Value and vision behind local stocks

There are signs the tide may be turning in favour of local equity markets. Two factors especially should support them going forward.

First, value has returned. During the bull run, price-earnings ratios soared to obviously unsustainable levels. The sell-off, matched by dramatic increases in profitability given the strong macro backdrop, has restored valuations to much more reasonable levels. Our estimates of current trailing price-earnings ratios are in the order of 13-15. This is bordering on cheap for the market as a whole.

The second supportive factor is vision. Recently Dubai launched its 2015 vision for a massive expansion in economic activity. While one can always wonder whether the numbers will be attained, such a report provides two things of value.

First, it gives an idea of the 'quantum' of the emirate's goals. Even if they are missed by 10-20 per cent, such an 'under-performance' would be extremely impressive. Meanwhile, the success of the previous plan adds credibility to the plans announced.

Second, it indicates the direction of likely development. In the US, Europe or Japan, such a vision would not be worth the paper it was written on.

Crucial

Even in Singapore, with which Dubai's development model can be compared, the government is downplaying its ability to influence economic outcomes and stressing the role of the private sector. But in an economy where the government is still a very important economic decision maker, this is crucial information for business planning.

Abu Dhabi's investment and diversification drive is also well-flagged. Therefore, growth in the non-hydrocarbon sector is likely to accelerate on a structural basis, increasing the profit-making opportunities for the private sector.

Finally, the UAE is expected to release its 2010 vision soon. Interesting here will be any signs of greater coordination of strategies between the country's two largest emirates and between them and the smaller emirates. While there is a consistent development theme in the smaller emirates, with a particular focus on tourism, any signs of official federal backing would be very important for investor confidence.

All in all, low valuations and strong private sector growth prospects are a positive backdrop for local equity markets.

What could delay recovery? Two factors of particular note are still strong selling interest, and Iran.

After a sharp decline in equity prices, there is a tendency for those who did not sell on the way down to be looking for better levels to exit. This tends to cap rallies for some time (12-18 months).

Also, concerns about a military intervention are clearly rising in line with the hawkish rhetoric being heard from the US and associated media reports.

Therefore, while we tentatively believe the downtrend in stocks has been arrested, it is likely that returns will be much more modest than seen in the 2003-2005 period.

- The writer is Regional Head of Research, Standard Chartered Bank in Dubai.