Saudi Arabia and Russia engineered a dramatic rise in the price of Brent crude via output cuts, the French far right National Front did not win the Élysée Palace in the Presidential election and the US Dollar Index fell almost 10% in 2017. I thought the three powerful macro forces would be largely positive for foreign investor interest in the Dubai property market and would suggest a bottom in rents and capital values. I was wrong. Rents in even prime Dubai locations like Downtown, Palm Jumeirah and Sheikh Zayed Road continue to fall in 2018, in some cases 20 – 25% below cycle highs. The office market continued to be pressured with a glut of vacant space with occupancy ratios in dozens of Business Bay buildings in the 55 – 60% range.
The industrial segment is in a bear market, with a 25% fall in Grade A Jebel Ali Free Zone warehouse rents and a 30% vacancy rate for prime industrial assets. Hotel revenue per available room continued its fall even as occupancy ratios remained high in five star Dubai hotels, a clear indication that average daily room rates are under pressure. Marriot no longer manage its Westin, St. Regis and W luxury brands for one of Dubai’s most prominent hospitality companies. The concept of “key money has disappeared in key retail areas like the Gold Souk, Textile Market, Deira (Al Ras, Nasser Square). The most prominent metric in the Dubai luxury home segment is the dramatic fall in sales prices for villas, townhouses and ritzy apartments. It did not surprise me that DAMAC Properties, listed on the DFM, reported its third successive quarterly loss and its Group CFO wants to reduce $500 million of its $1.5 billion commercial bank/capital market debt and slash its cost base.
There has been a visceral investor disappointment in the performance of offplan purchases. I have so many friends who waited three to four years for their luxury flat only to find out that prices were 30 – 40% lower, if their flat or villa could be sold at all. Rents are now falling faster than capital values, clear evidence metric of a glut in existing units, let alone development pipeline. There is absolutely nothing to suggest that there is an imminent bottom in rents and capital values. Property markets, like all asset markets based on leverage and credit cost/access are inherently cyclical. An investor who cannot analyze the credit cycles in Dubai can and will be fleeced by the offplan sharks mercilessly with armies of commissioned brokers motivated by even 7% payouts. Dubai Land Department’s decision to seize the assets of Schön Properties and reference to the Public Prosecutor and Dubai Courts is absolutely mission critical to restore lost investor confidence.
Offplan sales accounted for 58% of total sales in 2Q 2018 when there is such an alarming number of villas and apartments available in New Dubai for purchase. Even Emaar’s offplan sales binge has plunged. Investors have clearly turned bearish on capital appreciation and just accept yield, the reason there is so much interest in the secondary market in International City and even labour/staff accommodation in Jebel Ali with the allure of potential double digit gross yields.
It is now possible to accumulate units in JLT for as low as 700 AED per square foot in units owned by laid off owners. In my experience, in Florida and Spain, property bear markets during a protracted banking credit crunch, bottom at a 25 – 30% discount to replacement value. So I expect, say, JLT to bottom somewhere in the 500 – 550 AED per square foot range.
Catalysts for the property bear market since 2014? The oil price crash devastated GCC liquidity and investor flows. Putin’s invasion of Crimea meant the Russian rouble collapsed from 30 to 85 and is even now 68. Brexit gutted the British pound at a time when UK investors were a core feeder market for Dubai. Developers imposed unrealistic service fee hikes. The Value Added Tax (VAT) added to the woes of retail. Banks slashed corporate and SME loan books. India demonetized the rupee. Saudi Arabia front loaded fiscal austerity. The Qatar embargo hit a core Gulf investor and tourism segment. Tens of thousands expat executives have lost their jobs. Above all, borrowing costs have and will rise. 6 Month EIBOR is 2.8 now and will rise to 4% next year as the Fed embraces tight money. This means the EMI-rent spread bleeds cash for homeowners with floating rate mortgages.
Currencies – A contrarian strategy call on the Indian rupee
My bearishness on the Indian rupee in successive columns has been vindicated with a vengeance in 2018. The Indian rupee has fallen to 70.90 as I write, even though the US dollar was soft last week on President Trump’s political/legal woes and signals from Fed Chairman Powell that he did not think the US economy was “overheating” at the Kansas City Fed’s Jackson Hole symposium. I had expected the rupee to fall to 70 by year end but the Turkish lira crisis and concerns about the BJP’s prospects in the general election, naked “welfare” handouts for the rural poor, the deterioration in the fiscal and current account deficit and exodus of offshore capital flows from Dalal Street amplified the angst on the rupee.
Narendra Modi, the same macroeconomic genius who sacked a world class monetary economist like Chicago’s Dr. Raghuram Rajan has now appointed RSS ideologue Gurumurthy to the board of the Reserve Bank of India (RBI). Frankly, Gurumurthy adds as much monetary policy finesse to the RBI board as Didi Rakhi Sawant or Sunny Leone, despite their other multiple talents. However, as a currency trader, I love my life in the second derivative, play three dimensional chess with the markets in real time. So paradoxically, I see a clear money making opportunity in rupee and position for my own passage to India via its long duration government bond market (G-Sec).
The Indian rupee is a buy at 71 for a 68 three month target because Planet Forex now prices in a September FOMC rate hike with near 100% probability but does not recognize that India’s inflation rate has now peaked. This means the Reserve Bank of India is on hold and the yield on the Indian benchmark ten year G-Sec could well fall 50 basis points to 7.40. I also believe Modi’s pre-election conversion to neo-Keynesian fiscal largesse (even Modicare!) means that he will defeat the Congress and its allies in the general election. RSS pracharaks on the board of India’s central bank mean the RBI will do nothing to offset Modi’s reelection odds with politically catastrophic interest rate hikes.
A swadeshi hostility to foreign investments, a joke privatisations like the IDBI deal, tariffs and Big Babu Raj define Modinomics 2.0. This is maximum government, minimum governance. No wonder the rupee has lost 10% of its value against the US dollar.
I expect a surge in expatriate remittances well above the $72 billion World Bank and BIS guesstimates. This is another reason to expect a short term pop in the rupee sometime in November or December. Crude oil prices could fall as the US shale rig count revs up and Saudi Arabia/Russia (OPEC is now ROPEC) increase output, I expect India’s inflation rate to have peaked for now. This means the RBI will do squat on the repo rate while the Modi bandwagon (yatra?) begins its second tryst with destiny. A BJP win will ignite a surge of foreign capital back into Dalal Street. Hence my recommendation to accumulate Indian G-Sec debt before the foreign fund managers realize that the fault, dear Brutus, lies not in the stars but in our refusal to discount the future while obsessively extrapolating the recent past. For me, neuro-reprogramming is as important as a grasp of monetary economics or Sangh Parivar politics when trading the Indian rupee.
Wharton Econometrics and RBI models estimate that a 10% depreciation in the rupee means a 45 – 50 basis points rise in the Indian domestic inflation rate. Naturally, India will pay a steep price for Modi’s tariff barriers, lavish handouts and total failure to roll back Big Government. This is a story for late 2019, not now when I anticipate a catastrophic fall in the Indian rupee amid a Turkish style inflation/borrowing binge. My G-Sec trade ideas is a three month view. I doubt if the depreciation of the Indian rupee will realise Modi’s Make in India dreams. It is impossible to reconcile the RSS’s xenophobic hostility to foreign investment with Chinese style “factory to the world” policies in the Deng Xiao Ping “open door” era. Besides, Indian labour unions and Netajis (Crooks R Us!) make Chinese scale or Western mass manufacturing impossible in India. Modi’s populist spending guarantees that the Indian rupee could well tank to 78 – 80 by end 2019 – but that is a story for next year!
Wall Street – Big Pharma, a coffee deal & global markets
It was entirely predictable for the Dow Jones index to give back 200 plus points for Thursday and Friday after a fabulous August that saw Apple soar 20% and Amazon rose 13% but Facebook and Google did squat. The financial markets are nervous about the meltdown on emerging market currencies, Trump’s latest threats of tariffs on $200 billion of Chinese imports and angst over a NAFTA deal with Canada. Wall Street has now recalibrated its earlier optimism on trade, the reason Big Pharma and biotechs have begun to outperform. September’s seasonals suggest this trend will continue.
The biotech index was up 5% while Alnylam Pharma up 27%. Celgene is now a momentum buy as it normally rallies into the election. Lilly, Merck and Pfizer are all Big Pharma megacaps and all rose 5% Roche and Glaxo are victims of Trump’s Europe bashing but I would avoid Gilead on drug pricing politics.
The real sizzler last week was Coca Cola’s $5.1 billion dollar takeover bid for Britain’s Costa Coffee chain, a beloved friend second only to Starbucks (O frappocino mio!). The real growth catalysts for Costa (2500 cafes in Britain but only 450 in China and none in the US) is in its global business. Coca Cola paid a rich 16 times earnings price for Costa. Starbucks, after all, has 3000 outlets in China. Coca Cola is reinventing its franchise beyond its core Coke soda business (unit declines), as Pepsi did with its Soda Stream deal. Costa Coffee gives Coca Cola a foothold in the $100 billion global coffee markets whose epicenter is Swiss colossus. Nestle and whose provinces go from Brazil to Coorg. The stock exchange was unimpressed by Coca Cola’s Costa Coffee deal, possibly due to the high price it paid. I disagree. This acquisition gives Coca Cola a global retail brand in a non-canned soda segment that can well quadruple its current 3400 outlets. After all, Starbucks boasts 27000 cafes. On any market hit, I will sell high delta Coke put options for premium until it reaches target prices.
The US stock market trades at 16 times forward earnings. Financials are up a mere 1% in 2018 but the big US money center banks have passed the Fed stress tests for six successive years begun to boost Basel Tier One capital ratios and boost return on equity and raise share buybacks/dividend yields. Loan growth in the US has been robust and the US consumer’s balance sheet has never looked so good. This is the reason I adore the US centric, Bank of America, the big bank most leveraged to higher US interest rates that has paid $70 billion in litigation fines.
It is ironic that emerging markets tanked last week despite a lower US dollar, lower US Treasury bond yields and continuous optimism on trade. Yet Argentina’s request to the IMF to speed up funding led to a speculative attack on the peso that fell 7% in a single session, despite 60% repo rates by the Buenos Aires central bank. Turkish President Erdogan and his son in law Finance Minister Albayrak have lost the confidence of global investors, the reason behind the lira’s bungee jump. Unlike Alan Greenspan in 1998 or Ben Bernanke in 2008, I doubt if Fed Chairman Jay Powell, appointed to office by an America First President, will slash US interest rates to bailout the developing world at a time when emerging markets owe $11 trillion in dollar denominated debt. This means the risk of cross-border contagion and a potential catastrophic endgame for the global economy.
So I track Brent crude oil like a hawk. In 2008, Brent fell from $148 in July to below $40 in December. I watch sovereign credit default swaps of vulnerable Third World states – the Kangladesh Brigade. The moment they spike in unison, I know it is time to short risk assets even in Wall Street. I watch Dr. Copper, the Japanese yen, gold, LIBOR and the Volatility Index. It is no longer about just risk but also ruin.
Deutsche Bank now trades at miserable 0.3 times book value. Something ugly is brewing out there. What is it? Dr. Copper and other industrial metals have plunged 20% since April. The Russian rouble and South African rand are both down 9% in August. Global mining shares have been in freefall. The Euro Bank Stoxx index was down 9% in August even while S&P 500 index soared to all-time highs. Merde happens!
