Dubai: A lot of investors believe that first-quarter optimism is not new, as the market positions itself for dividend stories.

However we note that the depth and the performance of the market tends to differ each year, even in the first quarter.

History suggests that the first quarter has not necessarily resulted in positive gains across all years, despite dividend stories playing out to full potential.

However, one key observation we have noticed is that, traditionally, the first quarter has indeed set the tone for full year performance.

To dwell more on the past, a bullish/optimistic index in the first quarter has translated to a positive performance/gains for the full year and vice versa.

To put things in perspective, for the full year 2017, we saw ADX and DFM index underperforming by 3.3 per cent and 4.6 per cent respectively.

In fact, the year started on a pessimistic note with first quarter 2017 clocking -2.3 per cent (ADX) and -1.3 per cent (DFM) returns respectively.

In 2016, ADX and DFM registered gains of around +1.9 per cent and +6.5 per cent respectively in the first quarter, and ended the full year 2016 with +5.6 per cent and +12.1 per cent returns.

While 2015’s full year slacking trend in performance mirrored its first quarter performance, in 2014 both the UAE markets rallied in the beginning of the year (and in the first quarter) — and ended with sizeable returns for the full year.

Over the last eight years, this trend has been true suggesting that the initial market momentum (positive/negative returns for stocks over the first few months are followed by several more months of positive/negative returns) decides the fate of the stock market performance for the full year.

Behavioural finance theory suggest that this results from systematic reaction of optimistic investors overestimating the true impact of earnings, and vice versa, which then gets carried away for few months before the thought process rationalises.

In the first week of 2018, we have seen DFM and ADX extending the gains +3.6 per cent and +3.0 per cent respectively. If the current optimism in the UAE market continues well until the end of the first quarter, history suggests there is an increased possibility of the index ending the year in green for 2018.

Macro/valuations are favourable; be more choosy and picky

Moving away from momentum, we note that economic fundamentals of the UAE and oil price trajectory are supportive of favourable stock market returns for this year. UAE GDP growth forecast is set to rise to 3.4 per cent in 2018 from 1.3 per cent in 2017.

This is on the back of recent budget releases, in particular Dubai (expansionary budget, a 20 per cent increase in government expenditure) and other policy indications on government investment plans.

We expect to see a greater push in infrastructure spending ahead of Expo 2020.

We expect the private consumption, hence consumer growth to take a hit due weakening purchasing power.

Nevertheless, we believe that the intensity of government spending to be positive, thus supporting the growth environment.

We further note that valuations and yields are attractive for the UAE markets, trading at a steep discount to EM and Mena, which we think is unjustified.

However, many investors question the tailwinds of current markets, which looks less promising.

To answer that question, we should bear in mind that we are operating in an environment where flat (operating performance of the business, given the reforms) is the new up, and the widening of valuation discount to emerging markets and developed markets, provides a compelling opportunity to increase allocation to UAE equity markets in the medium term. For 2018 in particular, our theme is similar to 2017; switch off the autopilot mode and stick to selective stock picking!

(The author is a vice-president at Shuaa Capital and can be reached at im@shuaa.com.)