The very strong performance of pan-Arab stock indexes over the past year, which have outperformed emerging- and frontier-market indexes alike, has made foreign investors increasingly aware of the strong fundamentals underpinning a number of markets in the region, most particularly among Gulf Cooperation Council (GCC) members.
This has led to substantial inflows into GCC equities, which has helped boost liquidity. Net inflows into GCC equity markets from outside the region came to $2.4 billion (Dh8.8 billion) in the first six months of 2014, compared with $3.7 billion for 2013 as a whole, while the daily volume of equity trades rose from $2 billion per day in 2013 to US$3.2 billion per day year by end June.
The largest inflows on record in the UAE and Qatar took place in May 2014 — just ahead of their official elevation to emerging market status by index provider MSCI. Increasing inflows have also been met by a rise in initial public offerings from firms in the region, with 16 new listings in the first six months of this year, raising more than $2.4 billion. 3
Our expectations for ongoing regulatory and institutional reform have materialised. Most importantly, the Saudi Arabian cabinet has finally authorised foreign direct investment in locally listed equities, with market opening now targeted for the first half of 2015. This is unanimously viewed as a massive step forward for the region. As Saudi Arabia is the largest equity market in MENA, this move will certainly put the region back on international investors’ radar and is likely to be transformative for regional equities. Saudi Arabia’s economic output, the size of its equity market and its population all vastly outstrip those of the other GCC countries. Saudi Arabia’s macroeconomic fundamentals bring scale to the already attractive dynamics that make the GCC region an interesting and differentiated addition to global portfolios. The market gives investors exposure to emerging market-type growth, coupled with low-risk sovereign credit quality.
Liberalisation of the Saudi Arabian market could also pave the way for future inclusion in the MSCI Emerging Market Index, following in the footsteps of both Qatar and UAE. Such a transition would likely boost trading volumes and could bring down transaction costs through improved scale effects.
Today, the Saudi Arabian market is dominated by local retail investors, who account for over 90 per cent of volumes traded, with foreigners representing just over 1 per cent. The opening up of the market will likely bring with it a higher degree of institutionalisation that will add sophistication and maturity to the market in time. In the medium term, such measures are likely to lead to an increase in initial public offerings, thus leading to a much-needed deepening of the equity market and improved sentiment among global investors, in our view.
Moreover, in recent weeks, Qatar has decided to widen the access of foreign investors to Qatari stocks, bringing it in line with the UAE and giving a significant boost to institutional interest in its equity market. Another significant market event was the decision to make exceptions to standard listing rules to facilitate the listing of a bellwether company on the Dubai Financial Market. These exceptions may presage a more generalised — and, in our view, much overdue — reform of listing rules in Dubai. Stepping away from the markets, we have also been heartened by the authorities’ decisive move to avoid speculation and curb the risk of a property bubble in Dubai by introducing higher real estate transaction fees and strict loan-to-value limits for mortgages. We believe these regulatory reforms are a critical element in the development of the region as a single, identifiable subset within the general emerging-market universe (in the same way as Latin America, South East Asia or Emerging Europe).
Despite the tangible progress on the regulatory front, we have witnessed an upsurge in volatility in recent weeks, resulting in the short-term underperformance of pan-Arab indexes. But the correction was temporary and, in our view, healthy.
Valuations had become especially frothy in certain parts of the UAE market. Large volumes of speculative money had been placed in the UAE and Qatari markets ahead of their elevation to emerging-market status by MSCI on June 1. The UAE market was also hit by the travails of one of the most heavily traded stocks on the market which underwent an internal upheaval in June. For its part, the Qatari market was hit by the negative sentiment generated by published allegations that bribes were paid in order to ensure that the emirate was awarded the 2022 World Cup.
While the Iraqi conflict has also kept some international investors at bay and risk premiums across the region elevated, the political backdrop seems to have improved in a number of countries in the region. In Egypt, the election in May of President Abdul Fattah Al Sisi, former head of the armed forces, was met by the promise of further aid from Egypt’s GCC neighbours. Investors have also appreciated the apparently serious intent shown by the Egyptian government to bring down the budget deficit — in part by cutting subsidies on energy and implementing new tax measures.
The sell-off in June does not mean we have grown more sceptical about the prospects for the MENA region. Far from it. The recent selling pressure has been indiscriminate, such that high-quality names have also been pulled down, along with companies that have weaker fundamentals. As such, we are using this market correction to add to names that meet our investment guidelines. We believe that individual companies in these markets continue to offer interesting potential.
We also believe that GCC equities in general continue to show characteristics that will continue to make them attractive to investors over the rest of this year. Average dividend yields in the region are among the highest in the world, while we think somewhat higher price/earnings multiples relative to other emerging markets are justified by solid earnings growth in the GCC, in addition to the region’s considerable growth potential outside the oil sector. The International Monetary Fund (IMF), for example, in May predicted that non-oil growth in GCC will climb to 5.7 per cent this year from 5.4 per cent in 2013.4 At the same time, as GCC countries continue to diversify their economies away from reliance on hydrocarbons, state finances remain in surplus and major fully-funded infrastructure programs have been boosting domestic economies. Finally, rising US interest rates could further enhance the relative attractiveness of GCC countries, most of which are pegged to the US dollar.
-- Writer is Head of MENA Equities at Franklin Templeton Local Asset Management
