Analysts expect rise in interest rates to impact markets; govt spending to reflect positively

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The rise in interest rates affected the movement of Saudi capital market and global markets, making them more volatile, analysts told Argaam.

On the sidelines of the Financial Sector Conference Talks 3 (FSC Talks 3), analysts said that investors are now looking for a return on assets (ROA) and the sukuk market is a great pick. They also noted that the Saudi market is expected to benefit from government spending.

Market Conditions

The Saudi market has priced sectors well on the changes taking place, as it is currently looking for new opportunities, said Mazen Al-Sudairi, Head of Research at Al Rajhi Capital.

Profit of the Saudi petrochemical sector is expected to face some headwinds over the coming three to six months. This is because the Saudi capital market is interconnected to the global markets, which are currently under pressure — especially the Chinese economy.

Mohammed AlShammasi, CEO of Derayah Financial, stated that the interest rate hikes contributed to global markets’ changes and fluctuations, including the Saudi market. This led to a search for more opportunities in less risky instruments with healthy returns.

“Market reflects economic performance,” AlShammasi pointed out, explaining that Saudi companies are maintaining profitability. Initial public offerings (IPOs) for government-owned corporations and family businesses still reflect excellent performance. Also, the market is benefiting from government spending.

These changes led to a strong transfer of funds from stocks and high-risk businesses, such as technology and venture capital, to opportunities with lower risks and returns like bond markets.

The rise in the cost of funds reduced margin calls in general, as investors' expectations are now inclined towards achieving profits that outweigh the financing cost, he clarified.

Meanwhile, Mazin Baghdadi, CEO and Managing Director at Alinma investment, affirmed that the market is going through critical and fundamental stages affected by higher interest rates. This pushed investors to tap ROA from banks to realize a better return.

The increased cost is a challenge for some companies. However, it may be useful for enhancing returns, whether in investment or in the main activity of the company, in order to achieve higher growth rates.

The market is enduring economic cycles and must go through corrective stages. But, the most important factor is the financial performance of these companies, while achieving profitability to determine the fruitful segments.

“Inflation rates in the Kingdom are much better than global markets,” Baghdadi stressed.

Market Outlook

Al-Sudairi predicted government spending to improve the banking sector’s liquidity in the coming period.

Internal expenditure and mortgages are witnessing improvements, which will reflect positively on the construction sector in the coming period.

“The banking sector is projected to benefit from higher interest rate and to support mega projects,” Baghdadi said.

AlShammasi explained that equity markets are a machine of expectations. He clarified that the US Federal Reserve started giving signals of a slowdown in interest rate hikes, which are expected to be less than 75 basis points (bps) by the next meeting in December.

He further expected a decline of even less than 0.5 bps in Q1 2023, as the pace of interest rate increases decelerates.

“Equity markets react to these signals positively,” AlShammasi said, noting that the unprecedented rise in interest rates encouraged investors to tap more financial instruments in the local market (such as bonds and sukuk) in the short term.

Al-Sudairi indicated that the consumer situation in 2021 was abnormal due to the COVID-19 repercussions. This led to growth that did not reflect the seasonal movement in the consumer sector.

“Al Rajhi Capital sees 2023 to be better for consumer business compared to 2022,” Al-Sudairi stated, confirming that it will be the main year for measuring business developments.

Al-Sudairi added the markets will continue to see high policy rates for one year, as the Federal Reserve is set to maintain its measures but at a slower pace.

He expected investors to claim higher dividends from companies that record returns, amid rising interest rates.

This will reflect on the valuations of dividend-paying companies, particularly those that do not witness growth in prices as the market needs higher returns in case there is no growth.

Al-Sudairi added that the retail and consumption sector can handle inflation, especially after the earnings announced by US-based retailer, Walmart.

The direct correlation between the Saudi and US markets is over and will not exist again. Moreover, the influence of institutional investors is higher on the market.

He added that market depth increased amid the presence of institutional investors, whose ownership in free float, excluding Aramco, exceeds 13%. Large portfolios are deemed institutional, due to the financial management of risks.

Stocks or Sukuk

Baghdadi expected more sukuk issues in the coming period, as new listings in the stock market make sukuk issuances easier.

Listed companies can benefit from sukuk offerings and capital hikes through rights issues to finance mega projects.

Al-Sudairi added that investors have a positive outlook for the bonds and sukuk market. Forecasts for the Kingdom also bode well, thanks to cash inflows, as seen following a sukuk issuance by one of the local banks.

On the other hand, AlShammasi said that keeping interest rates at the current levels or a little higher will give continued momentum to the fixed-income markets over the next couple of years.

Liquidity is expected to head towards more attractive, higher-risk markets with regard to risk-weighted profits, he indicated, noting that the bonds and sukuk markets allow for this opportunity.

Baghdadi added that market diversification and the introduction of new products, such as sukuk and bonds, which are deemed attractive in light of high-interest rates, will be an excellent pick for a portfolio manager to diversify risks and tap this category of assets and yields. The sukuk market is a good option for companies that find it hard to secure financing.