Arab stock markets under stress

Dubai: High valuations in various Arab stock markets have finally caught up with investors, bringing a steep correction across the board. Stock market indices dropped from their highest level attained in the past few months.

Few long-term investors are seeing this as an opportunity to buy and build strategic positions in solid companies whose prices they believe have unjustifiably declined with the rest of the market. Others are waiting on the sidelines hoping to buy the shares closer to the bottom of the cycle.

Economic conditions remain supportive. The region is going through a period of prosperity unparalleled in its recent history.

We have booming economic conditions in the Gulf countries, where nominal GDP grew by 15 per cent to 30 per cent in the past two years and with real GDP growth above 7 per cent.

This has spilled over to the non-oil countries of the region as well, through capital inflows, exports, regional tourism and higher remittances. Jordan for example grew at 7 per cent in real terms last year and Egypt at 6 per cent.

Strong corporate earnings in 2004 and 2005 have justified higher share prices in the region's stock markets. Last year, aggregate profits for the Shuaa Capital Arab Composite Index rose by about 49 per cent, reaching an annualised peak of 65 per cent in first half of 2005, but dropping to 35 per cent in the second half.

According to the National Bank of Kuwait, about 25 per cent to 30 per cent of last year's earning for listed Kuwaiti companies were derived from non-operating profits, such as revaluation of listed share holdings and real estate related gains.

The ongoing correction of share prices in the region's stock markets means that the deterioration in non-operating income this year for listed companies who have exposure to the stock market will dampen the overall profitability of these companies and in the process bring forth higher P/E multiples by year end compared to its levels at the beginning of the year.

Companies will have to work harder to make up for the potential shortfall in their non-recurring income on quarter to quarter and year to year comparisons of their total earnings. This will keep downward pressure on share prices and may bring forth deeper and more painful corrections. The longer the markets fail to deliver high returns, the more likely it is that investors will lose interest and exit the market.

Speculators may find it advantageous to cut their positions and exit sooner than later.

This is what has been happening in the regional stock markets during the past few months. Investors have been downgrading earning estimates for 2006, taking away the non-recurring profits booked last year in the booming national and regional stock markets. Not only will the first quarter results of 2006 be lower than the corresponding period of 2005, but also losses incurred in the stock markets will have to be taken into consideration.

The appetite for IPOs in the region will continue as more enterprises decide to convert from private to public share holding companies. Most of the new issues are expected to be oversubscribed.

Also, existing public shareholding companies will choose to issue more equity than debt to finance their expansion plans given the relatively lower cost of capital in the region's stock markets compared to the rising cost of borrowing. All this will reduce excess liquidity available to the stock markets, dampen speculative pressures and add to the ongoing correction.

We expect the region's stock markets to continue to correct downward from the peak attained in the past six months, before recovering somewhat towards the end of the year.

In the weeks and months ahead, speculators and small investors begin migrating away from the market, although regular event-driven trading opportunities ensure that some remain active.

Real estate prices will soon peak and may then start a downward correction as well. The market will eventually revert back to a positive slope in late 2006 as broad economic fundamentals remain supportive.

- The writer is the CEO and founder of Amwal Invest.