|By Matein Khalid| Dubai based Gulf Islamic Investments (GII) acquired a one million square foot Amazon logistics center in Dortmund, Germany for $144 million. This deal is a testament to the boutique global merchant bank created in Dubai by GII’s co-founder/CEO Pankaj Gupta, who I am honored to call a friend. I consciously model my own firm Asas Capial on the strategic path laid out by GII and Bahrain’s Investcorp, founded by my Chase Manhattan Bank mentors all those years ago.
GII has evolved into a merchant bank that originates, syndicates and manages complex global property deals for some of the Gulf’s most sophisticated royal, family office and bank investors. Naturally, I feel immensely proud that the firm is based in Dubai. As Dubai becomes the Arabian Gulf’s preeminent private wealth hub, real estate merchant banking will become a stellar growth engine for the emirate.
The Amazon deal offers investors ten year or more in leveraged annual rental yields of 8%. However, there are far higher returns available in the US public industrial REIT market or in Germany’s own Mexico-Poland. For instance, I had recommended America’s preeminent industrial REIT Prologis (PLD) in successive columns in 2016-2017. Prologis returned 28% in 2017, not bad for a liquid stock that my assistant buys for me at a transaction cost of a mere $50 net on the fabulous Interactive Brokers electronic platform! The E-commerce revolution in the Teutonic Fatherland can also be accessed via industrial projects in Poland and the Czech Republic, where leveraged leases for prime tenants can offer 15% net to the investor.
A friend called me to criticize my failure to analyze new supply trends in my take on the Dubai property market in 2018. I concede his point. The proliferation of offplan sales is a critical variable in any valuation paradigm that seeks to model Dubai property prices. It is just that a 750 world column only gives me space for a macro snapshot.
The global property firm JLL estimates 80,000 new units will be added to the Dubai home property market by end 2019. Nakheel and Deyaar alone announced new projects worth AED 4.2 billion at Cityscape 2017. Transaction volume in the secondary markets have plummeted since 2014 since few expat investors have the funds to put down 30 – 40% of a villa’s value as a down-payment for a bank mortgage plus pay another 5 – 7% in transaction costs/fees. It is far easier for wannabe property speculators to play Russian roulette with offplan deals, put up only 10% down (50% of which is pocketed by brokers incentivized to hard sell fake dreams!) and take advantage of attractive down payment plans offered by cash flow stressed private developers. I know of no other segment in the world where the offplan purchase of a golf view villa can net an investor a free Tesla, Lambo or even his own private jet. Fly, Habibi, fly or as Bob Marley would say, no punter, no cry!. The economics for client, broker and developer dictate frenzied speculation in offplan new project launches. There is only one problem. If JLL estimates are right, 80,000 new units mean a mother of all oversupply gluts will haunt the market in 2018-19.
There are two problems with this imminent glut. One, unlike 2015-16, rents in villas and apartments in even the ritziest communities have begun to fall at a faster pace than capital values. This suggests both an erosion of rental demand due to systemic job losses and rising desperation by one or two unit landlords to rent space at any price when faced with a spiral in service fees/taxes. In fact, many senior bankers who lost their jobs finance their Dubai lifestyle via rental income alone.
Two, the world is on the eve of a major rise in short term US dollar interest rates as the Federal Reserve tightens monetary policy and slashes $470 billion from its inflated, post-Lehman balance sheet. Since the UAE dirham is pegged to the US dollar, local dirham borrowing rates will rise sharply in 2018. I expect the three month Emirates Interbank Offered Rate (EIBOR) to rise by 150 basis points in the next eighteen months. Since a house/apartment is nothing more than a (depreciating, thus high maintenance cost) long duration brick and mortar bond with a declining coupon (rent), a significant rise in EIBOR means a 20% price fall even if there was no oversupply glut or geopolitical risk. Statistics, like Shakira’s hips, don’t lie!
Wall Street – Making and losing money in US money center banks
The “annus horribilis” for Wall Street’s (and the world’s) biggest banks was 2008, a year I will never forget. Lehman Brothers failed, Citigroup was hailed out by Uncle Sam, Bear Stearns and Merrill Lynch disappeared via shotgun marriages into the ample wombs of J.P. Morgan and Bank of America, UBS (the world’s largest wealth manager LOL) lost $50 billion of its own money and only survived due to a secret Swiss-Fed central bank swap line. The trauma of 2008-9 has reshaped the ecosystem of global banking and even the nature, scale and velocity of financial intermediation itself.
Yet 2017 was an “annus mirabilis” for Wall Street’s money center bank shares. Donald Trump selected Steve Mnuchin, a second generation Goldman Sachs partner as Treasury Secretary and Jay Powell, an ex-Carlyle partner, as Fed chairman. The top two financial policymakers in the US are aligned on an aggressive rollback of regulation (Dodd Frank, the Volcker Rule, the anti-derivatives Gestapo etc.) for the first time in the modern history of Wall Street.
Banks are also huge beneficiaries of higher interest rates, higher infrastructure spending, higher loan growth, global merger mania and Trump’s tax cuts. I would not be surprised to see the earnings of America’s top money center banks to rise 15 – 17% in 2018 even as returns on equity rise by 150 to 200 basis points. This, ipso facto, is a compelling argument for a valuation rerating.
Readers of this column know I have made no secret of my enthusiasm for Citicorp since 2012, the year an ex Solly bond trader named Mike Corbat replaced Vikram Pandit as CEO. Citi was in terrible shape in 2012, with the loss of dozens of businesses, 50,000 staff and $500 billion in assets in the “bad bank” (Citi Holdings), a fraud in its Mexican Banamex subsidiary, later an embarrassing failure in the annual Fed mandated CCAR stress tests. The shares were trading at 25 when I wrote column after column arguing that Citi was grossly undervalued relative to its earnings potential I thought Citi would be a double bagger for my own family and client portfolios. I was wrong. Citi was not a double bagger. It was a triple bagger, now 75.
I lost a few powerful friends in Morgan Stanley’s New York, London and DIFC offices because I recommended investors short the shares of John Mack’s go go, bond trading obsessed investment bank in March 2008, when The Bear died (and we all knew the Gorilla at Lehman was toast). Morgan Stanley shares plummeted 50% before John Mack got his chums in Washington to ban short selling and became a bank to access the Fed’s discount window. Then Jamie Gorman replaced Mack as Morgan Stanley CEO, clinched the Smith Barney venture from Citigroup, slashed risk budgets in the trading room (and axed at least a dozen buddies who were managing directors in Manhattan or Canary Wharf) and accumulated $2 trillion in wealth assets. The result? Morgan shares have risen from 10 to 53 in one of the epic money making opportunities in banking.
2018 presents me with a dilemma. Should I take my chips off American banks, load up on banks in Europe, Japan or even emerging markets like Russia, Brazil and South Korea? I am certain that prominent sell side Street bank analysts will raise their estimates for the six biggest banks. I also know that the Powell Fed is behind “the inflation curve” even before poor Jerome has been anointed king of the Fed’s white marble palazzo on Constitution Avenue. This could mean an epic bond market bloodbath and a 20 – 25% correction in US bank shares. Remember August 2015 to February 2016? China mismanaged its yuan devaluation and Citi shares lost 30% of their value in New York while HSBC lost 40% of its value in Hong Kong and London Then there are the black swans that have triggered banking crises throughout history, from the Florentine Renaissance to Creditanstalt/6000 US bank failures in the Great Depression to Continental Illinois (history’s first electronic bank run) to the post Lehman dominoes of 2008.
Yet the Cassandra in me cannot ignore the flattest yield curve in a decade, the spike in deposit betas and the Fed’s liquidity pump’s sputter (adieu, QE!) and Mifid/Basel Three are beyond even Mnuchin’s power to fix and bank mergers pose acquirer deal risk. This means 2018 will be the year to make big money or lose it in US bank shares.
Macro Ideas – The bullish case for metals, energy and the commodities complex
As synchronized global growth accelerates in 2018, Chinese GDP growth hits 6.5% and US wage inflation rises well beyond 3%, a continued rally in industrial metals, energy and soft commodities becomes my base case scenario for 2018. Dr. Copper, the red metal with its doctorate in economic cycles, gave us a vision for the future as it surged 32% on the London Metal Exchange in 2017. Nickel, aluminium and, above all, palladium (up 50%) confirmed this trend. This is the reason I recommended investors buy the shares of Freeport-McMoran, the world’s largest listed copper producer, at 12.70 last March. Freeport is now 20, a 57% profit in 9 months for my valued readers.
The 10% fall in the US Dollar Index makes metal and energy firms irresistible to me, as their cost of production in local currencies rises. Take Dr. Copper, for instance. The world’s largest copper producer is Chile’s Codelco and the strike in the Escondidas mine kick started the rally as the market has gone deficit at the precise moment Chinese demand explodes due to new electronic vehicle applications and pollution control becomes a political priority for President Xi’s Politburo.
The protests in Iran, the widest sine the regime crushed the Green Movement uprising in 2009, are hugely bullish for the price of crude oil. Trump could well tear up Obama’s Iran nuclear deal and the world would face a geopolitical supply shock, amplified by events in Libya, Nigeria, Venezuela and Qatar. The oil shock of 1979 coincided with the protest in Iran that culminated in the last Pahlavi Shah’s loss of his Peacock Throne. Could history repeat itself in the Brent crude spiral in 2018? Absolutely.
Saudi Arabia and Russia both have an economic and political stake in higher oil prices. Putin faces reelection in March and needs to distribute petroroubles to the Kremlin siloviki (men of power) clans. Saudi Arabia needs to boost economic growth, reduce the kingdom’s budget deficit and engineer a successful IPO of Saudi Aramco. A Saudi-Russian output pact has led to a surge in Brent crude from $28 in February 2016 to $67 now. A sharply weaker US dollar, blowout Asian demand and now a geopolitical supply shock in the Gulf can well take crude oil to $80 a barrel. Note that gold has crept up above $1300 an ounce even though the Yellen Fed has been adamant about its planned 2018 interest rate hikes. When US inflation rates begin to accelerate, metal and energy prices go ballistic. True, 2018 will be the year US shale oil output tops 10 million barrels a day and the oil’s swing producer is now the Permian Basin in Texas not Ghawar in Saudi or Burgan oilfields in Kuwait. Yet add Iran and the calculus for higher crude oil prices become compelling, unless the Powell Fed panics, hikes the Fed Funds rate four or five times and King Dollar soars.
I have historically “locked in” on embryonic bull markets in commodities via trading the West Texas/copper contracts on the New York Merc or Brent in London. Yet futures trading demands real time access to the exchange (3% margin can mean instant ruin on an adverse position) and should never, repeat never, be attempted by non-professional investors. If you feel an urge to trade commodities futures, my advice is to go to Jumeirah Beach at sunset, chill out and relax until the urge goes away. I know too many poor souls in Dubai wiped out by colossal losses on margin trading futures accounts. The S&P Goldman Sachs Commodities Trust is a far less riskier exchange traded fund listed in New York. I am also long the single commodity exchange traded funds in copper and silver.
Note my enthusiasm for commodities exporter Argentina, profiled in successive columns after President Macri ousted the Peronists in late 2015, settled the Paris Club creditors and led to a $30 billion bond issuance spree in 2016-17, was vindicated with a vengeance. Argentina was the world’s best performing stock market in 2017, up 74%. Hola, jefe!
A safe macro call is to accumulate the shares of the Big Oil supermajors. West Texas crude has risen above $60 for the first time since June 2015. Yet oil and gas supermajors (the Seven Sisters) are not priced to reflect the new realities. I want high output growth, share buybacks, long life reserves, LNG trains on steam. This leads me to France’s Total, Britain’s Royal Dutch Shell and California’s Chevron. The Prize!
Also published on Medium.