Even in normal times, there is an element of drama to the markets unmatched by most other areas of discourse. From oil prices to interest rates, there is always a sense of a Shakesperean tragedy for those on the wrong side of the bet.
However, the last few months have taken the drama to an extreme; from the Adani saga to the fixation on interest rates being ‘higher for longer’, the yield on interest rates and its effect on borrowing has had opinions yo-yoing. This has been reflected in asset price valuations, which have had a strong start to the year after a terrible 2022.
Headlines have screamed that the Nasdaq has had the best January since 2001, forgetting that the dotcom bubble burst only a couple of months later. Amidst all this, we know that financial markets reflect expectations about the future, and then assign a valuation figure on them. So, it is not surprising when markets have been so chaotic based on an increasing amount of questioning regarding valuations (an error in ‘Bard’ leads to Google’s $100 billion loss in market cap?).
Investors have been asked to diversify, yet the traditional 60/40 portfolio has performed appallingly. The supposed risk-free rate returned a real return of -24 per cent last year. What is more concerning is that investors who have been asked to be more patient feel that they have not enough time to recoup their losses. And therefore, the impulse is to increase portfolios to fixed income securities, where yields have gone up.
Fixated on valuation
This has become the mantra of investment managers in 2023, forgetting the fact that rising bond yields have not yet caught up with inflation. And rising coupons are not yet in a position to maintain purchasing power. Given the market commentary at present, it seems more likely than not that interest rates will continue to creep higher, and therefore valuations will remain volatile.
In this environment, investors should not only be looking at valuation dislocations that have exposed themselves throughout the world, but also realize that fixating on macro-valuations such as interest rates have no effect on long-term wealth creation. Valuations that have been stretched in the West and have been suppressed in emerging markets like the UAE, will likely move the other way as money flows start to correct the asymmetry, as they have in the real estate markets.
A growth + dividend strategy
Granted that they are smaller in size relative to their Western counterparts, but that in no way deprives investors to capitalize on this valuation discrepancy. Companies like Q holding, Tabreed, Salik, Dewa, Empower, Etisalat, Air Arabia, Emaar and others have demonstrated both their ability to develop superior revenue growth in the high double digits.
Plus, buttress it with dividend yields that complement capital gains, as we have seen already play out. Even as there has been increased acceptance of the real estate asset class in the UAE, so too there has been increased activity and activism in the domestic capital capital markets.
Even as the media continues to be fixated on all things Western when it comes to financial markets (there remains a remarkable paucity of analyst reports for domestic companies), companies in the UAE have steadily capitalized on domestic, regional and international opportunities to invest their free cashflows. (Etisalat’s increasing acquisition of Vodafone shares being the most recent example).
UAE’s growing blue-chip universe
This illustrates not only the growing ambitions of these companies, but also building in diversifying revenue streams in the process. Gone are the days where attaching ‘crypto’ or ‘meta’ to every activity resulted in a pop in the valuations. Investors are pivoting to dividend payouts and companies like DEWA, Salik, Empower, Bourouge, and the Adnoc companies are getting increasing attention as core underlying cash generation engines complement cash payouts.
In the current environment, the media has been enraptured by the wave of IPOs, which is exciting enough, but it ignores the larger picture of growing underlying profitability. Valuation metrics have to correct for that, and it is this that investors should be focusing on, rather than macro factors such as interest rates (which investors should mostly sleep through).
Not every stock is a bargain to be sure, but for the most part, the domestic capital markets are offering a gift to investors, in the way that real estate markets did in 2002. Such opportunities do not come by very often but when they do, investors should grab at them with both hands.
