GCC stocks no longer out for the count

Regional markets have really picked up in the past three months. How do you account for that performance?

Let's bring it into context. The region in general has been quite a substantial laggard in the global rally. Why was that? In essence, sentiment was still pretty low here, [with] oil at $30 (Dh110) a barrel, bearing on investors' feel-good factor.

Since the start of the year we have seen credit default swaps and sentiment really improve. We have seen oil pick up to close to $80 a barrel, [and] also seen initiatives by the government here that have been very strong and bold — and that has really helped.

Undoubtedly we are in a challenging economic environment, and obviously no one envisages a quick fix on that. But equity markets are lead indicators. Stock markets usually try to price in a recovery six to eight months before it actually happens in the real economy.

If you drill down to the UAE, it has really outperformed, with investors looking at highly cyclical trades. In a recovery process cyclical sectors and stocks outperform. If you look at the global economy, we are [coming] out of a recessionary period. Naturally, investors are looking at playing the ‘beta' [more volatile] stocks. It's ‘catch-up' trade now.

And is it sustainable? How do you view the overall equities trend in the region going forward?

Do I believe the sort of the run we have seen will continue? Absolutely. If we look at some of the supports behind it, such as valuations, they are still compelling. We still feel that year-to-date [these stocks] are still laggards. [Whereas] Far East and emerging markets are up 70-80 per cent, we are up on average 30-40 per cent. If I am looking at markets where I can generate ‘alpha' [outperformance], this region is still an attraction.

[There are] two cycles. The first is playing catch-up, when the general market drifts higher. In the second, one has to differentiate on quality. Presently it's a ‘top-down' [view]. Then you will be looking at a more ‘bottom-up' approach, when you look at earnings, at profitability, at balance sheets and, really, stock-picking — differentiating good companies and bad, [finding] those that have a prudent and robust business model and where we can see that in operational performance.

So which stocks and sectors are you bullish on in this environment?

The markets in the UAE are dominated by banks, real estate and telecom, and they have all benefited in the first phase. In the second phase you cannot look at the industry on the same basis. You have to look at the individual player. I think you can pick winners even in the real estate sector today. You can find banks which are performing better than others. So it's a relative trade. Having said that, banks will always be the focus. Whether it's the UAE or Saudi banks, those are the two leading areas, the so-called ‘regional big players'.

You touched upon valuations. How do they fare in the Gulf relative to emerging markets?

Multiples relative to emerging markets are undoubtedly attractively priced. Historically, this region has always traded at a premium. Now valuations here are at a substantial discount. Emerging markets [themselves] still aren't too expensive. Here, corporate earnings are still very supportive. [In fact, even] regional real estate, financial and telecom are at a substantial discount, on an historical basis and also on a global and emerging markets basis.

In the Gulf, some [markets] look ‘cheaper', some look fair [value]. For us, Saudi Arabia looks fair, while Qatar and the UAE are less expensive. [Within] the Middle East and North Africa (Mena) region, particularly Egypt, [valuations there] are also at a discount to the emerging markets whereas historically they have been at a premium. Corporate earnings in Egypt, and even economic growth, are still very high.

There has been a marked improvement in terms of foreign investors taking an interest. Do you see their return as being in the manner of long-term investors, or just as speculators, leaving markets vulnerable to another ‘boom-bust' cycle?

I think we have seen a change in the industry. Undoubtedly, some of the investments from overseas are that sort: speculative money, and you will always find that in any sort of emerging market. [But] we have seen a trend in terms of a little bit of long-term money entering.

I will give you an example. Credit Suisse has just launched a Mena fund, which is long-term focused, to the region. That shows the commitment by foreign investors changing to a certain extent.

What we have noticed is foreign investors providing an underlying uptrend in the market. In fact, the trend is being initiated by those foreign investors. But to consistently play out on a medium- to long-term basis, we need the local money really to provide the required momentum. To achieve long-lasting performance will always depend on the local investors.

Given the nature of the markets here, mostly still retail-dominated, when such investors do return, won't the markets still be subject to the vagaries of the retail mindset?

There's no quick fix. How the retail money trades, sort of ‘non-fundamental', I think that's still here to stay. I don't see any changes to that pattern or the volatility. We are in the early stages of a maturing cycle. We are nowhere near a phase where retail money has become [to some extent] very mature, or the portion of retail money been diluted by more local institution money — that hasn't happened.

One has to always appreciate that; it should not be seen as something of an obstacle. It should be seen as an opportunity. Naturally, we know that retail money always lags institutional money. So, in behavioural finance, [with] the sort of herd instinct which retail investing is all about, there is an opportunity in terms of the timing aspect.

If you understand what really drives retail investing, for instance dividend income, and if you can second-guess what a dividend policy is going to be, or whether it's going to be compromised, you can know what kind of reaction there will be from the retail side. Also in terms of corporate news flow: how that is disseminated to the retail community. [Knowing] how that will be translated by the retail space, that provides opportunity.

How about Saudi Arabia, where stocks are not so cheap as in the UAE? What is that reflecting?

The Saudi market in terms of valuations has always traded at a different multiple to the region — always.

Obviously the banking community is in a challenging environment, and that sector is a huge portion of the weighting in Saudi Arabia. We haven't really seen the kind of bottom-line growth in some of the Saudi banks. [Yet] subdued earnings have been translating into multiples that don't look as cheap as others going forward.

In terms of the economy, it's safe to say the consensus call has always been [in favour of] Saudi Arabia. They have the sort of fundamental dynamics, unlike anywhere else. It's always been a closed market historically, and foreigners have just recently starting to invest there because of regulatory [change]. Even Gulf investors have just started to invest. That means it's sort of opening up, and evolving as well.

In that case, will other markets suffer relatively, with money flowing to the bigger market?

I really can't see that happening. I think everyone wins; the region wins. When you get a large market opening up, and you have a fully-fledged market in terms of investability, you get much more traction, much more of an investor base. The smaller markets benefit, [because of] more attention, more focus to the region. The other ‘nearby' markets are then an indirect play on the Saudi economy and growth.

There are some long-term aspects of that. In the post-crisis scenario, we not only need consolidation on the industry side, i.e. among companies, but also among exchanges; we have too many. When liquidity dries out, some markets, small and illiquid, suffer more than others.

Qatar's stock market, notably, hasn't really been doing well, though its economy was one of those less affected by the crisis. What's your reading of that?

It has surprised a lot of people. It's another consensus call that Qatar is one of the favourite destinations for investors. There is an interesting statistic, if you look at the trough and the year to date, the market is actually higher than any other market here. They bottomed quite early, and from that point they are actually the better performer.

Again, there are two parts of the cycle here. We have seen a lot of the performance being driven by the initiatives of the government (purchasing some of the bad assets), helping investor sentiment. Foreigners have in fact invested quite hugely into Qatar, but to continue that momentum, you need the local investors, and that's where it has been disappointing.

Retail money is still reluctant to participate in the global rally — and that's anywhere in the world. The global rally has been about institutional investors.

Apart from consolidation, what would you say are the lessons to be learned from the crisis for the markets of the region? What kind of changes do you expect?

Even before the crisis we were in a development stage here, in companies' investor relations — in terms of reporting on time, being transparent on earnings, talking about mergers or potential mergers. These are all issues that were there pre-crisis, and remain post-crisis.

We have seen some of the capital market authorities being quite bold, saying (for instance) "if you don't give us disclosure in certain areas, you can't report on your earnings." I feel their intentions [as policymakers] are great.

[The trends now are] still in line with this maturing cycle, and development of a classical frontier market; it's still an ongoing process. A lot of investors I touch base with would like to see more transparency on the earnings side, but also in the way the corporate news is disseminated. Also, it's important to safeguard liquidity, maybe to look at some dedicated market-makers for certain markets, so investors can get in and out.

Does it make you positive about the future?

Absolutely. As we gain more traction in the global recovery, this region will be one of the outperformers. When liquidity improves, you will even find the UAE will outperform, as a classical frontier market. We are quite positive on [the outlook for] oil, and that has a bearing on the economic growth of the region, which is really aggressively going to pick up in 2010.

That clearly bodes well in terms of investors, and investability, within the region. For us, the Middle East will be one of the top choices. It will be in the top quartile [of performers] in the recovery phase. [Looking ahead], it's still small, a maturing environment that has great outperformance appeal.