Market Outlook: Boom or Bust?

Saudi Deputy Crown Prince Mohammed bin Salman says his country will not freeze oil production if Iran refuses to freeze its own output. REUTERS/Yves Herman

Uncertainty masks the fate of global economy amid lack of action from the world’s leading powers

BY Ahmad Khatib

It has been the first quarter of rebounding indices. After its worst first week of a year in history, the Dow Jones industrial average managed to rebound and complete its best quarterly comeback since 1933. Other major indexes also witnessed similar moves throughout the first quarter of 2016.

Hydrocarbon prices also recorded positive quarterly gains in 2016, for the first time in the past nine months aided by a rebound in crude oil prices this year after reaching their lowest level in January.

But all of that was not enough to remove the uncertainty governing the markets’ outlook. This is  due to the fact that they have witnessed by volatility from August 2015.

When the Fed started its Quantitative Easing programs, it must have thought that by 2016 it would be only tightening in order to stabilize the markets again. However, it is now in a position that makes raising interest rates by quarter a percentage point a dilemma, during every meeting at the Fed. Furthermore, talks about negative rates and additional easing is no longer considered peculiar.

This summary is critical as any movement or shift in international markets, along with the fluctuation in oil prices, have always been a driving factor when it comes to Arab markets. Most stock markets in the Middle East in general, and the Arab region in particular, follow suit as to their international counterparts.

This has been keenly felt here, especially when the trends abroad are negative, and that leads to a significantly negative impact in our region.

Meanwhile, global powers have yet to show any intention of changing their current fiscal policies towards growth and recovery. Since the global financial crisis in 2008, the official focus by the world’s governments and their central banks was on monetary policies with the question: Should these policies be eased or tightened?

In March, the Federal Reserve Chief, Janet Yellen, raised concerns about another potential drop in oil prices and spoke of its negative impact on any potential growth in the global economy.

But despite that warning, Yellen did not suggest any solution or action to be taken should her prophecy (that oil prices would drop) come true. However, she went on at length about the Federal Reserve’s cautious tightening and ability to ease its monetary policy, “if needed.”

Meanwhile, the Deputy Crown Prince of Saudi Arabia, Mohammed bin Salman, suppressed speculation late March, when he said his country won’t freeze its crude output if its nemesis across the Gulf waters, Iran, refused to abide by a freeze to its own oil production. In saying so, Prince Mohammed bin Salman put pressure on oil futures—given that hopes are slim now of any potential production cut during an oil producers’ meeting to take place in Qatar later this month.

The Iranian oil minister had repeatedly said his government won’t freeze its production at current low levels, while Saudi Arabia produces over 10 million barrels of crude per day. The Persian state’s production last month stood at 3.2 million barrels a day, an output which Iran looks to increase to accrue more revenue as it recovers from international economic sanctions that were imposed over its nuclear program. The sanctions were lifted in January this year.

But the Saudis are sticking to their strategy, which gives priority to market share over interim prices, despite the impact such a strategy has on the budget deficit for the time being. Only the future will tell if this strategy pays off on the long run.

Concerns over lower oil prices came from the U.S. and not from Saudi Arabia. Apparently the kingdom’s long-term plans, which aim to diversify its own economy away from oil, differ from those of the West.

In that context, the kingdom has been gradually introducing economic and structural reforms since the beginning of 2015. So it is not a surprise to hear Prince Mohammed bin Salman latest announcement about establishing a Saudi Sovereign Wealth Fund, (SWF), worth $2 trillion.

Though the specifics of the new SWF are yet to be announced, Saudi officials have said that it will include floating 5 percent of the state-owned oil giant, Saudi Aramco. The shift will therefore be from relying on oil exports to investing globally, and a new investment structure has to be set for the SWF.

Unlike its counterparts in the Arab Gulf region, such as the United Arab Emirates and Kuwait, Saudi Arabia has always preferred to limit its global investments to low-risk bonds and financial tools. Such investments were managed by the Saudi Arabian Monetary Agency, (SAMA)—the kingdom’s central bank—without having an investment management structure; while the country’s Public Investment Fund only managed the government’s local investments, which includes shares in companies such as SABIC and the National Commercial Bank.

The funds raised from floating a 5 percent share in Aramco demands time for a thorough assessment. And it is not clear if the investment sold will include oil reserves, or only the activities of Aramco.

In all cases, listing Aramco on any exchange in an initial public offering, will disclose a lot of information about the results and operations of the company for the first time ever since it was founded in 1933.

Meanwhile in Europe, the situation looks similar to that in the U.S.; a full focus on monetary policy with the Quantitative Easing program in action and interest rate cuts. The results so far are shy of expectations and appear in need of longer periods than initially thought to get the effect needed. This plays down any potential positive impact from Europe on the global economy in the near future.

Looking eastward, the structural economic changes which China had introduced seem to portray the Asian giant’s determination to turn its economy into that of a consumption-driven one, rather than an export-driven nation.

During its boom years, China was a major oil consumer, and its increased demand for crude had an impact on the state’s finances, as well as the country’s economy during the periods of rising oil prices. The lower growth in Chinese gross domestic product (GDP), is expected to persist over the next couple of years. This means there will not be a higher demand on oil as in the past.

The Chinese government will be dealing with its strategy and challenges over the coming years, including challenges tied to inflated stock markets and the management of the local currency.

With both the biggest oil producer and the biggest oil consumer appearing to focus on economic reforms away from efforts to increase oil prices, Yellen will face a tough time easing the worries of investors this year. Her success or failure in doing so will decide if the stock markets can sustain the quarterly gains or post new records but in the opposite direction.

Ahmad Khatib is the Chief Executive Officer at the financial services group Amana Capital.

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