MENA FX OUTLOOK
Egyptian pound
EGP: Egypt is to hold presidential 2018 the central bank should be to direct more FX inflows to the
elections in 2018, with the exact able to cut interest rates by 4-5% interbank market we have been
dates still to be finalized but the as the inflationary impact of the expecting the EGP exchange rate
general expectation is for March or pound devaluation and energy to become more volatile, within
April. President Sisi, if he decides subsidy cuts from mid-2017 will a likely range of 17.00-18.50
to run, is widely expected to win fade. In our view interest rate in 2018; in that we differ from
the elections. Thus we don’t expect decreases will help the Egyptian many local banks which expect
that politics will get in the way of economy in various ways: 1) appreciation. We think that still
the economy, which still remains it will boost economic growth relatively high levels of inflation
the priority. The government has through cheaper bank lending in Egypt mean that the Egyptian
stated that no subsidy cuts are to to consumers and businesses; 2) pound should weaken in nominal
be implemented before the end it will help the government to terms to prevent the currency
of the current fiscal year which reduce budget deficit financing from appreciating in real-effective
runs from July 2017 until June costs, which are very high; and, exchange rate terms. As a result
2018. Therefore assuming that 3) it will direct finances from of all of the above, we suggest
the currency remains relatively the government towards private being long EGP Tbills in 6-12
stable, the Central Bank of Egypt investment. We remain positive months tenors to benefit from
(CBE) will begin an easing cycle, on the progress Egypt is making the relative currency stability
most likely in January when the in its reforms, which are very bold and relatively high interest rates
inflation declines to the low 20s and represent a clear break from where the FX risk is hedged
or high teens. In the first half of the past. Since the CBE started with NDFs.

MENA FX OUTLOOK 67
Nigerian naira
NGN: It is a mixed story for Nigeria course of 2018. Inflation has

and depends very much on one’s turned in Nigeria, and should
outlook for oil prices. Considering gradually fall to the 10-12% range
expectations that the oil cuts in the first half of 2018 i.e. above
are extended into 2018, oil prices the central bank target range
should stay above $50 a barrel. of 7-9%, but still giving them
This level of oil prices works for room to cut interest rates from
Nigeria as during 2017 the FX the current level of 14%. The
reserves of the Central Bank of key risks to this story are: 1) a
Nigeria have increased from below sharp and prolonged decline in
$30 billion, to $36 billion (as of oil prices below $50; 2) a drop in
November). This happened at the the oil production volumes due to
same time as the CBN was actively continued instability in the main
selling dollars on a weekly basis producing region of Niger Delta;
in the local FX market to support 3) political instability related to
the naira to the tune of $200- the deterioration of the health of
400 million. On the currency, the President Buhari, and succession
market expects the two main FX struggles. Similarly to Egypt, we
windows (NIFEX and NAFEX) to look to be long local-currency
converge somewhere between 6- and 12-month Tbills hedged
NGN 340-350 per 1 USD in the with NDFs.

68 MENA FX OUTLOOK
South African rand
ZAR: In South Africa, political performance of the rand in 2017 is weak a vicious circle begins
events will dominate the markets was a telling story, as during where currency depreciation
as a change in the leadership of the course of the year it moved leads to higher inflation, forcing
the ruling ANC party is expected from being one of the top-three the South African Reserve Bank
in the first quarter of 2018. How performing EM currencies, to one into hiking interest rates, in
the market reacts will , depend of the worst performing towards turn leading to a slowdown in
largely on who will lead the ANC, the year’s end, mainly driven economic activity and further
i.e. will the winner be perceived by political events. The trend currency weakness. On top of this
as market-friendly or not. The in USDZAR is upward, and more negative outlook one needs to
ruling party is at a crucial point, rand weakness can be expected be mindful that accommodative
where the wrong choice could in 2018. The sovereign credit global monetary policy is coming
set it on a course to potentially rating is likely to be downgraded to an end, with the likelihood
losing power in the future, or a in the near future to junk, forcing that the USD strengthens. In
move towards populist policies many investors in local-currency summary, we are bearish on the
possibly detrimental to long- debt out of South Africa. rand, and on local currency debt
term economic growth. The Additionally, whenever the rand in South Africa.

MENA FX OUTLOOK 69
Postscript: The ZAR strengthened successor by proposing that the

sharply at the end of 2017 as government delivers free higher
the more ‘market-friendly’ Cyril education from this year, despite the
Ramaphosa was elected as the new fact that this would not be fiscally
President of the African National sustainable. Thus Ramaphosa will
Congress. As an experienced need to act quickly to avoid further
businessman and former union attempts by the Zuma camp to
leader he has the credentials to hinder his progress towards the
reverse the rapid economic and country’s main executive seat.
political decline seen in South Africa
under the stewardship of Jacob
Zuma. However it won’t be an easy
job, as three of the ruling party’s
six-member leadership team are
considered to be Zuma supporters,
which may initially make it difficult
for Ramaphosa to execute important
corrective decisions, including
getting Zuma to step down as
the country’s President before his
term officially ends in 2019. The DANAY SARYPBEKOV
incumbent has already thrown FX & Rates Products,
down the gauntlet to his eventual Global Markets

70 ASIA FX

ASIA FX 71
ASIA FX

72 ASIA FX
ASIA FX
With easy financial conditions

and support from fiscal policy,
there’s no doubt that we are in
a continued strong expansion
in the world economy. In such
a goldilocks environment, no
one will benefit from inflows
more than EM regions, India and
Indonesia included. In short,
we are bullish of both India
and Indonesia where growth
is still rebounding. But more
importantly, it’s worth putting
these two countries side by side
for our outlook because both have
large, relatively younger, and
lower-income populations. They
have recently missed out on the
growth pickup elsewhere, but as
the global growth environment
starts to accelerate, we will
see a quick catch-up in these
two economies.

ASIA FX 73
Chinese renminbi
In the past year, China saw be trimmed-down as continued yields to the real economy tends
maintained strong growth in its effort from the government to to be slow, but not a factor that
economy, with GDP year-on-year clamp down and regulate off- can be ignored. Yet the on-
growth at around 6.8%, and CPI balance sheet products has been going internationalization of
well-contained below 2%. Policy- implemented. The key issue will the stock and bond market (via
makers have mentioned that be how the government, while the stock-connect and bond-
the focus for 2018 will shift from maintaining GDP growth at around connect programs in Hong Kong)
boosting growth to maintaining 6%-6.5%, can deleverage in a should trigger more capital
stability, supply side reform, and managed way that does not harm inflows into the country on the
stressing financial deleveraging. the economy. Recently, Chinese back of improving corporate
The impressive growth from the bond yields have been trending governance – and international
property and auto sectors, which higher as money supply growth recognition of this. Combining
has been supporting strong GDP slows down due to deleveraging, all these factors, FX flows should
growth this year, should now which is expected to continue into be well-balanced during 2018,
slow down, and shadow banking next year. The transmission of and USDCNH should remain
activity should also continue to higher funding costs due to higher quite stable.

74 ASIA FX
Indian rupee
Moody’s just raised India’s credit

rating from Baa2 to Baa3, while
changing their outlook to stable
from positive. This reaffirmed our
view that the progress on economic
and institutional reforms (the banks’
recapitalization plan) will enhance
India’s high-growth potential, and
the reforms will help reduce the
general government debt burden
over the medium term. Given such
a supportive global environment
and a positive story locally, it’s
possible that we could see India’s
GDP growth going back to 7.5%, as
shocks from 2016’s demonetization,
the 2017 GST implementation, and
the NPL problem start to dissipate.

ASIA FX 75
However, it’s worth touching on year’s fiscal target at 3.0% of GDP, Source: Bloomberg Finance
some possible headwinds in 2018 to but if the public sector banks

this positive macro picture. We see recapitalization plan requires
three potential headwinds for India: a larger capital injection than
RBI policy tightening as inflation anticipated, then fiscal slippage of
picks up, fiscal developments in 0.3-0.5% is possible. Lastly, global
FY2018 and 2019, and the global oil prices, especially having trended
oil price outlook. Given the recent higher recently, are negative for
surge in oil prices, the RBI’s forward India’s macro outlook. If Brent was
guidance will likely become more to rise to 65-70/barrel, investor
hawkish than before. However, sentiment for India could be
the bond market has not given up negatively impacted, and it would
on expectations for further rate complicate fiscal and monetary
cuts. So, if the RBI’s stance starts policy decisions. Despite such
to change in 2018, we could see an outlook, we still see USDINR
some serious outflows from India. trending lower (i.e. the currency
The second risk is fiscal slippage. strengthening), perhaps towards
The government has set next 62.50 or 62.00 in 2018.

76 ASIA FX
Indonesian rupiah
Source: Bloomberg Finance
There’s nothing specific worry regarding Indonesia is

about Indonesia that is worth the foreign bond ownership,
highlighting, perhaps apart which currently stands at 39%,
from the same old tax amnesty considered the highest in the
program and subsidy cuts which region. October and November,
weighed on consumption in 2017, saw some re-pricing of
2017, and political uncertainty higher rate hike expectation
following the Jakarta election from the Fed, and the reaction
which is negative for private in IDR and bond yields was
investment. However, these quite sharp. Thus, in 2018, if the
local headlines are quite policy tightening cycle is not as
insignificant compared to accommodative as the market
overall global sentiment. If expects, INDOGB and IDR will
global flow in EM is strong, be vulnerable. Our forecast for
Indonesia will be one of the USDIDR in 2018 is 13,000
most beneficial. Our only to 13,200.

ASIA FX 77
South Korean won
Strong performances in the

electronics and wider technology
sector drove KRW to outperform
the USD in 2017. Export data
remains strong, leading to healthy
current account surplus and
growing FX reserves. This trend
should continue into 2018. The
market is expecting the Bank
of Korea to hike policy rates by
at least 50 bps next year due to
its improving economy. Tension
between China and South Korea
has lessened, which may boost
tourist volume from China,
adding to the current account
surplus. We are targeting 1050 for
USDKRW, based on a constructive
economic picture.

78 ASIA FX
Malaysian ringgit
Malaysia enjoyed a strong 2017 on returned as the FX market stabilized,

the back of recovering oil prices. and the ratio in the GBI-EM bond
GDP growth leaped to around 6% index remained unchanged after
and CPI climbed to 3.5%. A hawkish being lowered in 2016. FX reserves
stance from the central bank after also picked up last year. This growth
the November meeting was seen, trend should continue, with EM
and the market is expecting a 25 growth and capex still improving,
bps rate hike for Malaysia in 2018. hence we are targeting USDMYR to PINRATH WONGTRANGAN
Bond market liquidity gradually head towards 4.0000 during 2018. Asian FX & Rates, Global Markets

EUROPEAN (EX-UK) EQUITIES: A POSITIVE OUTLOOK 79
EUROPEAN (EX-UK) EQUITIES:

A POSITIVE OUTLOOK

80 EUROPEAN (EX-UK) EQUITIES: A POSITIVE OUTLOOK
European (ex-UK) Equities: A Positive

Outlook for 2018
We believe the asset class reforms (such as what President Why we are positive on
should benefit on one hand from Macron is doing regarding France’s European equities
synchronized growth among labour laws). So the economic and
the main global economies political background is improving In terms of relative valuation
- maximizing the Eurozone’s for stocks, and potentially not just compared to the S&P500 (see
exports - and on the other hand for exporters. chart below), and also reflecting
from an overall improvement that the Eurozone’s business cycle
in domestic demand, based on is lagging that of the US, European
a better ‘feel-good’ factor as equities are trading at just under
economic growth improves, and an 18% P/E discount to the S&P,
waning political risk. The ECB will and just under a 17% discount for
continue to be supportive, via 2019. A structural discount for
its ‘dovish taper’ i.e. ultimately the STOXX looks deserved, if just
reversing its previous quantitative because the return on equity (ROE)
easing, but keeping official is rather lower than for the S&P
interest rates at quite low – but the potential for leveraged
levels to keep the euro down to positive earnings surprises for the
sustain export growth. In short, STOXX in 2018 could be very good,
the Eurozone should be able to especially if Eurozone economic
capitalize on the growth of world data continues to come in ahead
trade, and to reap the benefits of of expectations.

Chart: P/E ratio on S&P500 vs. P/E on STOXX Europe 600
Source: Bloomberg Finance
Certainly the recent macro begin raising interest rates in encourage them to borrow in the
data has been very strong July, 2019. We don’t expect this near future, rather than to delay
(for instance with Markit’s to impact European equities this. Accordingly, we are very
Eurozone Composite Purchasing too negatively, as the ECB even much in favour of investing in
Managers Index posting bullish considering QE reversal would the equities of quality European
readings of above 57, and with indicate their view that the global banks. Banks currently represent a
EU consumer and industrial economy is recovering of its fraction under 13% of the STOXX
confidence at 17 and seven-year own accord – and that they can 600 index, while insurance is just
highs, respectively), all of which begin to reduce their involvement above 6%, and including other
further explain the positive in the management of the diversified financials the total is
background we envisage, driving bloc’s economy. 25%, whose prices tend to move
business capital expenditure and broadly together.
domestic earnings – and which We do expect a recovery in
underline the likelihood of upward business capital expenditure in
estimate revisions. Europe, and part of that overall
capital requirement will be met by
In terms of ECB monetary policy, bank borrowing. Any perception
they are expected to cease QE in on the part of corporates that
September this year, and possibly interest rates will rise would

The STOXX Europe 600 index

is trading at 14.9x earnings
for 2018, based on Bloomberg
consensus earnings growth
of 8.74%, with the P/E falling
to 13.6x for 2019, assuming
earnings growth of 9.0%. A key
point is that estimate revision
for the index appears to have
bottomed last August, and with
the possibility that more top-line
(revenue) growth could fall to
the bottom (earnings) line, this
may help earnings estimates for
2018 and 2019 improve, further
supporting valuations.
SECTOR COMMENTS: FINANCIALS: “European equities are almost

a perfect ‘value’ play for
With our house view of the likely Positive - Given their positive 2018”
trading range of the euro/dollar correlation with rising interest
being) 1.12-1.20 during 2018 rates and GDP growth, Banks,
(vs. just under 1.18 currently we Diversified Financials and Insurers
therefore don’t expect a stronger are expected to outperform in
euro to be a headwind to export 2018. As we have noted, Financials
earnings. We have stated our account for approximately 25%
case for owning bank stocks. Also, of European market capitalization
generally speaking we favour - and well-positioned to benefit
domestic over internationally- from further economic recovery.
exposed stocks, to specifically We have seen an uptrend in
capture the improving Eurozone demand for loans in the EU that
situation. Although we have will support the Banks’ earnings
arrived at the sector opinions growth. We favour Banks over
included below, as investment Insurers due to the higher margin
advisors we place as much – if expansion and cheaper valuation
not more – emphasis on a stock- of the former.
specific rather than a sectoral
approach as we aim to select
quality names.

Chart: Capex vs. Software EPS growth
INFORMATION TECHNOLOGY: ENERGY: CONSUMER DISCRETIONARY:

POSITIVE POSITIVE NEGATIVE, ALTHOUGH POSITIVE
ON LUXURY GOODS
Tech Hardware and Semi- The sector has room for
conductors are expected to see growth, partly because it has Consumer discretionary was the
the biggest margin expansion in underperformed since 2015 and is second-best performing sector in
the sector in 2018. Technology trading today at a cheap valuation. 2017, outperforming the STOXX
accounts only for 6 % of European With an average dividend yield of 600 by 20%. In terms of valuation,
equity market cap, which largely 5%, the sector offers the highest most companies are trading at P/Es
explains why European stocks yield in Europe (the average being which appear to fully price-in their
underperformed US stocks in 2017. 3.3%). At current oil prices (Brent prospects, and which are therefore
The European IT sector trades at is at $65.71 as we go to print), yet close to being fully-valued. In the
a deserved premium, and should still perhaps with a bit more upside more generic retail segment, the
benefit from the capex recovery potential we see the sector as main structural issue remains:
mentioned above (see the chart fundamentally undervalued. growing online competition is
below). Capex has been flat this putting pressure on the margins of
year and is expected to grow in traditional retailers. In the event
2018. Higher capex and higher that the euro is stronger than we
margins are linked as companies anticipate, that would negatively
invest more when profitability impact the whole sector as export
is improving. values would be eroded. We are
positive on luxury goods because
they should benefit from quite
strong synchronized global growth
and, additionally, from Chinese
consumers trading up.

CONSUMER STAPLES: UTILITIES:

NEUTRAL NEGATIVE
Trading on a prospective P/E As we believe that interest rate

valuation of 22x P/E for 2018, the will rise, at least to a degree,
sector looks expensive relative this sector looks vulnerable as it
to its top-line and EPS growth usually gets de-rerated in periods
prospects. Like its defensive of rising bond yields.
peers, we don’t expect this sector
to outperform in 2018. Should INDUSTRIALS:
interest rates rise sufficiently to POSITIVE ON CONSTRUCTION –
de-rate the sector, we might look SIMILARLY TO CHEMICALS
to upgrade it at that time.
Construction is a way of playing
TELECOM: NEUTRAL/POSITIVE ON further economic recovery.
QUALITY NAMES European construction industry
confidence is at its highest level
- After a year of continued since 2007, and the housing
earnings misses, the sector has market is strong in many
begun to recover, based on cheaper European countries. Expected
valuations: for instance, relative EPS growth of 12% in 2018
EV/EBITDA (Enterprise Value-to- should make this an attractive
Earnings before interest, tax, overweight for 2018.
depreciation & amortization)
is at an eight-year low, and the EUROPEAN EQUITY MARKET RISK
prospective P/E is at the lowest FACTORS FOR 2018
level since 2014.
Yields may rise quicker than
MATERIALS: expected following the ECB
POSITIVE ON CHEMICALS tapering its QE, Europe is under-
exposed to IT vs. other global
The sub-sector is driven by a equity markets, Unexpected
seemingly persistent recovery in Euro strength could impact
margins and supportive commodity internationally-exposed
prices. Chemicals outperformed companies A ‘hard’ Brexit,
the European market by 10% in Political risk in Italy related to
2017, although we believe this can the elections, leading to a
continue in 2018, helped by the return of euro-exit fears, The
improving outlook for global growth aftermath of a bad Catalonian
and the push this should provide to general election result MELINA JEAN
‘late-cycle’ sectors. in December. Private Banking, Geneva

JAPANESE EQUITIES: THE INVESTMENT CONUNDRUM OF OUR TIME? 85
JAPANESE EQUITIES:
THE INVESTMENT
CONUNDRUM OF OUR TIME?

86 JAPANESE EQUITIES: THE INVESTMENT CONUNDRUM OF OUR TIME?
Japanese Equities: The Investment

Conundrum of our Time?
INTRODUCTION:
Since the early 1990s, when
Japan became locked in
persistent deflation, global
investors haven’t really taken
Japanese equities seriously.
There may have been some
index-tracking commitments,
but apart from the occasional
alpha generated by a few good
stock-pickers on the ground,
interest has been very low
indeed, despite it being the
world’s second largest investible because it has usually worked. P/E multiple expansion has driven
market. However, the TOPIX Yet rather than simply looking returns since 2013. So after a recent
index is up 18.1% for the year-to- for reasons to explain why they 25-year high, should investors be
date (and 22.6% in dollar terms), have been underweight in a prepared to give the asset class
with global investors seeing it on year of good Japanese equity the benefit of the doubt? The
their radars as they search for performance, many investors answer depends on one’s overall
global laggards - and especially (including ourselves) have chosen assessment of some interesting
in developed markets that to more thoroughly re-evaluate and highly unique factors.
their investment committees the country’s fundamentals and
have heard of. (By the way, we its asset classes. Companies used large stock
prefer the TOPIX to the Nikkei buybacks to boost EPS growth
225 because the TOPIX is free DISCUSSION: in 2015-16, offsetting the
float market-cap weighted, and adverse effect on earnings of yen
much more representative of the Firstly looking at earnings and appreciation, but those buybacks
broader Japanese market with valuation, we note that the TOPIX ended in 2016, almost coincident
over 2,000 stocks, whereas the uses a March fiscal year-end. The with the yen peaking at ¥100
Nikkei is price-weighted). As we 2018/19 P/E stands at 14.7x, to the dollar. Recent work by
go to print, the TOPIX in dollar with forecast growth in earnings JP Morgan, they say, suggests
terms is therefore just over 3% per share (EPS) estimated by no good reasons to believe
ahead of the S&P500, helped by Bloomberg at 8.4% (after 2.9% for that the negative correlation
some relative yen strength/dollar 2017/18, when exporters were between Japanese equities and
weakness earlier this year. Many held back by a stronger yen). As the yen - based on a relatively
global equity investors have been Goldman Sachs has observed, Japan high proportion of revenues and
underweight in Japan for a long is the only developed market in earnings coming from exports
time – often for many years, which earnings growth - rather than - should break down. Readers

should also note that the Bank equity market. the JASDAQ, in which they typically
of Japan (BoJ), the central bank, The TOPIX currently represents account for 50-60% of trading
has in recent years been buying 2,031 stocks in the ‘first section’ volume. The JASDAQ Stock Index
huge quantities of Japanese (large companies) of the Tokyo is up an impressive 41.3% year-to-
equities (via exchange-traded Stock Exchange (TSE). The first date, and according to Bloomberg,
funds, or ETFs), to supplement its section is where sizeable global trades on a forecast P/E of 19.4x for
quantitative easing (QE)-related funds invest, whereas Japanese the year ending March, 2018, with
purchases of Japanese bonds. The retail investors concentrate on the EPS growth projected to be 14.8%
FT recently estimated that the BoJ TSE ‘second section’ (embracing (revised upwards from 13.0% a few
owns about 3.2% of the Japanese the so-called ‘Mothers market’ and weeks ago).

POLITICALLY: stands at 0.7%, year-on-year, and LDP in the process. He called the
The Economist’s consensus is at election more than a year earlier
Mr. Shinzo Abe of the Liberal 0.5% for 2017. The huge amount of than constitutionally necessary,
Democratic Party (LDP) was voted QE applied by the Bank of Japan on the platform of revising
in as Prime Minister in 2013, and (BoJ) since 2013 has left most Japan’s pacifist constitution,
his economic policy programme economists bewildered. and almost certainly benefitted
known as ‘Abenomics’ - essentially from the Japanese people being
involving huge monetary Earlier in 2017 Mr. Abe was caught worried about two missiles fired
relaxation/quantitative easing up in two political scandals, by North Korea over the island
(QE) - began in spring of that year. which hurt his ratings. Seeing the of Hokkaido in September, 2017.
The aim was to kick-start growth, opportunity a few months ago, Investors wanted to be more
ending more than two decades of he called a ‘snap’ general election, certain of the re-appointment
on/off deflation. Almost five years which he won by a landslide, of Haruhiko Kuroda (or someone
later, Japanese headline inflation winning a ‘super-majority’ for the like-minded) as governor of the

BoJ, to ensure the continuation achieved has been pushed out. Japan’s gross government debt
of ultra-loose monetary policy. It should be noted that Japan as a percentage of GDP stands at
Near-zero interest rate policy has just enjoyed seven straight 239.3%, with a forecast of 233.9%
should continue, with yield curve quarters of economic growth, and for 2022. Despite the levels of QE
control. So Mr. Abe and Japan’s that unemployment is at sub-3% and debt, Mr. Abe above all means
central bank will be able to (2.8%). political stability to the Japanese
continue facilitating a weakening people - and the LDP very recently
yen, via the BoJ’s monetary policy In 2014, Mr. Abe made a significant voted to allow a Prime Minister to
divergence from the US Federal policy error by increasing the be in place for three terms, rather
Reserve (who as we know have national sales tax from 5 to 8%, than just two.
been raising rates). Meanwhile, the which resulted in a recession, and
stated inflation target still stands he now wants to increase this
at 2% (like the Fed), although again, to 10% in October, 2019.
the time horizon for this to be The IMF’s latest estimate of

ECONOMICALLY
imports) was the biggest source
In their October forecasts, the of reported growth in that quarter
IMF said they expected Japan’s (2 percentage points of it), with
real GDP to grow by 1.5% in 2017 shipments of cars and electronic
(The Economist poll of forecasts components to the US and Asia
stands at that figure), up from the strong, reflecting growing global
1.0% growth achieved in 2016, demand. Japan’s closely-followed
but followed by only 0.7% in 2018. Tankan business conditions index
The latter sounds like a reversion for large manufacturers rose to
to the low growth expectations its highest level since 2007 at
that for years we have had for the end of the third quarter, (at a
Japan). The view from the OECD is reading of +22). We believe the yen
more optimistic on Japan’s growth (currently at ¥112.54 to the dollar)
than the IMF; they are forecasting has resumed a gradual downtrend
growth of 1.2% for 2018 (half vs. the dollar, helping exporters,
a percent better than the IMF), and at a time when exporters
but expects this to fall to 1.0% in should benefit from replacement
2019. The economy grew quite cycles in electronics components.
a lot faster than expected in the
third quarter of 2017 (at a revised Japan’s Producer Price Index
2.5% annualized), making it seven increased 3.5% year-on-year at
straight quarters of growth. Net the end of November, up from
external demand (exports minus 3.4% the previous month. However

it remains to be seen whether early 1990s it has been a very earlier, the unemployment rate is
Japanese industry can pass much sad picture. Japan’s consumer down to 2.8%, with some firming
or any of this on in the form of confidence as measured by the in real wage growth: data from
higher product pricing. The latest Economic & Social Research Japan’s Ministry of Internal Affairs
available CPI year-on-year data Institute has been in a steadily suggests year-on-year real wage
shows headline inflation falling rising trend since mid-2011 (from growth of 2.9% (up from 2.0%
back to 0.2% at the end of October, a reading of 35.2 at that time, to earlier in 2017).
down from a high of 3.7% in 44.9 at the end of November) –
2014. Japan’s definition of ‘core’ however, investors need this to Bloomberg has reported that
inflation (i.e. ex-fresh food and be translated into a sustainable ‘delays to construction projects are
energy) likewise stood at only improvement in retail sales. becoming chronic’, with companies
0.2% year-on-year at the end of offering more permanent
October, down from a high of 2.8% Turning to demographics, we know employment contracts, pensions
in 2014, so the data has begun about Japan’s falling, and aging, and bonuses. Another example
to suggest that actual deflation population, while Bloomberg (and of extreme labour tightness is
could be about to return. Recently others) have reported the extent in caring for the elderly – but
there was some hope that retail to which Japan’s tightening that’s surely not a surprise, given
sales might finally pick up, based labour market is now making it the aging population. Our sense
partly on an improvement in real increasingly difficult for companies is that companies are of course
wages, but this appears to have across a range of sectors to doing whatever they can to
been a false dawn. We looked at operate – and not helped by the avoid actually raising wages, yet
the longer-term pattern of retail fact that Japan doesn’t appear to aggregate employment costs must
sales and sure enough since the welcome foreign workers. As noted be climbing with wages.

What else do we need to know to

finish describing the economic
scene? Firstly, the current account spend more out of income unless Looking at Citi’s Japan Economic
balance is consensus forecast wage gains accelerate as a result Surprise index to see how data
(from The Economist poll) for the of productivity gains, because has been coming in relative to
current account surplus stands unemployment is already so low – market expectations, this is
at 3.6% of GDP for 2017, however and the last recorded government still positive overall (just above
the fiscal deficit is forecast at data on the domestic savings rate neutral, at 13.70), but nowhere
-4.5% of GDP, so the latter is an has this at just 0.7% of income. At near as good as October’s reading
intractable problem. Gross debt is least female labour participation of 72.00. We must decide the
239% of GDP, predicted to fall to is improving, although slowly. likelihood that Japan can do
234% in 2022 by the IMF, although A Cabinet Office study last year better in the future than simply
of course the latter is a rather found that a record 74% of enjoying a ‘rising tide lifting
high-risk forecast (and net debt Japanese are satisfied with their all regional boats’, with Japan
is about 120% of GDP). With this lives, and the majority with their being one of them. Would it
much debt, interest rates naturally income, and this helps complete a all be export-led? Our readers
have to stay very close to zero picture of extreme conservatism, might agree with us that
(continuing to make life difficult which also seems to exist in deciding whether to invest in
for Japanese banks). The country business. Some have pointed to Japanese equities – as some
clearly needs to reduce its fiscal the higher profitability of business would say, simply because they
deficit, although this would be since Abe took over, yet in the are going up – is certainly an
very painful to do – Abe will have two years after he came to power interesting conundrum.
to find ways of doing this, maybe the yen depreciated by about
by finding ingenious ways of 20%, so this must have artificially Having hopefully set the scene,
taxing household savings, or by driven exports, and the grim path we’ll try to summarize some
shaking up the cash-rich corporate of retail sales suggests a lack of negatives, and some positives, to
sector. Mrs. Watanabe can’t domestically-derived growth. help reach some conclusions.

INVESTMENT NEGATIVES:
The perception of many foreign capital funding.

investors (at least with regards to Global investors like us are still
large-cap companies), is that Japan trying to understand - and to
has lost its entrepreneurial spirit of see the end-game - of the BoJ
old. Maybe Japanese corporations buying huge amounts of Japanese
are just very bad at deploying equities. When the world’s central
their cash - part of this being that banks did this in bonds to avert a
in the modern world they are major and protracted economic
simply afraid to? To do nothing is slump, investors at least in the
much easier. With the exception end understood that disaster
of the likes of Softbank, Japan had needed to be averted, even
lacks the corporate ‘superstar’ if many still remain wary of
equivalents of the US’s ‘FAANGS’ the ultimate outcome. The BoJ
(Facebook, Amazon, Apple, Netflix has been timing its purchases,
& Google (Alphabet)), or the likes concentrating its buying on weak
of Baidu, Alibaba, and Tencent days – that as determined buyers
(known as the Chinese ‘BATs’). of equities are supposed to. We
Time and time again we come have heard speculation that the
across the comment that Japan Government Pension Investment
is a ‘failure-averse’ environment Fund may somehow acquire some
( - the opposite of the US). of the BoJ’s equity holdings, but
Unsurprisingly, there also appears we have seen no confirmation
to be a distinct lack of venture of this.

INVESTMENT POSITIVES: CONCLUSIONS:
In the ‘Outlook’ of a few years ago the Government’s hands on some Many sensible economists
we wrote about the ‘value’ aspects of the corporate cash pile to help and investors have completely
of corporate Japan – for instance, fiscally, and/or to boost growth. written Japan off, and can’t see
wouldn’t it be good if Japanese Talking of value, the average TOPIX any way that Abe’s rampant QE
companies could begin to unwind stock is only trading at 1.40x book will not back-fire. Similarly, by
some of their complex cross- value for the current year, falling to reference to the negatives, foreign
shareholding structures, and to 1.32x for 2018/19. portfolio managers will be able
deploy some of their surplus cash to adequately explain to their
effectively? Irrespective of whether Our reading suggests that Mrs. investment committees why
Japanese companies know, or Watanabe is not totally averse despite the good performance
don’t know how to reinvest their to investing in Japanese equities of Japanese equities they should
cashflow and historic cash piles, at (from our numbers in the not increase exposure – through
least they have the cash in the first introductory paragraph) - indeed explaining how the economy
place! Also, we should note that she may be rather good at it! is backed into a corner – and
Mr. Abe launched the Corporate Recent data has the proportion examples such as the BoJ buying
Governance Code in 2014 (as of average household assets held huge quantities of equity ETFs.
part of ‘Abenomics’), designed to in equities rising steadily since So sizable investors will either
improve corporate governance. 2012, and now in the region of index-track, or move underweight,
The evidence regarding the results 10% of the total, the highest for a also given the likely downside in
from it is inconclusive, yet Abe decade – and this is a proportion of the yen. Having said this, many
must surely be working on how to assets that sounds logical i.e. it is investors will still see the asset
further boost it – and how to get quite small. class as having some classic ‘value’

attributes, with the unlocking one of them. Meanwhile, back in

of these worth waiting for. The the typical investment committee
Japanese government must tax they will worry that if Japanese
savings to help the deficit, and also equities represents just under 8%
try to get financial refreshment of investible world equity value,
from the corporate cash-piles. that is a number that has to be
Back in the economy, the low decided upon, as it’s not too small
unemployment rate and high to matter – and the US may be
job-applicant ratios suggests a 51% of the world, but Japan is
culture of not letting employees still No.2, even if there are some
go. The big picture is one of a strange factors that have to be
large economy with huge and considered. So what is the answer
intractable structural problems, for our clients? It’s probably
such that massive amounts of this: find one (or two) excellent
QE had to be undertaken simply local Japanese equity managers CLINT DOVE
to allow the patient to keep operating in the Second Section, Investment Strategy,
breathing. In a growing global and allow them to mine the rich Products & Services - Wealth
economy in which world trade is pickings that we know exist in that & Private Banking
growing – and especially in Asia- market. We think Mrs. Watanabe
Pacific – Japan should enjoy some understands. Last, hedge the KEH CHUN WEI
respite as the rising tide should lift currency, and take a medium-to- International Banking,
many of the boats, Japan being long term view. Singapore

96 MENA EQUITIES

MENA EQUITIES 97
MENA EQUITIES

98 MENA EQUITIES
MENA Equities
Introduction: Looking back at a result, most regional markets that MENA equity performance
2017, MENA equity indices broadly underperformed, despite an is likely to remain event-driven.
underperformed their global and improved oil price environment. The key themes for 2018
emerging market peers. Initial Throughout 2016 and 2017, MENA are likely to include: (1) The
excitement emanating from the equity performance appeared continued decoupling of overall
final quarter of 2016 dissipated to be event-driven. For Saudi equity price performance from
as 2017 progressed, with the Arabia, the rallies during October- oil prices, (2) Saudi Arabia’s
implementation of fiscal austerity December, 2016, and June, renewed transformation
measures by GCC oil exporters. The 2017, were due primarily to the program, and (3) potential
introduction of non-oil revenue government’s partial clearance Emerging Market index inclusion.
measures (general tariff increases, of pending contractor payments Overall investor confidence
expat levies, and land taxes) and a combination of a potential should improve, and be a key
and lower government spending positive MSCI/FTSE announcement factor determining the progress
reduced consumer purchasing and senior leadership changes. We of privatization efforts and
power and income stability. As expect a similar trend in 2018, i.e. IPO launches.

MENA EQUITIES 99
Fundamentals
There has been a disconnect
between the performance of
oil prices, on one hand, and oil
producers’ equity indices on
the other – given that oil prices
recovered quite well during 2017,
those equity indices have not
reflected better oil prices. Starting
2016 at $37/barrel, Brent crude
has steadily moved up throughout
2016 and 2017 to reach $63
per barrel in December, 2017.
Reflecting OPEC supply cuts and a
general rise in demand, monthly
averages are now in a $55-63
range, much closer to the break-
even oil prices of major MENA GCC oil producers’ governments to book, and (2) Price to earnings.
oil exporters. have undertaken many measures Included in charts 3 & 4, we note
during the last few years to help that MENA markets, represented by
As we can see in Chart 1, despite stabilize fiscal budgets following the S&P Pan Arab Index, are trading
Brent crude being up more than the overall deterioration in oil prices quite close to 5-year lows on both
70% since January, 2016, the since mid-2014. Considering recent measures. Accordingly, there could be
GCC indices have not kept pace; increases in local interest rates potential for higher equity prices in
Kuwait is +16.9%, UAE is -0.6%, (although still low historically) and the event that the regional economic
and Saudi Arabia +3.7%. Although pre-existing low asset turnover, any outlook improves.
this difference in performance major corporate capital expenditure is
could be explained by increased likely to need governmental support. CONCLUSION:
pricing of regional risk, higher oil We see improved likelihood for
prices do represent a key positive, fiscal stimulus, however, due to the We expect an improvement in regional
given the continued importance growing reform trend throughout the economic growth on the back of
of hydrocarbon-led government region. For example, Saudi Arabia’s increased governmental activity and
spending within the GCC. national transformation program reform. Higher oil revenues could,
includes new infrastructure projects, along with the implementation of
As we can see in Chart 2, fiscal a revival of spending in the oil and non-oil related revenue generators
break-evens can be divided gas sector, and higher government (such as VAT), allow increased
between countries that are well spending elsewhere. government spending. While low
positioned in the $40-60 range (i.e. valuation multiples reflect currently
UAE, Kuwait and Qatar), and those When looking at the pricing of a weak investor confidence, valuations
above $70 (Saudi Arabia, Oman, potential improved outlook, two provide the potential for re-ratings
Bahrain, Iran and Algeria). measures offer insight – (1) Price should conditions improve.

100 MENA EQUITIES
Country Outlooks:
For Saudi Arabia potential
catalysts include privatization,
Saudization and potential MSCI/
FTSE inclusion. The UAE and Kuwait
are expected to benefit from a
gradual pickup in government
spending and earnings growth.
Egypt, which suffered from a steep
currency devaluation and soaring
inflation, looks set to continue
its transition towards stronger
macroeconomic conditions.

MENA EQUITIES 101
Saudi Arabia
In Saudi Arabia, if austerity release government equity. We see progress of privatization initiatives
dominated as a theme for 2016, evidence on all three counts with where, as mentioned earlier we
2017 was more about balance. SAMA’s comment on the loans- expect some traction in 2018,
For 2018, the leadership shuffle to-deposit ratio hike being the combined with higher net interest
and subsequent statements most recent example. We also see margins as rates move higher.
from both the IMF and various Saudization as being an actionable The insurance sector is expected
government officials indicate theme which, along with VAT to benefit from higher volumes
that revenue-raising measures implementation, would continue to because of a recent decree allowing
could be staggered to maximize support market dynamics. women to drive, in addition to the
growth. A growth fillip may not potential for market consolidation
necessarily mean a sharp rebound In 2017, Saudi’s Tadawul All Share as regulations are tightened.
in overall spending given the Index managed to close in positive The petrochemical sector is
substantial fiscal stimulus of 7-9% territory, up 3.7%. The market is benefiting from higher product
of GDP in place. Saudi Arabia is in currently trading at a 15.4x P/E pricing, driven by higher oil prices
a technical recession and Saudi trailing 12 month multiple, close and strong demand. Meanwhile
unemployment is inching up, thus to its 5 year average of 14.6x. a positive announcement from
the political argument in favour Amongst the sectors, we see MSCI regarding its EM indices and
of growth is strong. Credit growth, absolute value in the Saudi banking the expected go-ahead from FTSE
privatization and Saudization offer sector; the key catalyst for this in June, 2018, would increase
attainable and effective options would be credit growth, which in investor interest and flows into the
to address growth concerns and turn would be contingent on the Saudi market.

102 MENA EQUITIES
United Arab Emirates
We remain positive on the 56.6 billion) will be 19.5% higher The Dubai market was down 0.6%
UAE market, helped by Dubai’s than 2017, while the UAE’s Federal in 2017, while Abu Dhabi was up
relatively diversified economic budget of AED 51.4 billion is 2.2%. Abu Dhabi’s ADSMI index
base offering resilience, and as the expected to be 5.6% higher. In is currently trading at a 11x P/E
bourse benefits from EM funds Abu Dhabi, government spending multiple, a discount to its EM peers
flows and a safe-haven status. is likely to have troughed in 2017, (at 15.2x).
The UAE real estate sector has and could see a recovery. Abu
been broadly weak in 2017, but Dhabi is planning to spend AED
select real estate players have 400 billion in the next five years
seen successful with property boosting gas output and investing
launches. Dubai is clearly ramping- in international downstream
up infrastructure spend in 2018 in activities. These above measures
preparation for Expo 2020. should support higher economic
growth in the immediate
In 2018, Dubai’s budget (at AED years ahead.

MENA EQUITIES 103
Kuwait
Kuwait was the best performing lowest fiscal break-even of major Index inclusion and sustained
market in the GCC in 2017, GCC markets, allowing it much economic growth remain key
with a price-weighted index more freedom to drive current themes for Kuwait coming into
return of 16.9%. Historically projects and spending initiatives. 2018. Recent announcements
underperforming Saudi and UAE Despite having a pegged upgrading Kuwait from frontier to
markets, Kuwait has led GCC currency, Kuwait’s Central Bank EM should help drive both active
markets throughout most of 2017. has avoided raising rates since and passive fund flows given
We expect this trend to continue March 2017 likely looking to earnings growth at reasonable
in 2018 given the room for fiscal support growing economic valuations. Financials look to be
stimulus. Whereas UAE & Saudi activity and loan growth (+5% well positioned to leverage fiscal
boosted government spending year on year versus flat/negative stimulus with market expectations
and infrastructure development in UAE for example). The market of double-digit earnings growth
in recent years, Kuwait’s spending is currently trading at a 12x P/E, driven by credit growth, margin
was much more controlled. As we at its five-year average, similar expansion and lower provisions
can see in Chart 2, Kuwait has to Saudi. in 2018.

104 MENA EQUITIES
Egypt
Egypt looks well-positioned to
maintain its economic recovery post
the Egyptian pound’s devaluation
at the end of 2016. Strong
adherence to IMF guidance and
the implementation of pro-growth
measures continue to facilitate the
country’s return to pre-devaluation
levels of economic activity. The
country’s immense potential
remains intact, especially given its
favourable demographics.
The currency devaluation and the

removal of government subsidies
led to inflation rising dramatically
throughout 2017, with the ‘core’
rate above 26%, year-on-year, at the
end of November. In response, the
Central Bank of Egypt tightened
monetary policy. The overnight
deposit interest rate stood at
18.75% in December. However
monetary policy should be relaxed
during 2018, with lower rates
possible, as according to the IMF
headline inflation should decline
to 10%, year-on-year, by June,
2018. Easier monetary conditions EGX30 index up by 25.6%. The
would likely reinvigorate delayed market is currently trading at a
corporate capital expenditure. 9.3x P/E, lower than its five-year
Looking ahead to the elections this average, and in-line with some SALEEM KHOKHAR
year, the incumbent, President Sisi, of its MENA peers. Looking into Investment Management,
is widely expected to be re-elected, 2018, we remain positive on this Products & Services, Wealth &
and together with the other factors market as we expect a succession Private Banking
mentioned above, FDI into the of interest rate cuts, a pick-up in
country should increase. capital and consumer spending, ABHISHEK SHUKLA
and the continued implementation Investment Management,
Egypt was the best performing of the IMF’s program to improve Products & Services, Wealth &
market in MENA in 2017 with the economic performance. Private Banking

MENA EQUITIES 105
Appendix
Chart 1 : Oil Price vs Oil Exporters Stock Market Performance
Source: Bloomberg. Indices used: Tadawul (Saudi Arabia), DFMGI (UAE) and KWSE (Kuwait). Values rebased to 100 as of 31/12/2015
Chart 2 : 2018F Non-Oil GDP g vs Fiscal Breakeven
Source: IMF

106 MENA EQUITIES
Chart 3 : Price to 12m Trailing Earnings versus 5 year range
Source: Bloomberg
Chart 4 : Price to Book versus 5 year range
Source: Bloomberg

UAE BANKING 107
UAE BANKING

108 UAE BANKING
UAE Banking

UAE BANKING 109
NET ADVANCES FORMATION : ADVANCES FORMATION TO SYSTEM LIQUIDITY IMPROVING AND

UAE banking system net advances IMPROVE IN 2018: COULD IMPROVE FURTHER:
reached AED1,471.1 bn in October System net advances evolution As advances formation has
2017 (+0.6% YOY and +0.3% reflects real GDP performance in decelerated since 1H15 and customer
MOM). The rate of net advances 2014-2017, a period of declining deposits continued to build, the
formation as measured by annual hydrocarbon prices. UAE real GDP system advances to deposits ratio
change has decelerated since peaked in 2015, at 3.8%, in the (ADR) has trended lower, indicating
June 2015 2014-2017 period. Net advances improving system liquidity. The ADR
growth in the UAE banking system landed on 91.9% in October 2017,
peaked at +10.0% in March 2015, which is a -4.9 pp decline from the
has trended down since then 96.8% print in September 2016.
and reached a low of +0.5% YOY An ADR level that is below 100%
growth in September 2017. With suggests banks in the system have
most economists anticipating a capacity to extend credit. Of the 15
recovery in UAE real GDP growth to UAE banks under coverage, only four
~3.4% in 2018 from ~1.3% in 2017, supported an ADR of at least 100% at
we expect UAE banking system 9M17 end. UAE banks are primed to
advances to expand by mid to pick up the rate of credit formation
high single-digit rates next year. in 2018, particularly should higher
Increasing advances momentum average crude prices in 2018 than
is a fundamental support for in 2017 and 2016 boost system
investing in UAE banks in 2018. liquidity further.

110 UAE BANKING
ADR: UAE banks

3Q16 4Q16 1Q17 2Q17 3Q17 QOQ ch
ADCB 105.4% 101.9% 98.4% 101.5% 101.8% 0.23
ADIB 79.7% 79.1% 76.6% 76.7% 77.5% 0.78
AJMANBAN 112.6% 111.5% 110.1% 108.0% 106.7% -1.32
BOS 86.6% 86.5% 87.9% 82.8% 69.1% -13.70
CBD 98.4% 95.9% 95.8% 98.8% 100.0% 1.19
CBI 102.4% 95.1% 94.4% 96.7% 95.3% -1.43
DIB 91.2% 93.9% 88.5% 88.7% 91.5% 2.74
ENBD 92.8% 93.4% 92.5% 95.0% 94.4% -0.62
FAB 93.9% 88.2% 87.8% 85.2% 86.6% 1.49
INVESTB 101.0% 98.2% 97.4% 99.8% 94.2% -5.61
MASQ 82.8% 79.2% 80.5% 80.2% 84.9% 4.76
RAKBANK 98.7% 97.7% 98.5% 100.1% 100.4% 0.28
SIB 96.9% 93.2% 89.2% 85.8% 92.0% 6.11
UAB 95.5% 85.9% 85.4% 96.5% 89.8% -6.75
UNB 98.3% 95.1% 97.2% 98.7% 96.2% -2.45
FABS from co data
NET INTEREST MARGIN (NIM):

Following the past 5 hikes in the the cost of funding for banks combination of re-accelerating
federal funds rate and in the in terms of time deposits has GDP and additional benchmark
corresponding benchmark interest trended higher as benchmark rate hikes, we expect UAE banks
rate in the UAE (in December 2015, interest rates have increased. to more visibly expand the NIM in
December 2016, March 2017, June Banks have, however, not been 2018 than they have done since
2017 and in December 2017) in able to pass on the full increase in December 2015.
the present tightening cycle, the the benchmark rate amid fierce
market expects the FOMC to lift competition and relatively more
the fed funds rate thrice in 2018. quality credit demand from the
In theory and as the benchmark (low-asset yielding) public sector
interest rate increases, banks than the from the (high-asset
should pass on rising cost of funds yielding) private sector against
via 1) the re-pricing of outstanding a background of declining crude
credit and 2) boosting the average prices and sector consolidation
asset yield as the underwriting across more than one industry.
of (incremental) credit at the The net interest margin of banks
front end of the advances book has therefore not expanded as
is agreed at higher rates than in investors in banking stocks would
the rest of the book. In practice have liked in the tightening cycle
and in the experience of the to date. See a summary of NIM
UAE and other regional banks evolution of the 15 banks under
in the present tightening cycle, coverage as below. Based on a

UAE BANKING 111
NIM (or NPM (Islamic banking ))

9M16 2016 9M17
Abu Dhabi Commercial Bank 3.02% 2.97% 2.89%
Abu Dhabi Islamic Bank 4.30% 4.30% 4.50%
Ajman Bank 2.06% 2.15% 1.95%
Bank of Sharjah 2.75% 2.79% 2.55%
Commercial Bank of Dubai 3.19% 3.40% 3.16%
Commercial Bank International 3.84% 3.71% 3.84%
Dubai Islamic Bank 3.20% 3.23% 3.13%
Emirates NBD 2.54% 2.51% 2.46%
First Abu Dhabi Bank 2.40% 2.40% 2.20%
Invest bank 3.87% 3.89% 3.57%
Mashreqbank 4.31% 4.57% 4.58%
RAKBANK 7.00% 6.90% 6.20%
Sharjah Islamic Bank 1.94% 1.89% 2.09%
United Arab Bank 3.60% 3.51% 2.93%
Union National Bank 2.64% 2.63% 2.60%
FABS from co data
DECLINING ASSET QUALITY

LETTING SOME BANKS DOWN
The table below shows the asset

quality of UAE banks under
coverage as adversely impacted
by declining hydrocarbon prices
since mid-2014 and industry sector
consolidation in 2016-17. Of the 12
banks that disclose their interim
NPL ratio, 7 reported rising NPL
ratios in 9M17.

112 UAE BANKING
LLR
YE 2015 9M16 YE 2016 9M17
Abu Dhabi Commercial Bank 128.5% 133.1% 129.9% 118.7%
Abu Dhabi Islamic Bank 111.4% 114.5% 97.5% 82.0%
Ajman Bank 172.6% 94.2%
Bank of Sharjah 105.0% 149.0%
Commercial Bank of Dubai 102.3% 100.2% 123.0% 89.0%
Commercial Bank International 96.6% 83.6%
Dubai Islamic Bank 95.0% 102.0% 117.0% 121.0%
Emirates NBD 111.5% 120.8% 120.1% 124.9%
First Abu Dhabi Bank 118.5% 124.6% 109.0%
Invest bank 96.9% 98.6% 107.0%
Mashreqbank 150.5% 293.3% 150.9% 115.0%
RAKBANK 81.4% 84.5% 84.3% 78.6%
Sharjah Islamic Bank 80.2% 92.9%
United Arab Bank 119.0% 107.9% 119.8% 102.4%
Union National Bank 107.7% 101.2% 108.3% 92.9%
FABS from co data
Minimum transitional arrangements

Basel II 2016 Basel III 2017 Basel III 2018 Basel III 2019
Minimum common equity Tier 1 7.000% 7.000% 7.000%

Minimum Tier 1 Capital ratio 8.000% 8.500% 8.500% 8.500%
Minimum Capital adequacy ratio 12.000% 10.500% 10.500% 10.500%
Capital conservation buffer 1.250% 1.875% 2.500%
Counter-cyclical buffer 0%-1.25% 0%-1.875% 0%-2.5%
FABS from CBUAE
INCREASING IMPAIRMENT COULD

CONSTRAIN PRE-PROVISIONING
PROFIT MOMENTUM INTO 1H18
The table below shows 8 banks pre-provision profit in 2018, some

reporting lower loan loss coverage of the banks may also need to lift
ratio at 9M17 than at YE16 and 4 provisioning at least until 1H18
banks disclosing LLR of less than end. That is operating progress
100%. By implication and while may get blunted by provisioning.
the improving macro backcloth
and accelerating asset formation
may help the majority of the 15
UAE banks under coverage increase

UAE BANKING 113
ADR: UAE banks

9M16 YE 2016 9M17
Tier 1 CAR Total CAR Tier 1 CAR Total CAR Tier 1 CAR Total CAR
Abu Dhabi Commercial Bank 14.7% 18.0% 15.7% 18.9% 15.3% 18.5%
Abu Dhabi Islamic Bank 14.4% 15.0% 14.6% 15.2% 15.7% 16.3%
Ajman Bank 16.9% 17.9% 17.8% 18.7% 15.4% 16.3%
Bank of Sharjah 20.7% 22.3% 21.2% 22.4% 19.2% 20.4%
Commercial Bank of Dubai 15.3% 16.5% 14.6% 15.8% 14.2% 15.3%
Commercial Bank International 13.0% 14.3% 13.2% 14.4% 13.6% 14.7%
Dubai Islamic Bank 18.0% 18.2% 17.8% 18.1% 16.3% 16.9%
Emirates NBD 18.0% 20.5% 18.7% 21.2% 18.8% 21.2%
First Abu Dhabi Bank 13.8% 17.1% 13.3% 16.6% 14.6% 18.0%
Invest bank 17.6% 18.2% 17.2% 17.8% 17.8% 18.5%
Mashreqbank 15.7% 16.7% 16.0% 16.9% 17.1% 18.0%
RAK Bank 23.9% 23.9% 22.3% 22.3% 20.4% 20.4%
Sharjah Islamic Bank 20.9% 21.6% 20.3% 21.4% 19.6% 20.6%
United Arab Bank 15.6% 16.1% 12.2% 13.1% 12.0% 13.3%
Union National Bank 17.4% 18.6% 17.8% 18.9% 18.5% 19.7%
FABS from co data
BASEL III CAR
Part of asset quality consideration

is the CAR, which indicates a bank’s
capacity to absorb credit loss. In
common with other jurisdictions,
Basel III CAR requirements are
being applied in stepped-up stages
in the UAE in 2017-2019.

114 UAE BANKING
Based on Tier 1 CAR and Total VALUATION RATING

CAR levels reported at 9M17 end,
no UAE bank is under immediate We note the majority of the UAE Ahead of finalising our 4Q17
pressure to raise capital, banks under coverage trade at earnings estimate, we have 3 BUYs,
particularly in the event the discount to the related market 4 ACCUMULATEs 6 HOLDs and
counter cyclical buffer requirement benchmarks, the ADI and DFMGI, 1 REDUCE on the 14 UAE banks
comes in at 0%. FAB and RAKBANK suggesting banking stock prices we rate.
aside, other UAE banks under have room to trend higher when
coverage reported CAR under Basel investors price in the improving
II regulations in 9M17. When banks macroeconomic backdrop and
report at YE17, investors may find asset momentum in 2018. Banks
that some banks are close to the offering more than 5% dividend
minimum CET1 level and need to yield will rally in 1Q18 ahead of
boost their common equity, which stocks going XD.
might impact their distribution
policy as early as in 2018.


UAE BANKING 115
Target price and rating

(AED) TP CMP Potential Gain Rating
ADCB 8.00 7.03 13.8% ACCUMULATE
ADIB 4.00 3.75 6.7% HOLD
AJMANBAN 1.25 1.12 11.7% ACCUMULATE
BOS 1.37 1.24 10.7% HOLD
CBD 4.00 4.10 -2.4% HOLD
CBI 0.83 0.77 7.3% HOLD
DIB 7.50 6.05 24.0% BUY
ENBD 9.15 8.15 12.3% ACCUMULATE
FAB 10.20 NO RATING NO RATING
INVESTB 2.45 2.43 0.8% HOLD
MASQ 83.79 73.60 13.8% ACCUMULATE
RAKBANK 4.85 4.65 4.3% HOLD
NBS 1.62 1.37 18.3% BUY
UAB 1.60 2.00 -20.1% REDUCE
UNB 5.00 4.26 17.4% BUY
FABS estimate
UAE BANKING
SECTOR CONSOLIDATION
After the announcement on the Bank were in merger talks that

proposed FGB NBAD combination could create an institution with
in June 2016, investors expecting ~AED50.6 bn of assets. Market
other mergers in Abu Dhabi talk of a BOS-INVESTB combination
involving large banks have been began making the rounds in 2016.
disappointed. M&A activity in In 3Q17, the market was made
small to medium-sized banks aware of the potential for Tabarak
appears more imminent than a to acquire the 40% stake in United
transaction involving a large bank. Arab Bank held by Commercial
Sources told Reuters in November Bank in Qatar, which mostly
Bank of Sharjah and Invest accounts for UAB’s high PE rating.
SANYALAKSNA MANIBHANDU
FAB Securities

116 REAL ESTATE AS AN ASSET CLASS

REAL ESTATE AS AN ASSET CLASS 117
REAL ESTATE AS AN
ASSET CLASS

Real Estate as an Asset Class
INTRODUCTION:
The asset class is favoured by professional advisors to facilitate passive, with the long-term in
investors wanting to hold ‘hard’, successful specific asset selection. mind, or they can operate on a
tangible assets, and seeking Real estate needs to be maintained, more opportunistic basis. Indeed
reliable income in addition to and tenancies and projects must the universe of possibilities is
long-term capital appreciation. be properly managed. Sovereign substantial, while at the ‘quality’
For a ‘Conservative’ investor, FAB wealth funds (and other sizable end of the markets there will
recommends a 10-15% exposure to investors) also increasingly make always be attention from investors
the asset class (always excluding infrastructure investments looking to make strategic, safe,
one’s primary residence), down alongside their existing real estate investments, often in prestigious
to perhaps 5% for a ‘Growth’ portfolios, through private equity so-called ‘trophy’ assets.
profile, with ‘Balanced’ somewhere funds and/or direct placements.
between the two. It is an asset class Real estate in many instances
that can add useful diversification continues to provide reasonable
to global investment portfolios yields in a world of still historically-
holding a mixture of equities, bonds low interest rates, and against
and cash. Investing in real estate is the background of sometimes
probably best viewed as a long- volatile capital markets. Investors
term proposition, and involving in real estate can be relatively

REAL ESTATE: SUPERIOR REAL ESTATE: REAL ESTATE:

RISK-ADJUSTED RETURNS INCOME STABILITY A HEDGE AGAINST INFLATION
Broadly speaking, global real estate A key feature of real estate The inflation-hedge nature of real
has averaged total returns of 8.7% investment is the significant estate stems from the generally-
and 5.6% per annum over the past contribution of rental income accepted theory that a positive
5 and 10 year periods respectively, to long-term total return. This is correlation exists between GDP
according to Knight Frank. These helpful in that investments that growth and real estate demand.
performances were achieved with rely more on income streams During periods of economic
lower levels of volatility than tend to be much less volatile growth, demand for real estate
both equities and bonds, thus than those that rely more on will push rents upwards, which
resulting in highly competitive capital appreciation alone. When usually results in higher capital
risk-adjusted returns. comparing many rental yields values. As a result, real estate will
(especially on commercial real tend to maintain the purchasing
Part of the ‘low volatility’ estate) with more traditional power of capital, by passing some
characteristic of real estate sources of income return i.e. on inflationary pressures on to the
returns is based on the infrequent bonds, real estate frequently tenant and by absorbing some
nature of transactions. This provides higher yields than on inflationary pressure through
means that property values are quality sovereign bonds, for capital appreciation.
often determined by third-party instance, especially in these times
valuations, which can lag the of still-low global interest rates.
market. This is an inescapable
fact. Infrequent transactions
and valuations often result in a
smoothing of returns, as valuations
will tend to underestimate market
values during an upturn and
potentially overestimate market
values in a downturn.
However, given the prevailing

economic environment, with
volatility in more liquid markets
an ever-present issue, more
stably-priced real estate (in
the majority of years) can be a
welcome attribute.

REAL ESTATE: REAL ESTATE AND ITS CHARACTERISTICS OF

THE LIQUIDITY QUESTION SUB-SECTORS: REAL ESTATE INVESTMENT:
The main drawback for investors The traditional sub-sectors of Investors will find real estate
in real estate is its lack of liquidity. Retail, and Commercial (offices, ‘dealing sizes’ on average much
Unlike equity or bond transactions, apartment blocks, and senior- higher than in equities or bonds -
which can be completed in citizen housing) and Industrial unless one invests in Real Estate
seconds, real estate transactions (factories, warehouses, and Investment Trusts (‘REITs’), which
can take months to complete. That research & development are collective real estate funds
being said, some solutions to the space) constitute the majority that trade like individual stocks.
liquidity problem are available, of institutional portfolios. In REITs facilitate quoted real estate
mainly in the form of listed REITs recent years there have been exposure for investors. There
and real estate equities. These an increasing number of sub- are also private equity funds
provide indirect ownership of sectors added to these, namely specializing in real estate, or real
real estate assets as a class, and hotels, healthcare, student estate partnerships; investors in
some liquidity. accommodation, and also car-parks these are locked-in, usually for at
have seen increasing interest. least five years.
So many choices are available,
with considerable diversification Although transaction costs in
possible across the real estate real estate can be higher than
sectors, constituting portfolios in in other asset classes, investors
their own right. who understand the asset class
have tended to ignore these
Residential real estate can be split as impediments to purchase,
into single-family homes or ‘multi- particularly in the case of
family housing’ (apartments), prestigious assets. In fact, dealing
each of which can be classified costs can often be a useful
as urban or suburban. Offices can barrier to entry to other potential
be of the ‘multi-tenant’ variety, investors for what can be limited
or dedicated to just one client. stock in popular locations such as
‘Mixed-use’ constitutes retail, Central London.
offices, residential, healthcare
facilities and maybe a hotel
within the same complex. In
addition, farmland and timberland
are also possibilities, as well as
undeveloped, raw land, the most
speculative sub-asset class within
the broad sector.

RISK FACTORS &

OTHER CONSIDERATIONS:
Above all, investments in real

estate can be very illiquid,
requiring much patience on the
part of the investor. Changes in
fashion or popularity can adversely
affect particular areas or designs
in real estate, although carefully
selected advisors will be able to
help investors avoid areas that
might underperform. Real estate
in prime locations will always have
a special position in the market,
while successfully identifying areas
likely to be ‘gentrified’ next can be
especially rewarding.
Property maintenance has to

be carried out satisfactorily and
regularly to offset as much of the
natural deterioration (and hence
depreciation, in the accounting
sense) of an asset as possible. rewards can be substantial for the Having the right financial partners
In a good property investment, far-sighted and patient. is therefore crucial, and NBAD’s
the inherent value will rise over Sharp increases in interest rates highly-qualified Real Estate
time, although if it is not properly can represent risk to real estate team can help clients explore all
maintained the cost of anticipated investments, even if debt is not the possibilities.
refurbishment/redevelopment will used, because other developers In the past, real estate has been
adversely affect any valuation. and end-users may not have been a good hedge against inflation, in
so careful. The reverse can be the sense that real estate is viewed
Macro (and local) economic and true in the event of interest rate as a ‘hard’ asset. It is also possible
business conditions can and reductions and greater capital to inflation-proof an asset, for
will fluctuate, and these can availability, and/or during periods instance if lease agreements are
impede the returns on a property of prolonged relatively low rates. inflation-linked, rental upside can
investment. With new projects, be locked in for the landlord.
planning and permitting can take a The purchase considerations in real
long time. The development period estate can, as mentioned above, Certain real estate risks such as fire
- which can be complicated by be substantial. Accordingly, the or subsidence can be covered by
unforeseen delays and cost over- availability and cost of funds are insurance, provided by specialized
runs - can be very risky indeed, important factors determining and very knowledgeable brokers
although of course the ultimate real estate investment strategy. and insurance companies.

THE REALITIES OF VALUATION;

SURVEYING:
The valuation of any particular They can also vary according to

real estate asset can sometimes demographic factors.
be rather subjective, and there Astute real estate investors pay
is much truth in the saying that for the best detailed surveys
‘the true value of a property is before buying, going beyond
what someone is prepared to pay what may be thought necessary
for it’. All valuations are subject for valuation purposes alone. The
to certain assumptions, and these total costs of buying what turns
may not be realistic. out to be a poor or damaged
asset can be substantial, and may
The majority of individual never be fully recovered.
real estate assets are unique,
according to their sector/land- Due to the special characteristics
use, location, design, age, and of different cities, and the
construction quality - and in extremely diverse nature of real CLINT DOVE
terms of whether they are estate, it is unwise to generalize Investment Strategy,
freehold or leasehold (and the regarding real estate asset Products & Services - Wealth &
number of years left on leases). price performance. Private Banking

RISK CONTROL FOUNDATIONS IN GLOBAL PORTFOLIO MANAGEMENT 123
RISK CONTROL
FOUNDATIONS
IN GLOBAL PORTFOLIO
MANAGEMENT

124 RISK CONTROL FOUNDATIONS IN GLOBAL PORTFOLIO MANAGEMENT
Risk Control Foundations in Global

Portfolio Management
WE WILL EXPLORE THE
FOLLOWING TOPICS IN DETAIL,
NAMELY THE:
• Diversification benefits of
model portfolios
• 2017 Model
Portfolio Performance
• Total risk level and adequacy
between model portfolios and
pre-determined risk profiles
• Single-asset model portfolios
(100% Bond or Equity)
In so doing, we aim to help

the reader understand the
assumptions under which we build
portfolios, along with the benefits
of systematic risk management.
THE DIVERSIFICATION BENEFIT

OF MODEL PORTFOLIOS:
The timeless adage, “Don’t put all as well as the instrument selection Growth). Each comprises different
your eggs in one basket” perfectly done in conjunction with our asset class proportions and each
illustrates the importance of Investment Product & Solution satisfies a particular level of
diversification in an investment specialists. This asset allocation risk tolerance:
strategy. This strategy involves implies the split of investment
spreading your money among portfolios across different asset
various investments with the idea categories, such as Equities, Fixed
that should one investment lose Income, Alternative Investments,
money, the others stand a chance and Cash.
of compensating for losses.
To make the asset allocation
Our Model Portfolios are based on process easier, we use a choice
the FAB Investment Committee’s of three different risk profiles
asset allocation recommendations, (Conservative, Balanced, or

WHILE THERE ARE 3 DIFFERENT 2017 MODEL PORTFOLIO PERFORMANCE

INVESTMENT APPROACHES
FOR EACH RISK PROFILE, With year-to-date returns of Within Equities, we have been
EACH ONE IS BASED ON THE almost 22%, the ‘Overweight’ confident about Asia (ex-Japan),
SAME INVESTMENT PROCESS, recommendation for Equities paid Europe, and North America. Among
SPECIFICALLY: off. The trend for Equities remains the Equity sectors, Information
clear, due largely to good global Technology and Financials have been
• Asset Allocation Funds economic growth forecasts and seen as the most attractive sectors by
(recommended for clients with strong corporate results. With stock- far. Within Fixed Income, Government
up to $1 million in assets); market volatility continuing to be Bonds continue to be very much out
• Third-party/ETF model portfolios low, this indicates that confidence in of favour.
(recommended for clients with global economic growth is strong.
$1-5 million in assets), and Bearing in mind the above, our model
• Shares/bonds only Fixed Income and Real Estate have portfolios have returned performances
(recommended for clients with lagged behind Equities by quite a of between 7.40% and 15.73% as the
over $5 million in assets). distance, with returns of close to year comes to a close. Compared
6% to 8%. The outlook for Fixed to the models’ corresponding
Income is not particularly bright, benchmarks, our overall strategy
however, due to expected interest- resulted in a relative outperformance
rate increases in the coming quarters. of 1.15% for the Conservative, 1.42%
That said, the recommendation for for the Balanced, and 0.97% for the
Fixed Income remains ‘Neutral’. Growth models, respectively.

Model Portfolio Performance (in %)1

Conservative Balanced Growth
Portfolio Benchmark Portfolio Benchmark Portfolio Benchmark
YTD – 2017 7.40 6.25 11.79 10.37 15.73 14.76
2016 6.71 5.61 6.32 6.01 6.23 6.74
2015 -0.50 -3.07 1.75 -3.90 3.95 -4.49
2014 2.11 1.42 2.81 1.30 3.71 1.91
Cumulative since inception 16.53 10.16 25.84 15.05 35.69 21.89
1- Performance shown is for our model portfolios and is not a composite of the performance of actual client mandates. While our goal is that
each client mandate will closely mirror the holdings and performance of our models, client account performance may, and does, vary according to
several factors. The performance of the model portfolios is calculated gross of management fee, and brokerage charges, if any.
2- Based on the Tactical Asset Allocatio
3 - 31 October, 2013
TOTAL RISK LEVEL AND

ADEQUACY BETWEEN MODEL
PORTFOLIOS AND PRE-
DETERMINED RISK PROFILES
Over 2017, The CBOE Volatility Index

(VIX) - widely considered the best
gauge of fear in the market - fell
to a record low on November 3,
2017, hitting 9.13, below the 9.31
low of December 22, 1993. This
is illustrated in our top-level risk
analysis (see Table below), which
reflects the risk of the FAB Model
Portfolios given the Investment
Committee’s tactical bets.

2017 Model Portfolio Top-level risk (in %)

Conservative Balanced Growth
Portfolio Benchmark Portfolio Benchmark Portfolio Benchmark
Performance (YTD) 7.40 6.25 11.79 10.37 15.73 14.76
Excess Return (YTD) 1.15 1.42 0.97
Volatility 2.28 1.87 3.04 2.69 4.46 3.97
Tracking Error 1.31 1.84 2.94
Correlation 81.84 80.13 76.28
Sharpe ratio 3.24 3.35 3.88 3.85 3.52 3.72
To measure how closely a portfolio captured through the Sharpe Ratio. At between 3.24 and 3.88, our
follows its benchmark, we use the The latter is defined as a reward- Model Portfolios demonstrated
standard tracking error statistic. to-variability ratio, measuring the very impressive Sharpe Ratios in
Again, if we consider the Balanced excess return (or Risk Premium) 2017, indicating that the risk taken
Model Portfolio, its tracking error per unit of risk in an investment has been very well-rewarded.
is 1.84%. This is in line with what asset or a trading strategy. The
is required for a balanced profile, excess of return is calculated over
and indicates the Investment a benchmark return.
Committee’s tactical bets remain
well controlled. Finally, the The beauty of the Sharpe Ratio
portfolio’s correlation level (80%) is that it captures how the
confirms the similarity of the markets reward risk. While a
model portfolio to its benchmark. positive and high Sharpe Ratio
means high return for risk, a low
Finally, we focus on the risk/ positive Sharpe Ratio means poor
return characteristics of the model performance related to the risk
portfolios over 2017 to determine taken, and a negative Sharpe
if risk is adequately rewarded. Ratio indicates so-called ‘unfair
The risk/return trade-off of each territory’, where risk is punished by
model portfolio considered here is negative performance.

SINGLE-ASSET MODEL PORTFOLIOS (100% BOND OR EQUITY) CONCLUSIONS:
A diversified portfolio should diversification across different The analyses presented in our
be diversified at two levels: 1) bond instruments. Highly-rated report highlight that proper risk
between asset classes, and 2) companies within the corporate analysis is an integral part of the
within asset classes. So in addition portion, and well-diversified funds asset allocation and portfolio
to allocating investments across for Emerging Market debt offer construction process. Furthermore,
Equities, Bonds, Cash Equivalents, the possibility of maintaining the we have shown the importance
and possibly other asset Bond Model Portfolio’s total risk in of controlling risk at global,
categories, we spread investments line with its benchmark. asset allocation, regional, and
within each asset category itself. sector levels.
For the Equity Portfolio, we carried
What is the key here? - Being out the same exercise, retaining
able to identify investments in a geographical breakdown. North
segments of each asset class that America represents the principal
may perform differently under allocation (47%), followed by
different market conditions. Europe (20%). In addition to
the latter two regions, Asia ex-
One way of diversifying the Japan (11.5%) and Japan (7.5%)
investments within an asset enhance Developed Market
class is to identify and invest in exposure. Finally, Global Emerging
a wide range of companies and Markets (7.5%) and MENA (6.5%)
industry sectors. However, the add exposure to less-developed
stock portion of the investment markets (as defined by MSCI).
portfolio will not, for example, be Finally, sectors can be played
properly diversified if we invest in as themes, usually within the
only four or five stocks. Indeed, at North American and/or European
least a dozen carefully-selected regional groups
stocks are needed to ensure true
diversification, and this is exactly
the way our Bond and Equity
Model Portfolios are built.
The Bond Portfolio is well-

diversified, with a ‘core’
governments portion (47.5%) and
a ‘satellite’ portion, each of which
are allocated into investment-
grade and non-investment grade
Corporates (30%), Emerging
Market Debt (15%), and GERARDO AMO, PHD
MENA bonds (7.5%). To control Discretionary Portfolio
interest rate risk, it offers wide Management

AN INTRODUCTION TO BITCOIN, BLOCKCHAIN AND THE FUTURE OF MONEY 129
AN INTRODUCTION TO
BITCOIN, BLOCKCHAIN AND
THE FUTURE OF MONEY

130 AN INTRODUCTION TO BITCOIN, BLOCKCHAIN AND THE FUTURE OF MONEY
An introduction to Bitcoin, Blockchain

and the future of money
The initial price of bitcoin, set in Once seen as the main province of money are going public,
2010, was less than 1 cent. Now of computer scientists and mainstream, and could quite
the price has exceeded $18,000. technology firms, bitcoin is today soon be considered legitimate
What should we think, say, or do drawing millions of dollars from financial assets. Bitcoin got
about bitcoin? different types of investors. The a boost when the Chicago
recent price surge, helping drive Mercantile Exchange Group,
the total market value to about the world’s biggest exchange
$300 billion, could represent a operator, recently introduced
bubble, or it could be a belated futures contracts tied to the
recognition by the worldwide digital currency in December
community that digital forms last year.

Trying to explain Bitcoin in short

order is no easy task. Bitcoin (capital
‘B’) is an information technology
platform that facilitates both a
secure, decentralized, payment
system, and a tool for the storage,
verification and auditing of
information, including digital
representations of value. A bitcoin
(lower ‘b’) is the intangible unit
of account that facilitates the
decentralized computer network
of Bitcoin users, or in other words
refers to a unit of account that
may be transferred from one
party to another on the Bitcoin
network. Bitcoin is not a company
or a company product, and it is not but the basic premise of a reliable A significant business sector has
something that you can hold in and prompt network agreement grown, and continues to grow,
your hand. regarding information is at the heart around Bitcoin, both as a payment
of this technology. network and as a potential
Bitcoin is important because it Unlike traditional computer information technology platform.
represents a new means of forming networks and payment systems, There has also been substantial
consensus reliably and promptly Bitcoin is not administered by any investment in bitcoins as a digital
across time and geography. As centralized authority or controlled asset. Activity in it is driven on the
currently designed, Bitcoin is an by any rights holder. Instead, it one hand by direct participants
open and transparent system that was introduced to the world as an and investors seeking to disrupt
allows all users to easily come to an ‘open source’ project. It may be conventional systems, and on the
agreement on the authenticity of utilized by anyone, without a fee, by other hand by financial institutions
transactions and information stored downloading Bitcoin software and seeking to appropriate the
on the network, all without the need accessing the peer-to-peer network. innovation to improve those same
to involve a trusted third party, and These users collectively provide existing systems. Understanding the
without the concern of censorship the infrastructure and computing diversity of the sector begins with
of information or value transmitted power that processes and verifies understanding Bitcoin itself. Broken
across the network. Adaptations transactions and information posted down at its most basic level, Bitcoin
of the Bitcoin technology allow through that network and recorded is comprised of three separate
for different controls and access, on its decentralized ledger. innovations, as highlighted below.

Bitcoin, Blockchain and bitcoin to enthusiasts and computer exert a tremendous amount of
The first is Bitcoin (capital ‘B’). scientists focusing on testing the computing power toward the
When using the capitalized term, software in an attempt to verify singular purpose of validating
one is referring to the Bitcoin Bitcoin’s technology and platform, and clearing transactions on the
software and the decentralized which were largely drawn from Bitcoin Network.
computer network of users public-private key cryptography
running that software. The Bitcoin or the ‘Hashcash’ proof-of-work The distributed and decentralized
software and protocols were first algorithm, and peer-to-peer network allows each individual
described in a research paper network connections using a user to verify the validity of
released in November, 2008, by a consensus protocol. individual transactions and the
group of people under the pseudo- system, as a whole, through the
name of Satoshi Nakamoto, and Online games have long used cryptographic protocols and the
Bitcoin itself was released in a virtual or digital currencies, transaction history of the Bitcoin
proof-of-concept software client in a sense to ‘reward’ the Network, which is stored by each
to the public in January, 2009. players. However - and unlike user on a distributed ledger known
The team’s innovation spawned prior attempts to develop a as the Blockchain.
from an online community digital asset - the technology
of computer scientists who proposed by the team who KNOWLEDGE BOX:
studied cryptography and the introduced Bitcoin did not rely
application of the technology on a centralized or a trusted third ‘The word Bitcoin first occurred
toward the creation of a secure, party to verify money supply back in October 2008, and it is
efficient, and verifiable digital and transactions. Instead, the the combination of ‘Bit’, that is
asset system. Upon the launch of Bitcoin community progressively the basic unit of information in
the Bitcoin Network in January, built out a decentralized the digital world, and the word
2009, users were largely limited network of computers that ‘coin’ referring to a fiat currency

used primarily as a medium of spot in a database it maintains is decentralized and distributed,

exchange and issued by a central of accounts and balances, and that tracks the movement of
bank, a central authority or a credits it in another. You can see assets, whether they are cash,
national government.’ the result if you log on to your or shares in a company. Each
account but the transaction record in the open ledger is
The ‘Blockchain’ represents the falls under the bank’s control called a block, and contains
second great innovation. The and authority. The bank is being details such as the transaction
simplest way to understand entrusted to remove the right timestamp, transaction details
blockchain is to see it as the amount of money from your as well as information about
evolution of a publicly visible, account, and it is also making the previous block. A new block
anonymous online ledger that sure you cannot spend that is always added after the block
records every single Bitcoin money again. The blockchain is with the most recent timestamp.
transaction. Think about what a database that performs those As such, a chain of blocks - or a
happens if you make an online tracking functions, but without ‘blockchain’ - forms and evolves.
transfer using a bank. The bank the central authority. In Bitcoin’s blockchain, the
verifies that you have the funds, In other words, the Blockchain is Blockchain contains information
subtracts that amount from one a record-keeping open ledger that about transactions in bitcoin.

KNOWLEDGE BOX:
‘The current size of the Blockchain clearance of securities and other as mining rewards distributed
file or the distributed ledger has transactions. International as compensation to miners in
passed the 100 gigabytes of data’. logistics companies are outfitting the process that adds blocks to
The Blockchain technology shipping containers with devices the Blockchain. At the moment,
can be applied to a variety that will beam out the cargo’s more than 16 million of bitcoins
of purposes other than the location, how much it is vibrating have already been mined, in
transfer of digitally stored value. as it travels, and its ambient other words the current supply of
Although, the first core use case temperature. The data will flow bitcoins on the Bitcoin Network.
of Blockchain technology has into a single blockchain repository By 2026, approximately 90
been as a payment system, the in the cloud so the entire supply percent of all bitcoins will have
Blockchain technology is seen as chain can be informed if a been mined. The innovation
having the potential to reshape shipment has been delayed. That of bitcoins as digital assets
the global financial system and will prevent redundant e-mails, lies in the ability to verify the
is drawing interest from various faxes and phone calls. Instead of authenticity and ownership of a
industries including finance, having separate databases, the bitcoin and the ability to transfer
healthcare, retail, supply-chain, blockchain repository in the cloud possession nearly instantaneously
shipping, manufacturing, and would allow all companies to tap for little or no cost, all without
entertainment. Recently, more the information in real-time. the reliance on a trusted third
than 100 international banks are party or central clearinghouse.
working as part of an international The bitcoin (lower ‘b’) references The Bitcoin Network makes such
consortium to find ways to use the core unit of value on the verification possible through its
Blockchain as a decentralized Bitcoin Network. Under the use of cryptographic proof of
ledger to track money transfers, Bitcoin software, a total of 21 control and the transparent and
investments, settlement and million bitcoins will be created distributed Blockchain.

KNOWLEDGE BOX: UNDERSTANDING THE ROLE OF PEER-TO-PEER NETWORKS, MINING

AND CONSENSUS MECHANISM.
‘ The total number of bitcoins that As a distributed online ledger, in a peer-to-peer network to
will ever exist is set to 21 million the Blockchain file is stored on ensure the Blockchain is secure
of bitcoins. Currently, 16 million the local computer of every user and up-to-date. Every node
bitcoins have been mined and running the Bitcoin software. The stores the complete, updated
in circulation, which represents Blockchain records the history version of the Blockchain. Every
nearly 80%. When the last bitcoin of every transaction sent and time a new block is added to the
is mined, bitcoin miners will be confirmed on the Bitcoin Network. Blockchain, it is added through the
awarded transaction fees, and To use the Blockchain as a ledger consensus mechanism, and all the
these fees should keep the Bitcoin for transactional data, the nodes update their locally-stored
network afloat’. Blockchain needs to be checked if Blockchain accordingly.
a transaction has been made to
a certain electronic address, or in
other words to an electronic wallet.
If the Blockchain is only stored on

one computer, and it happened
to be turned off, this would
be annoying to say the least.
Therefore, the current state of
the Blockchain is downloaded,
synchronized and made available
by a large number of computers
worldwide. These computers are
called ‘nodes’, and work together

The consensus mechanism is ‘mines’ the new block to add to supply is rules-based and involves
a protocol or a set of rules on the chain, is rewarded by the a projectable and known growth.
how blocks are added to the network. A pre-defined amount New bitcoins are introduced
blockchain, when blocks are of new coins is created and into the money supply through
considered valid and how conflicts given to the miner, together a block reward or coinbase
between nodes are resolved. with the transaction costs of currently set to 12.5 bitcoins
all transactions contained in and paid to Bitcoin miners who
The process of adding a block the block. successfully validate and clear
to a blockchain is called mining. Bitcoin transactions by adding
Nodes try to add a block to When a miner solves the puzzle a block to the Blockchain. In its
the chain (called ‘miners’) use and mines the block, all the current state, after every 210,000
computational power of their nodes in the network will check blocks have been added to the
computers to try and solve a if the block is valid and add it Blockchain, the size of the block
cryptographic ‘puzzle’. The rules to their copy of the blockchain reward is halved. It is estimated
state that only when this puzzle and the state of the blockchain that in year 2020, the bitcoin
is solved, a block can be added to updates. Subsequently, all miners reward for mining a block would
the blockchain. The miner that will start mining the next block. be reset to 6.25 bitcoins down
solves the puzzle, and therefore Knowledge Box: ‘ Bitcoin money from 12.5 bitcoins’.

ADVANTAGES AND
DISADVANTAGES OF BITCOIN
AND BLOCKCHAIN
ADVANTAGES
• TRANSPARENCY: With the

Blockchain, all transactions are
registered and recorded, and
they are available for everyone
to check and to verify, however
personal information is hidden.
Only the public address is visible
and personal information is not
tied to this public address.
DISADVANTAGES
• VERY LOW FEES: Currently there
are either no fees, or very low • DIFFICULT TO USE AND TO • STILL DEVELOPING: So far
fees associated within Bitcoin ACCESS: Bitcoin is still not a there has been limited retail
payments. With transactions, retail or consumer-friendly and institutional adoption.
users might include fees in order platform. Most existing software The use of Bitcoin remains
to process the transactions is either complex or difficult to somewhat limited, relative to
faster. The higher the fee, the use. Third-party software and existing payment systems or
more priority it gets within solutions that can simplify this financial technology.
the network and the quicker it involve entrusting bitcoins to
gets processed. such third party.
• INSTANTANEOUS • DIFFICULT TO SECURE:

TRANSACTIONS: Bitcoin Although the Blockchain and
transactions are very fast the cryptographic protocols
when compared to traditional that underlie Bitcoin are secure,
channels. A Bitcoin transaction users must safely store and
could be processed within use their private keys in order
10 minutes. to safeguard their bitcoins.
Securing private keys either on
• CROSS-BORDER AND CROSS- a computer or other medium
TIME: Digital currencies do requires proper personal
not recognize the concept of computing, and/or home
geographical borders, time, bank security that relies on individual
holidays or any other limits. user sophistication.

DIFFERENT TYPES CONCLUSIONS:

OF CRYPTOCURRENCIES
The development of Bitcoin and
• ETHEREUM: Ethereum is a platform. Similar to Bitcoin, Blockchain technology is clearly
decentralized computing Ripple uses a public ledger highly significant, and in a growing
platform that features smart and a consensus mechanism number of ways – not just in the
contract functionality. The process to all exchange, global FinTech economy. The
platform executes peer-to-peer remittance and payments in a Blockchain phenomenon has
contracts using a cryptocurrency distributed environment. taken the world by storm, opening
known as ether. Ethereum is or disrupting a wide range of
different than bitcoin in that • LITECOIN: Litecoin is a peer- industries and sectors, including
it allows for smart contracts to-peer digital currency and data storage, the financial industry,
which can be described as highly it is inspired by and almost the insurance industry, real estate,
programmable digital currency. identical to bitcoin. However, retail, healthcare and almost
The smart contracts can only Litecoin’s network is faster everything else being managed
be executed when certain than the bitcoin blockchain and by a central entity or exchange.
conditions are met. transaction fees are currently In addition, the Bitcoin Network
lower and nearly non-existent. has resulted in new eco-systems
• RIPPLE: Ripple is a real-time of projects raising large amounts
currency exchange, remittance for investment in venture capital
network, and settlement system. financings. Such investments will
It offers instant, low-cost and allow entrepreneurs and financial
cross-border payments. Ripple institutions to experiment with
is a decentralized computing each of the Bitcoin, the Blockchain,

as well as bitcoin, all collectively • We would be concerned • CFTC data has reflected the
with the possibility that the world if growing numbers of extent of the ‘long bias’
of international finance and unsophisticated investors
information technology could became involved • …while the cost of rolling
be transformed. positions into the active month
• Those retail (or other) investors are unacceptable to many traders
Will digital currencies be the future thinking it’s OK to ‘bet the farm’
of money? It is perhaps too soon to should seek professional advice • FOMO (the ‘fear of missing out’)
tell at this stage, yet we must arrive has sucked in money that may
at a few interim conclusions, as this • Similarly, we would worry have been lost elsewhere
is simply far too important. if investors liquidated other
investments to invest in bitcoin • Crypto-currencies have been used
Although the technology behind by criminals to launder money
it all might be totally fascinating, • …or if they used borrowings (‘outside the system’)
the risks in taking a long position secured on other genuine
in bitcoin itself at the – uniquely investments to do so • Bitcoin (and related) prices could
volatile – screen price do need to be soar – although we are NOT
fully appreciated. • Traders should not think that the recommending purchases
norms of technical analysis can
IN SUMMARY: be transposed in this case • We are fascinated by the
technology, and will be doing
• For the time being, at least, the • Investors might make tiny more work on it
bubble in the bitcoin price itself investments to invest in the
has burst technology – but seek advice first! • In essence, bitcoin (or similar)
should not be a part of a
• The bitcoin in reality has no • The advent of futures markets in sensible portfolio
intrinsic value, with no financial bitcoin should reduce volatility in
entity guaranteeing it the spot price • In reality, investment is always
far better than speculation
• The bitcoin market does lack • Remember that a few bitcoin
natural sellers, other than the exchanges have been hacked,
‘miners’ and/or went bankrupt
• If the bitcoin price crashed, • …and that interruptions to

‘created’ value would disappear, trading on some exchanges have
but the system could cope been unacceptably long
• As yet bitcoin has not seemingly • Certain central banks have JOSEPH BECHARA
been used as collateral – how cleverly expressed a desire to Investment Advisory, Products &
could it? utilize the technology Services, Wealth & Private Banking

140 ‘Universal Basic Income’ – A Solution to the Third Industrial Revolution?

‘UNIVERSAL BASIC INCOME’ – A SOLUTION TO THE THIRD INDUSTRIAL REVOLUTION? 141
‘UNIVERSAL BASIC INCOME’

– A SOLUTION TO THE THIRD
INDUSTRIAL REVOLUTION?

142 ‘UNIVERSAL BASIC INCOME’ – A SOLUTION TO THE THIRD INDUSTRIAL REVOLUTION?
‘Universal Basic Income’ – A Solution

to the Third Industrial Revolution?
The concept works like this: Mankind has been ever-resourceful this presents challenges for
Qualifying citizens are given a in trying to make life easier over society. In the past, the increased
regular, unconditional allowance the centuries. In the beginning, use of machines was embraced;
without any pre-conditions, the hunter-gatherer with his spear automation has transformed often
replacing state benefits. Most provided food for survival. As menial and repetitive jobs, and also
welfare systems around the world time moved on, this was replaced some of which were hazardous. In
have strings attached and can by farming and mechanization, the UK back in the 1800’s, children
lead to long-winded form filling helping human sustenance. worked long hours often for very
and means-testing. Universal Eventually the need to go hunting little pay. The increased use of
Basic Income (UBI) does away disappeared altogether. These machines helped liberate them,
with all of this, bringing the days, ‘artificial intelligence’, and eventually the employment
concept of an ‘allowance for all’. along with robotic technological of children was banned altogether.
It has a two-pronged approach. advancement could ultimately One of the most famous
It gives workers greater financial replace more and more humans inventions of that era was the
security, for instance in the event in the workplace. The need for introduction of the ‘spinning
that mechanization takes their efficiencies and cost-reduction Jenny’, a yarn spinning machine
jobs away. At the same time UBI drive the corporate world, yet that revolutionized fabric making
would go some way to reducing while beneficial in terms of output in an industry that was booming at
income inequality. and the availability of products the time and employed thousands

of people in the North of England. robotics. However, in an example in wanting to avoid a future
One machine could replace from the US, a scheme is being problem from resulting mass
hundreds of workers at a single piloted in which robots are being unemployment. These gentlemen,
stroke. By such means increased programmed to give general thought leaders as well as business
efficiencies and productivity medical advice by reference to leaders, have suggested that UBI is
growth continued during what data banks for everyday common a possible solution to avert this.
became known as the ‘Industrial medical ailments. This initiative
Revolution’ in Britain, facilitating started quite innocently as a way Some critics argue that UBI
better standards of living for the of reducing the burden on doctors would create a culture of laziness.
population as a whole, together (where there is a shortage), who Earnings for working has been a
with the emergence of a growing have had less time to spend on the norm for decades, but as Mark
middle-class from the ranks of more serious cases needing face- Zuckerberg has argued, we need
the working classes. This is a to-face visits and examinations. to think differently and embrace
significant transformation that is Despite the clear need to the concept as a workable solution
continuing in the emerging (and minimize mistakes, these medical for today’s world. In schemes in
also some frontier) markets around robots could now be joining the which this is being trialed it has
the world today. continuing evolving ranks of been shown that some areas of
outsourced mechanized models economies that are underinvested
For some years now, free for an increasing number of our or neglected have benefited from
enterprise has moved hand- needs. In summary, whether we UBI. For instance research has
in-hand with innovation, are considering on-line shopping shown that ‘home help’ services,
often proving to be a potent - or driverless vehicle technology caring for elderly people, as well as
combination. Through the - people are gradually becoming working on new ideas have all been
application of increasingly less relevant throughout many boosted by the introduction of UBI.
sophisticated technology, industrial and commercial sectors.
machines are giving way to The financial austerity that came
‘smart’, intelligent problem-solving Perhaps ironically, it has been out of the financial crisis of 2008
robots. Accordingly we are seeing the IT leaders of the world, has resulted in more households
machines that once replaced including Bill Gates, co-founder of with several generations living
‘basic tasks’ giving way to those Microsoft, and Mark Zuckerberg, under the same roof. This is
capable of challenging skilled Facebook’s chairman, as well as becoming a trend in the developed
labour-forces in developed (and Elon Musk, founder of Tesla, who world, not seen since the Great
other) economies. Skilled labour, have recently sounded the alarm Depression years of the 1930’s.
with its specialized training and on the outlook for people’s jobs State-provided care for the elderly,
knowledge used to be able to due to the pace of technological and the building of so-called
successfully differentiate itself and advancements in the workplace. ‘council houses’ can be expensive
not be particularly threatened by These tech leaders appear united for governments, so this trend

Source: Focusingfuture.com
has been beneficial in the short- decided to try the UBI experiment giving people a little more of a
term. The younger generations by giving over euro 500 (tax- level playing field with others could
are beginning to take care of free) to 2,000 of its qualifying inspire them to do more. This could
the older ones due to the high, citizens over a two-year period in turn help create a better, more
and in many cases unaffordable who had already been receiving forward-thinking society in future,
costs associated with care home government assistance. Other leading to more innovation. Others
facilities. We have seen a shift countries are also trialing the have argued, however, that other
from a less-caring society in the scheme in the hope that funding assistance-led schemes operating
1990s, towards one that is more in for social breakdown can be in these trial areas could be
tune with people’s needs. reduced in the long-run. Mark affected, creating animosity and
At the start of 2017, Finland Zuckerberg has pointed out that leading to more social problems -

the opposite to what UBI is trying

to achieve. Economists at the
Roosevelt Institute have estimated
that in the US a guaranteed
income of $1,000 per month for
all Americans could accelerate
economic growth by an additional
12.5% over the next eight years.
If financed through debt at the
Federal level, that could produce
an additional 2.6% of GDP over
a decade. The Federal deficit is
estimated to shrink by 1.4% under
the Roosevelt model, and in both
cases unemployment is projected
to fall.
The Roosevelt Institute’s

conclusions about the broader
economic impacts of UBI
highlights a well-known economic
concept called the ‘marginal
propensity to consume’. As those
in the lowest income brackets are the long-term unemployed. The 62 people owned half the world’s
more likely than the wealthy to fact remains that many people assets. This report went on to say
spend additional income, so UBI remain trapped in poverty, or just that the wealth of the poorest half
would put a greater proportion above the bread-line. It has been of the world’s population has fallen
of cash into circulation. UBI can estimated that perhaps more than by a trillion dollars since 2010, or
perhaps be a modern form of half the UK workforce has more 38%. This has happened with the
redistribution of wealth, bringing than one job, as people as simply global population rising by about
to mind the Robin Hood philosophy unable to make ends meet. Linked 400 million people during that
of robbing from the rich to give to this, we are increasingly aware period. At the other extreme, the
to the poor. Of course income tax of the rise of the so-called ‘gig’ wealth of the richest 62 people
increases would be needed to pay economy, based on the prevalence has increased by more than half
for a fully-funded UBI. In many of short-term contracts, rather a trillion dollars, to $1.76 trillion.
countries around the world there than permanent jobs. Of those Also, by the way, only 9 of the
are only low rates of wage growth people, about 40% are thought 62 are women, so women are
vs. historically, and this is the to have decided to start their still some way behind men in the
case across the developed world, own businesses. wealth index.
mainly linked to innovation and
efficiency gains. Not only could UBI Returning to inequality, a report Both the Organization for
help alleviate immediate poverty, by the charity, Oxfam, released Economic Cooperation &
but it could also provide hope for in January, 2016, suggested that Development (OECD) and the

International Monetary Fund and the existence of families Source: blog.ficci.com

(IMF) have been modeling what without a bread-winner. Many
a UBI scheme would look like studies around the world show
in each of the economies in that where poverty is entrenched,
the world. Unsurprisingly the with long-term unemployment,
cost varies markedly from one there has tended to be a sole
part of the world to another. reliance on state benefits. This
For example, in the Eurozone, has proven to be a failed model,
where social security is heavily leading to a perpetuation of
funded, the move to UBI would poverty, with a heavy cost burden
only be an additional few billion to the governments concerned.
dollars on average. In the UK, The costs associated with the
where the welfare state has rolling-out of a UBI scheme seem
been under-funded over time, worthwhile if it can break the
that figure is closer to $50 billion vicious cycle of hopelessness
in estimated additional cost to and despair. The tech billionaires
the government. As mentioned mentioned earlier have pointed
earlier, it is hoped that a ‘kick out in their speeches that they
start’ to people’s lives could be believe UBI would not only give
achieved by UBI. Ambition is not people a better chance of escaping ALAIN MARCKUS
only stifled by poverty, but high poverty, but also to create and Head of Investment Strategy,
social costs accrue from clinical build more efficient economies and Products & Services - Wealth &
depression, social problems, crime, societies in the long run. Private Banking

VALUE ADDED TAX 147
VALUE ADDED TAX

148 VALUE ADDED TAX
Appendix: Value Added Tax

Value Added Tax (or VAT) is an
indirect tax on consumption,
usually imposed on many goods
and services that are bought and
sold. It is ‘indirect’ in the sense that
it is contained within the price that
the consumer pays - as opposed
to a ‘direct’ tax (e.g. income or
corporation tax) levied directly on
the individual or corporate entity.
VAT is one of the most common
types of consumption tax found
around the world. Over 150
countries have implemented it (or
an equivalent of it, such as a ‘Goods
and Services Tax’), including all 29
members of the European Union,
Canada, New Zealand, Australia,
Singapore and Malaysia.
collect from their customers, those WHY HAS VAT BEEN
Sales Tax vs. VAT: Unlike a traditional businesses may also receive a refund IMPLEMENTED IN THE UAE?
sales tax (e.g. a percentage added from the government on tax that
to a hotel bill), VAT is a levy on they have paid to their suppliers. The UAE Federal and governments
consumption that taxes the ‘value To help illustrate the way in of the individual Emirates provide
added’ to a product or service by which the value added along citizens and residents with many
businesses at each stage in the supply chains gets taxed, the UAE different public services, including
chain of production. Businesses Ministry of Finance has provided an hospitals, roads, public schools,
along the chain collect the tax excellent webpage: parks, waste management, and
and send it to the government, police services. These services
which is generally considered to (https://www.mof.gov.ae/En/ are financed from governments’
help maximize the efficiency of budget/Pages/VATQuestions.aspx) budgets. VAT will provide the
revenue-collection efforts – the UAE with a new source of income
ultimate/’final’ consumers generally helping to contribute to the
bear the VAT cost while businesses continued provision of high quality
collect and account for the tax, public services into the future. It
therefore acting as a tax collector on will also help our governments
behalf of governments. progress towards the goal of
reducing the dependence on oil
As seems logical, while businesses and other hydrocarbons as a
pay governments the tax they source of revenue.

VALUE ADDED TAX 149
IMPLICATION OF VAT IMPLICATION OF VAT

ON INDIVIDUALS ON BUSINESSES
While the general cost of living is much VAT an individual is required As mentioned above, VAT-
likely to increase slightly, this will to pay on a transaction. Based Registered businesses and traders
vary depending on an individual’s on this information, consumers will charge VAT to all of their
lifestyle and spending behaviour. can decide whether they need to customers at the prevailing rate
If an individual’s consumption is adjust their expenditure. and incur VAT on goods/services
weighted towards goods or services that they buy from suppliers.
that are VAT-exempt, they shouldn’t The difference between these
see any significant increase. In any sums is reclaimed or paid to
case, a VAT rate of 5% is really very the government.
low on a global basis. The excellent
UAE government VAT website will (Source: https://government.ae/
answer most questions asked about en/information-and-services/
all aspects of the introduction of finance-and-investment/taxation/
VAT in the UAE. valueaddedtaxvat)
The UAE government has naturally

included rules that require
businesses to be clear about how

IN ADDITION TO
ALL OUR AUTHORS,
SPECIAL THANKS
SHOULD GO TO:
ALICEL LACAD
ANDREW STYLES
ANWAR CHBAITA
CHAVAN BHOGAITA
CLARENCE SINGHAM-ZHOU
JATIN JALLA
MICHAL SOBIERAJSKI
PHILIP MEHL
SAGAR PATEL
SATYAKAM PATNAIK
SHIRAZ HABIB
WALID DAHDAL
WALTER ALLEMANO
WILLIAM MATTHEWS (KNIGHT FRANK)
DISCLAIMER:
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Global

FAB GLOBAL INVESTMENT OUTLOOK 2018

2017: THE YEAR THAT WAS

FAB GLOBAL INVESTMENT OUTLOOK 2018

2017: THE YEAR

GLOBAL GROWTH GAINED

POLITICS: Trump was inaugurated

GLOBAL CENTRAL BANKS: The

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

ECONOMIC & INVESTMENT

FAB GLOBAL INVESTMENT OUTLOOK 2018

THE ECONOMIC & INVESTMENT

FAB GLOBAL INVESTMENT OUTLOOK 2018

Central banks will move towards THE INVESTMENT BACKGROUND:

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

THE GLOBAL MACRO

FAB GLOBAL INVESTMENT OUTLOOK 2018

The Global Macro Economic Outlook

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

“At the worst, we are thinking

being done within the emerging

In US politics, if Trump was

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

• Global trade is growing; • If or when commodity • Asia-Pacific is seeing a shift

• Global growth drives • Demographics are poor in • Japanese growth is improving -

FAB GLOBAL INVESTMENT OUTLOOK 2018

• There is a good balance of corporate profits in China (vs. RISK FACTORS:

• China’s Baidu, Alibaba & Tencent • And which is the nation-state

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

The Oil Market

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

even be drafted, with tax reform, CONCLUSION:

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

THE MENA REGION

FAB GLOBAL INVESTMENT OUTLOOK 2018

The MENA Region

FAB GLOBAL INVESTMENT OUTLOOK 2018

FAB GLOBAL INVESTMENT OUTLOOK 2018

United Arab Emirates

FAB GLOBAL INVESTMENT OUTLOOK 2018

Kuwait’s overall real GDP growth

FAB GLOBAL INVESTMENT OUTLOOK 2018

“With the war over Iraq now

autonomous region’s decision to

FAB GLOBAL INVESTMENT OUTLOOK 2018

Turkey’s economy performed far

On the economic front and

FAB GLOBAL INVESTMENT OUTLOOK 2018

“The recent strong recovery

negative reactions triggered by