I find it laughable when investment bankers come to my office and try to assure me that warehouse and logistics space in Dubai is a “defensive” investment. Mathematical reality does not support this argument. Rents in Jebel Ali Free Zone (JAFZ), the most prime industrial enclave in the Arabian Gulf, have fallen from AED 44 a square foot in 2014, when crude oil prices peaked at $115 a barrel, to AED 35 now. In the financial markets, a peak to trough fall of 20% constitutes a bear market and the JAFZ rent declines now demonstrate that prime industrial, logistics and warehouse space is not immune to the slump in the business cycle and is hugely correlated to the economic/credit cycle in Dubai. The glut of planned real estate investment trusts in UAE will only increase the supply of industrial property and further reduce rents and capital values in this sector.
The protracted banking credit crunch, thousands of job losses in sectors as diverse as oil and gas, aviation, finance, construction and hotels will lead to a sharp shrinkage in retail volumes and thus demand for warehouse space in 2017. This is reflected in the 20% fall in warehouse rentals and capital values. Bankers and developers dazzled by the sharp 30% rise in the values of JAFZ warehouses in 2013 – 2014 did not anticipate that the oil price crash, fiscal austerity, contractor debt/banking credit crunch in the UAE would also gut demand for industrial assets at the precise moment when supply of warehouse space was set to soar. The result? A painful bear market that will not bottom out in 2017. Warehouses, like luxury homes, are a kiss of death when demand slumps as their market is so illiquid. As J.P. Morgan rightly observed “Liquidity is like a cab on a rainy night. It disappears when you need it the most”.
The real pain in the industrial property sector is felt by many local traders who had acquired warehouses and logistics on credit in 2014, near the peak of the market cycle. As the business cycle deteriorated since international and local banks slashed credit facilities to these accounts. When import/export volumes and retail sales plummeted in 2015, these traders were forced to sell their properties in a falling market. Increases in tenant fees/levies, insurance/storage security cost and the cost of upgrading decades old warehouses for the needs of high tech corporate supply chains have only exacerbated the pain, as has new supply from Dubai Investment Park and Dubai South. As usual, older, Class B warehouses in Al Quoz saw the steepest rental falls, down 25%.
I was shocked to read that the prices of Burj Khalifa apartments had fallen by 25% in the past year. Usually, prime property in global cities is viewed as a store of value, exhibits less price volatility as it has a relatively price inelastic demand curve. This is clearly not the case in the Dubai luxury home market. Prices for Palm Jumeirah apartments, Emirates Hills and Hattan on the Lakes villas have all fallen by 20 – 25% in the past two years. International property broker CBRE believes the steep price falls are due to the fact that major property developers ramped up construction of thousands of new villas and townhouses before Expo 2020. CBRE expects the number of new homes scheduled for delivery in 2017 and 2018 to “be well above” the last five year annual average of 15000. The tsunami of offplan product launches does not bode well for secondary market capital values. There is a major glut of luxury villas in Dubai at the same time as high priced expat executives in the AED 80,000 – 150,000 a month salary range are culled en masse in banking, oil and gas, aviation, construction etc. Expect the bear market in luxury homes to accelerate in 2017 and 2018 as the metrics for a market bottom are simply not evident.
The listing of the Al Jazira and Riyad REIT’s in Saudi Arabia on the Tadawul is an exciting milestone in the kingdom’s capital markets. With a local population of 24 million Saudi citizens, the kingdom is the most attractive market for new REIT listings. The Saudi secondary Nomu market is also an attractive exit option for investors in high yield property segments, such as Makkah hotels where cash on cash dividends can range between 14 – 16% per annum. However, as listed REIT’s on Nasdaq Dubai demonstrate, secondary market liquidity is simply impossible to attract when a leveraged distribution yield is below 5% or less than the cash yield on a studio in International City! My call? Caveat emptor! Buyer beware as it is no fun to be a victim of the greater fool theory in an illiquid market.
Stock Pick – Federal Reserve policy and US money centre bank shares
The US economy added only 98,000 jobs in March 2017, thanks to a snowstorm related fall in construction and the Black Death in retail/shopping malls due to e-commerce, down from the 235,000 payroll growth in February. This data shock from the US Department of Labor coincided with news of the US cruise missile strike on a Syrian military base from where the Assad regime’s aircraft launched a chemical weapon raid and another tragic terrorist attack in Stockholm, Sweden. While these seismic events led to a fall in US Treasury bond yields, with Uncle Sam’s ten year note now at 2.30%, down from 2.62%, Paul Ryan’s public doubt about the timing of tax reforms and the FOMC’s reference to expensive stock market valuations have also reinforced the rise in the Volatility Index to 13 and amplified angst on Wall Street.
It is doubtful if the Yellen Fed will be aggressive in the timing or magnitude of its next two rate hikes, though the US unemployment rate has fallen to 4.5% and a tactical cruise missile strike in Syria does not presage a new hot war in the Middle East. The March job shock need not shift the Federal Reserve’s interest rate policy calculus. Monthly job growth was an average 187,000 in 2016 and the three month average in 2017 is now 178,000, not statistically significant enough to trigger a Fed policy response. I expect the Yellen Fed to keep to its dotcom timetable, with 25 basis point rate hikes at both the June and September FOMC.
The American central bank will ignore the March jobs data as an aberration. For instance, construction job growth fell from 60,000 to 6000 in a single month due to snowstorms on the East Coast – and will sharply rise in April. Yet the fact remains that US economic growth is mediocre, the Trump White House was unable to repeal Obamacare, Paul Ryan has expressed doubts on tax reform, new geopolitical risks have emerged in Syria and North Korea means US interest rates will range trade, not spike higher, until the June FOMC. None of these data points is remotely bullish for US bank shares even though I agree with Morgan Stanley that a 4.5% unemployment rate makes a June FOMC rate hike a slam dunk. Now that the KBW bank shares index is down 10% from its post election high, it is time to nibble for value once again on Wall Street. This is the case even if consensus earnings growth estimates for big banks are too high at 15%, auto loans/shopping mall mortgage defaults have begun to haunt credit markets, loan growth is below consensus estimates and the US Treasury debt yield curve is no longer steepening, all bearish metrics for bank shares.
It is now prudent to accumulate bank shares whose bullish catalyst is an increase in shareholder capital return/div payouts (Citigroup), not just a steeper US Treasury bond yield curve (Bank of America) or a repeal of Dodd Frank and the Volcker Rule (J.P. Morgan, Goldman Sachs). True, I can easily envisage Citigroup shares trade down to 54 – 56 or 0.8 times tangible book value between now and the June FOMC. I had written successive columns in early spring 2016 reiterating my conviction that Citi was a strategic must own for UAE investors at $40 a share. Citi has now risen 50% in the past twelve months.
Citigroup is also a proxy for global banking since it derives 50% of its profits outside the US, well above J.P. Morgan’s 25% ratio. Faster growth in Latin America, the Pacific Basin and emerging Europe is a steroid shot for Citi’s revenue growth. Citi trades at a discount to book value, unlike Goldman Sachs and J.P. Morgan. At my suggested buy levels, Citigroup trades at 9.8 times forward earnings – and book value could well rise to $80 a share in the next four years. I believe the next four years could see an epic valuation rerating in Citigroup shares, as long as it does not get entangled in any 1991 or 2000 style balance sheet kamikaze death spirals. So I can well imagine Citi trading at 1.5 times book value, akin to electric utilities, in the next four years or $120 a share. Wishful thinking? Not really. In summer 2012, I wrote a column predicting Citi shares would double from their then $25 a share. Citi is $59 as I write. Investors in the GCC should really need Warren Buffett’s advice: “Put not your trust in the market timing but time in the market”! Patience is an undervalued virtue in the financial markets.
Macro Ideas – The silver and crude oil trade ideas were both winners!
I had recommended investors to accumulate the silver exchange traded fund (ETF) and West Texas crude a month ago in successive columns. The Silver index fund (symbol SLV) in New York has risen from 16 to 17.4 in the past three weeks. Crude oil, recommended when West Texas was $48 a barrel, is also a winner trade now that black gold trades 10% higher at $53.
There is no doubt that silver is now in a stealth bull market, exactly as I had expected a year ago. Spot silver rose 16% in 2016 and has risen 15% in 2017, easily outperforming gold. Silver is undervalued against gold with the gold silver ratio at 70, far below its cycle peak of 32 in 2011. Gold has risen 35X since the collapse of the Bretton Woods monetary regime in 1971 while silver has only risen (a mere LOL) ten times. Silver, unlike gold, is also leveraged to the uptick in global industrial economic growth and new applications in solar cells, space exploration and microelectronics. CFTA data also suggests that the smart money and global macro hedge funds are now accumulating silver futures contracts on COMEX. The rise in geopolitical risk is also positive for silver. I reiterate my forecast that spot silver can trade at $20 an ounce sometime this summer.
President Trump’s swift decision to punish the Bashar Assad regime with a 59 Tomahawk cruise missile attack on a Syrian military airfield in Homs Province is a game changer in international relations. Trump, who campaigned against US involvement in Middle East wars, has done a policy U-turn after the horror of the latest Syrian regime’s chemical weapon attacks on civilian victims. Regime change in Damascus could well become the policy objective of the Trump White House, the reason Brent crude surged to almost $56 a barrel and the Russian rouble/Turkish lira both tanked against the US dollar while gold’s $1265 price now incorporates a geopolitical risk premium that will also benefit silver.
I disagree with conventional wisdom that Trump’s missile air strikes will precipitate a classic US-Russian confrontation. This is not October 1973, when both the USSR and the US went on nuclear alert in the closing moments of the Yom Kippur/Ramadan war in the Golan Heights and the Sinai. The current tensions are more reminiscent of 1999, when US and Russia clashed over NATO’s bombings of Belgrade in an effort to overthrow Serbian dictator Slobodan Milosevic. After all, the Trump White House informed the Kremlin before ordering the missile strikes and Russia has no interest in confronting Uncle Sam in the Middle East. The missile strike demonstrates that the era of Obama’s “toothless” red lines is over. The message of the missile strikes, Trump’s willingness to use force, will be noted in Tehran, Moscow, Beijing and, above all, Pyongyang. After all, Trump interrupted a state dinner with the Chinese President to order the punitive missile strike on Syria!
Even though the missile strike in Syria was a surgical strike, not a 2003 Iraqi style invasion to engineer “regime change” in Damascus, crude oil prices could well incorporate a permanent geopolitical risk premium. If Saudi Arabia and its allies maintain their compliance with last November’s OPEC output cut and roll over the agreement in Vienna next month, it is entirely possible that Brent crude rises to $60 a barrel this autumn. This reinforces my enthusiasm for oil correlated energy shares on the NYSE.
South African President Jacob Zuma’s decision to fire his Finance Minister Pravin Gordhan has led to a 10% collapse in the rand and a S&P sovereign credit downgrade to junk. Zuma’s rule has been a nightmare for South Africa but he has packed his Cabinet and the ANC with loyalists and enjoys broad support in his Zulu tribal homeland. The odds are that Zuma will survive a no confidence vote in the South African Parliament on April 18. This could mean the rand falls to 14 against the US dollar despite the bull market in gold, platinum and palladium. The rise in crude oil prices is bearish for South Africa’s current account deficit while the prospect of Zuma in power in Pretoria until only accelerate capital flight from the Rainbow Nation. The South African rand was one of the world’s best performing currencies in the last twelve months but could well be the sad sack of emerging markets FX in the next twelve months. Cry the beloved country!
This article was originally published in the Khaleej Times.
