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Friday, 4 December 2009


Investors are likely to be increasingly concerned about rate increases over the coming months due to the much better than expected non-farm payrolls report. Using the last few recessions as a reference point it is likely that equity gains could become increasingly difficult to come by as the Fed is pressured to remove their accommodative stance and other programs are wound down.

Teun Draaisma at Morgan Stanley recently noted this in his “tightening checklist”. I would expect an upgrade across the checklist. As we expected job creation is certain to begin by Q1 and Fed language should begin to change dramatically.

Despite higher rates coming shortly, MS expects the rally to continue in the near-term. I can’t disagree with this outlook. Stocks are very buoyant heading into Christmas and it’s unlikely that this report will force the Fed’s hand immediately. Like Draaisma, I believe the rally could move higher into year-end based on this optimism, but could then begin to sputter out as 2010 becomes a year of higher rates and transition into an economy without a government crutch. MS analysts report:

We expect the sweet spot to last a bit longer. The cyclical bull market has some further to run, in our view. We expect 20%+ earnings growth in 2010, equity valuations are still attractive versus rates, and sentiment is not ultra-bullish yet. We prefer equities to fixed income, and we expect a further 9% upside to reach our 1200 bull case target for MSCI Europe based on the mid-cycle multiple on mid-cycle earnings of 15x 12% ROE.

Lessons from past tightening cycles. The start oftightening phases tends to lead to some indigestion and a defensive rotation in equity markets, for two quarters or more. The 1994 and 2004 episodes led to a 16% and 8% fall in MSCI Europe over eight and five months. Sector performance was defensive, but Oil and Materials outperformed, too. In the aftermath of secular bear markets tightening phases have been more severe, with equities falling on average 25% over 13 months.

Draaisma notes that it’s silly trying to jump on the back end of a 70% rally in an attempt to time the final leg up. As we wrote earlier this week:

But Draaisma isn’t getting overzealous here. He doesn’t see the rationale in getting overly aggressive in an attempt to capture the last 10% of a 70% rally when the downside could be greater. Draaisma believes market gains will be more difficult going forward and therefore the risk/reward of the current market is substantially more negative than it was a few months ago.

Although this morning’s report is an overwhelming positive for equity markets it could pose a major 2010 hurdle as investors transition from a market with a government crutch to a market without one. In the near-term, a Santa Claus rally might just be developing….

What Dubai Can Learn from Vegas

I was in Las Vegas for Thanksgiving week when I heard the news that Dubai World, the investment company owned by the emirate of Dubai, had asked its creditors for a freeze on its debt repayments. I found myself pondering casinos, banks, and casino banks. Sin City and the Sheikhs’ playground on the creek have many similarities, but the differences are worth considering and may indicate how each may weather and shape the continuing global economic peril. Las Vegas, despite its vulnerability to the recession, is well placed to adapt and recover from the crisis, due its open economy and market processes. Dubai, in whatever state it emerges from the debt crisis, will likely continue having problems while its political power is centralized in the ruling elite and shielded from media and market scrutiny.

Walking on the Vegas Strip, I was struck by the smell of sewage wafting between two of the fabulously opulent hotels, and I wondered whether this might be taken figuratively as a kind of miasma for a city going the way of Ozymandias. For 20-plus years, Vegas had seen incredible expansion. Had its winning run come to an end as abruptly as that of a cocksure Craps player who has rolled the dice once too often? Anecdotally, this seemed far from the case. The casinos and hotels I visited were packed and hummed with gamblers’ energy. Yet Las Vegas’ revenues have been inevitably hurt by the national decline in disposable wealth. Its conference business has been decimated by corporate reluctance to be seen partying in an age of taxpayer bailouts. It has been one the worst centers of the real estate foolishness with the highest foreclosure rate in the country. Experts fear that Las Vegas may be a bellwether for the feared corporate real estate crash that could trigger a “double dip” recession.

It’s not hard to spot the large aborted projects in Sin City. Fontainebleau, a $3 billion hotel and casino, sits unfinished, its shining “coming soon!” sign misleading and depressing. Boyd Gaming’s $4.8 billion Echelon is suspended. Several gleaming condo towers are currently housing only squatters. Almost 40 major projects lack firm completion dates. “Too Big to Fail” is a tag unlikely to be bestowed on a casino project by the Washington politicians who have bailed out Detroit and Wall Street, but that is exactly how parent MGM Mirage views its latest mega project, CityCenter, set to open before the new year. How CityCenter fares, with its 6,000 rooms, casino, and shopping centers will be key to Las Vegas’ immediate fortunes. Intriguingly, the construction, involving more than 8,000 workers, was jointly financed by Dubai World.

Introducing Sukuk: Islamic Loophole for Dubai Debt Debacle

U.S. Does Not Have Monopoly on Debt Driven Greed

The pricked debt bubble that spanned the range of Icelandic banks to Donald Trump (read more) has now spread to Dubai commercial real estate, evidenced by the plastering of recent global headlines. At the center of the storm is Dubai World, a quasi-government owned conglomerate of Dubai, which is in the process of negotiating a $26 billion debt restructuring with the government and sukuk bondholders.

This overleveraged Dubai market ($80 billion in total debt) helped finance the tallest building in the world, largest man-made islands, and a ski-resort based in the desert, in the face of collapsing real estate prices. Critical to Dubai World’s debt restructuring is a $3.5 billion sukuk bond issued by its commercial real estate subsidiary Nakheel Development (“Nakheel”). So what exactly is a sukuk (plural of sakk)?

Investopedia lists the following definition for sukuk:

“An Islamic financial certificate, similar to a bond in Western finance, that complies with Sharia, Islamic religious law. Because the traditional Western interest paying bond structure is not permissible, the issuer of a sukuk sells an investor group the certificate, who then rents it back to the issuer for a predetermined rental fee. The issuer also makes a contractual promise to buy back the bonds at a future date at par value.”

Fitch: Dubai has no impact on state-supported corporate rtg

Fitch Ratings says policy developments surrounding state support for Dubai-based entities will not result in a broader reassessment of how the agency assesses sovereign support, or current expectations of support, when assigning corporate bond ratings for state-owned enterprises (SOE) in other countries.

Dubai's policy volte-face has led to sharp rating downgrades for Fitch rated SOEs in the emirate (DEWA rated 'BBB-'/RWN; DHCOG rated 'BB'/RWN). A review of the conditions applicable to this individual case indicate, however, that the approach used by Fitch in rating state-owned enterprises (SOE) captures both the risks and benefits of state ownership consistent with other 'parent'/'subsidiary' relationships. As a result, although the ratings of all corporates generally remain more vulnerable than usual to rating downgrades, given the general economic background, Fitch does not anticipate major systematic revisions to either its expectations of state support, or their influence on our ratings.

- State ownership plays a minor role in Fitch SOE ratings

Saudi cbanker plays down Dubai debt impact on banks

Saudi Arabia's top monetary official on Friday sought to reassure investors and play down the impact of Dubai's debt crisis ahead of the first day of stock market trading in the kindgom since the news broke.

"The group's (of Saudi banks) exposure to Dubai World is very limited," Muhammad al-Jasser, governor of the Saudi Arabian Monetary Agency, told Saudi-owned Al-Arabiya television.

"If we look at the total balance of all Saudi banks ... exposure to Dubai World is less than 2 in a thousand," he said, without clarifying the comparison.

FT Alphaville » Blog Archive » Nakheel and the sukuk legal spook

FT Alphaville » Blog Archive » Nakheel and the sukuk legal spook

Creditors to refuse Dubai World deal

Creditors of Dubai World are expected to reject a standstill agreement proposed by the company, threatening to drag out negotiations over $26bn (£15bn) worth of the conglomerate's debt.

Advisers involved in the talks tonight said that the process could take months as more than 100 accountants, lawyers, bankers and other professionals descended on Dubai from London. "There won't be a standstill agreement," one said.

By rejecting the company's proposal to put interest payments on hold, creditors automatically trigger a default, leading to inevitable further wrangling.

A bad omen in Dubai

No other country built a ski resort in a desert. No other country constructed an archipelago of 300 artificial islands, complete with a man-made reef colonized by parrot fish. But even if Dubai is a gaudy outlier -- a sort of Donald Trump of a nation -- the bankruptcy of its flagship investment company, Dubai World, holds a warning for others. The nonchalance with which global financial markets have reacted is not reassuring in the least. The lack of alarm is alarming.

Start with the size of the Dubai bankruptcy. Most analysts reckon the emirate will end up defaulting on more than $30 billion. That's up from the $26 billion advertised at Dubai World but perhaps less than half of the city-state's accumulated $80 billion debt. Dubai's bust will be larger than South Korea's 1998 debt restructuring, which involved $22 billion worth of loans, and not much smaller than Russia's default that year (which affected loans worth $40 billion). The South Korean and Russian traumas spread panic around the world. Nowadays, investors yawn at losses that don't run into the hundreds of billions. This is a touch complacent.

Dubai's bust also signals that other leveraged commercial real estate players may be in deep trouble. Dubai World borrowed to buy ventures such as the former Knickerbocker Hotel in Times Square, the Fontainebleau Hotel in Miami and (more shades of Trump) a stake in a Las Vegas casino. Its debts have finally caught up with it. Meanwhile, J.P. Morgan estimates that U.S. commercial real estate prices will keep falling until late next year, raising the risk of more defaults and undermining the collateral that secures a large slice of banks' loan books. The banks will continue to bleed money, curtailing their ability to extend fresh loans to other businesses.

Dubai: A High Rise, Then a Steep Fall

As financial crisis roiled much of the world in October 2008, the head of Dubai's biggest state-owned developer unveiled his latest megaproject: a $38 billion development that would include a tower nearly two-thirds of a mile tall.

"I'm sure most of you are asking why we're launching this, and you'd be mad not to question it," said the executive, Chris O'Donnell, at a news conference. Though there would be economic ups and downs in the years needed to build the tower, he told listeners, demand would continue to outstrip supply.

"The fundamentals in the market are too strong," he said. "There won't be a crash."

Since then, residential real-estate prices in Dubai have slumped by almost 50%. Developers have slashed jobs and scrapped projects. Groundbreaking on the tower was long ago put on hold. The yearlong retrenchment culminated in last week's surprise announcement that Dubai would seek to restructure $26 billion of debts owed by Dubai World, the holding company for many of the government's port, infrastructure and real-estate businesses.

Dubai’s Cowboys Must Give Way to Grownups: John Stefakianakis

The Dubai development model has been seriously bruised and battered. It was predicated on a property play that turned into a bubble that burst. It was based on leverage aided by ample international liquidity during the heyday of the pre-financial crisis.

The aggressive building boom helped place Dubai on the world map. It should be no surprise to Dubai’s leaders that the world’s eyes are zooming onto them, since for many years Dubai lobbied the world for attention.

However, the Dubai corporate and decision-making elite have demonstrated a lack of transparency and candor during the past several days. They continue to deny the enormity of their city’s problems.

Reasons why the Gulf states look solid in the long term

With Dubai in the spotlight for all the wrong reasons, investing in Gulf equity markets now may seem to be dangerously contrarian. The manner in which Dubai communicated its decision to disaggregate sovereign and quasi-sovereign debt will weigh on credit spreads and local market performance until it can demonstrate that it can repay its debts in a timely and transparent manner.

But the structural and fundamental underpinnings of these markets paint a different and attractive picture for the long-term investor. The outlook for Dubai's hydrocarbon-rich neighbours such as Saudi Arabia, Kuwait, Qatar and Abu Dhabi is rosier. Despite having only 40m people, these countries have two-thirds of the world's oil and 45 per cent of its gas reserves. Debt levels are minimal and recent high hydrocarbon prices have led to huge reserve accumulation of over $1,000bn.

Gulf countries plan at least $2,000bn of spending on infrastructure projects in the coming years in order to diversify their economies away from oil.

Bahrain's economy 'has survived global crisis'

Bahrain has succeeded in withstanding repercussions from the global economic meltdown.

"The financial situation remains stable and assuring thanks to our balanced economic policies," His Royal Highness Crown Prince Salman bin Hamad Al Khalifa said yesterday.

He was speaking as he chaired a meeting of the Economic Development Board's (EDB) executive committee. He also highlighted the importance of precautionary measures to protect Bahrain's solid financial standing.


Washington presumably hopes that the gas would be shipped via the long-planned 1,641-kilometer-long Trans-Caspian gas pipeline. The route would funnel Central Asian energy to Azerbaijan, circumventing Russia. [For background see the Eurasia Insight archive]. From there, Turkmen energy would make its way to Europe along another long-planned route, dubbed Nabucco. [For background see the Eurasia Insight archive].

At a November 17 news conference in Ashgabat, Daniel Stein, senior assistant to the US Special Envoy for Eurasian Energy Richard Morningstar, stated that it might be possible to reach an agreement on shipping natural gas across the Caspian Sea without first reaching an agreement on the sea’s territorial boundaries. Talks on a comprehensive Caspian pact have long been stalemated. [For background see the Eurasia Insight archive].

After leaving Ashgabat, Stein traveled to Baku to meet with Foreign Minister Elmar Mammadyarov on November 18. The Ministry of Foreign Affairs in Baku has refused to confirm or to deny that Stein’s proposal is under consideration by Azerbaijani leaders. "If such an appeal is addressed to Azerbaijan, Baku will consider it, but I have to stress that it requires the consent of the second side [Turkmenistan], as well," spokesperson Elkhan Poluhov said.

Difficult times test legal system like never before

In Dubai, simply bouncing a cheque can land you behind bars. So it should come as little surprise that since the global economic crisis slammed a painful brake on the emirate's extravagant expansion, the courts have been busy with creditors struggling to recover debts from once booming businesses fallen on hard times.

Most of the cases so far have been small and have attracted little outside attention. But now that Dubai World is seeking to restructure $26bn (€17bn, £16bn), there is the potential for the United Arab Emirates' legal system to be tested like never before.

If creditors or bondholders did pursue legal action, however, they would be entering uncharted territory and taking on a system criticised for being outdated, unpredictable and lacking transparency.

Analysts see need for UAE banking aid

The United Arab Emirates may have to do more to support its banks and prevent the woes of a leading Dubai-owned conglomerate from causing losses and derailing a tentative economic recovery, according to bankers and analysts.

The decision by Dubai World, a flagship government holding company of developers, ports operators and investment companies, to restructure $26bn of its debts has shocked markets and rattled regional and international financial institutions, which had expected government support.

Standard & Poor’s, the rating agency, on Thursday downgraded a clutch of leading Dubai banks owing to their exposure to the troubled state-owned conglomerate, and warned further demotions could come soon. Fitch Ratings also put four banks on review for a downgrade on Thursday, including HSBC Middle East.

Emirates Airlines upbeat over debt repayment

Emirates Airlines says it faces no problems in meeting upcoming loan and bond payments, reiterating that it has never had government backing for its debt.

Since its launch in 1986, the fast-growing Dubai-government owned airline has not relied on state support, said Tim Clark, Emirates president.

“Emirates has always charted its own course,” he told the Financial Times. “We don’t see any change; the airline is profitable and our flights are full.”