While the consensus of stock market analysts at the end of a harsh 2006 was an uncertainty if those erratic equity markets – mainly those in the Gulf Cooperation Council (GCC) – have reached the bottom, recent research papers by some major financial companies were taking a view of better tidings ahead.
Dubai’s Shuaa capital in December said it is bullish on the UAE, Kuwait, and Oman and sees Saudi Arabia entering an accumulation phase. Kuwait-based Global Investment House predicts Kuwait, Saudi Arabia, and the UAE to show more than 25% growth in equity markets in 2007 and forecasts “moderate growth rates” of 17% to 23% for stock markets in the other three GCC countries – Oman, Qatar, and Bahrain.
In addition to these local firms, the Middle East research department of Japanese financial services house, Nomura, said “intuitive observations suggest that the markets are in the final stages of digesting last year’s excesses and are set to trough soon.”
Suffering big losses
By ways of a historic rather than financial analysis and comparison with bull-bear swings in other emerging markets, Nomura analyst Tarek Fadlallah provided statistics by which the past bull runs of 28 and 39 months on the Dubai Financial Market (DFM) and the Saudi Stock Exchange (SSE), respectively, were within the experience ranges of upturn phases previously seen in Asia and Eastern Europe as well as on the Nasdaq, given an average upturn-phase duration of 31 months within a range spread of 19 to 48 months.
However, when computing the severity of the correction, the DFM and SSE were not quite yet at the maximum loss level of 80% that emerging markets experience as average of their post-bubble corrections. Also in terms of duration, the regional downturn periods were still shorter in November than those seen in other markets before they entered recovery periods with attractive market gains.
In terms of financial analyses, the professional equity gazers have positive things to say about the way in which valuations have returned to levels comparable to other emerging markets. The process was certainly painful for exposed investors, especially retail buyers, who had jumped on the train late, while it was well into its ride to the peaks.
The most recent research notes by regional markets analysts of Shuaa Capital and Global Investment House put the price to earnings ratio estimates for GCC markets in 2006 at between 11 and 15 times earnings (Global) and nine times to 16 times (Shuaa). In the calculations of both firms, the SSE is the most expensive market and has the highest P/E. But being in a range of 15 times earnings is a big step forward for the Saudi bourse from the excessive valuations represented by last year’s prices, when stocks were pushed to trade at almost 40 times earnings.
Price to earnings ratios in the Saudi market have returned to rational levels and are now attractive to long-term investors, Global augured. Retail investors will contribute the thrilling aspects to the equation, it added.
One example for the starkness of the Saudi market correction is the petrochemicals behemoth Sabic, which parachuted from a price to earnings ratio of 40.1 to 13.4. As Nomura notes, this SSE blue-chip stock, contracted by some $130 billion in market capitalization from its peak valuation in February 2006 until December. That loss was more than the annual GDP of Singapore, Nomura said – or, to speak closer to home, it would in mere mathematics be equal to about twelve times of what Lebanon by some accounts suffered in short and long-term economic damage from the war between Israel and Hizbullah.
Although the huge monetary losses from the crash of the Arab bubble made this one of the “largest emerging market meltdowns in history,” the analysts see reasons to justify that the downturn of GCC stock markets will differ in important aspects from other big crashes that went down in history as triggers of macroeconomic crises in the affected economies.
The main element that appears to protect the region from even more painful crash consequences such as macroeconomic crises and need for far-reaching restructuring to remedy systemic flaws is the good economic outlook with high liquidity levels. Thanks to its oil billions, Saudi Arabia, which saw half a trillion dollars in market cap evaporate in 2006, could nonetheless reduce its public debt from more than 100% of GDP just a few years ago to around 28% for 2006.
In line with their strong oil outlook and ample liquidity, the region’s markets should rebound this year, and stock prices are widely expected to move in line with the corporate earnings stories of listed firms that will start to come out in raw versions from the middle of January. This is the ruling expectation, even though the overall respectable third-quarter 2006 results of major GCC corporations did not have enough punch to drive the markets out of their negative sentiments, a failing that Nomura’s Fadlallah described as missed opportunity to “muster a noteworthy rally during the autumn.”
Sector by sector
Smart investor decisions may be quite a challenge for 2007, however, testing investors on picking the right stocks to buy and sell and on basing their decisions on the proper information. “Bottom-fishing” for low price stocks, which some analysts promote, is described by others as a risky proposition, because the temptation is great to buy too early and gamble away both money and confidence. And sector by sector, no part of the regional equity scene can be considered free of risks and downsides.
Finance and banking is by far the largest sector on GCC bourses. Banking shares are stacked high on the outlook list of several regional investment advisory firms – some of which are well interlinked with those very banking stocks that they view favorably. However, while many have been very profitable and have continued good earning outlooks, banks in most GCC markets are sailing into more competitive waters and will have to prove themselves there.
In telecommunications, another high-attention sector in the region, the leading GCC-based players have positioned themselves convincingly on the international field. The caveat here too is that the share prices of several major regional companies are at levels that do not compellingly entice when compared to some of their global peers.
The sector to watch with greatest care in 2007 is, with strong probability, real estate. Consensus of market analysts is that the real estate price runs in various countries and sub-sectors of the GCC property markets will lead to a correction phase in the valuation cycle as supply-demand dynamics for real estate turn. The question, which analysts tend to approach with optimism, is if the real estate bubble will deflate gently or see valuation balloons pop right and left.
The property prices from the second half of 2007 and in 2008 in Dubai and the other GCC markets will provide important information on the challenges that the economies will have to master in this sector. But, serious analysts already warn convincingly that real estate investments in the coming years cannot be considered foolproof and guaranteed to realize double-digit rates of return. The end of the property bubble will be just as inevitable as it was for the equities bubble.
Raising the perspective to a regional look outside the GCC, the market valuations in North Africa are reaching bubble levels, warned Shuaa, and cautioned against exposure to the Moroccan and Tunisian exchanges. One national equity market that was largely absent from recent strategy notes was Lebanon’s BSE. This proved another testimony to the fact that while wars are bad for modern-day bourses, persistent uncertainty from perennial internal instability is even worse. Analysts call the Beirut Stock Exchange a wait or withhold.
The big question for the regional equity markets is if corporate earnings of 2006 will present enough substance to let retail stock market players shake off the post-GCC bubble blues early next year and turn their attention away from instinctive herd behavior to more fact-driven trading decisions and also towards opening additional new opportunities.
Global, which sees a stabilizing factor in outward diversification, singles out Pakistan as example for a growth market where GCC liquidity has positioned investors near the top of the pecking order. According to the researchers, UAE investors are the second largest source of foreign direct investment inflows in Pakistan after the US, accounting for 14% of all FDI. Saudi banks and industrial firms are also expansive in Pakistan and an impending free trade agreement between Pakistan and the GCC is expected to further boost FDI flows into this country from its Arab neighbors.
With the correction phase of the leading Arab bourses tapering out, GCC and Arab market risks persist nonetheless in structural and behavioral factors. While liquidity is the strong element at this moment, the yang that will keep the macroeconomic sting out of the bust of the GCC bubble, the darker side of the equation is the absence of market makers and independent minds, of transparency and convincing regulation.
Then there are still the incorporeal challenges to be handled, the investor psyche and confidence factors. For now, Global Investment House sees the GCC market drivers as dominated by emotions and fears “where all the good news is discounted and the bad news create more flutter.”
This speaks of the need to educate, build awareness, and improve governance and transparency. In a mirror image of their larger economic constitutions, the message that needs to be pounded into the securities markets is that of governance benefits and the increasing rationalism that will make markets more rational. The excitement of the stock market game will still guarantee that forecasts and expectations will be proven wrong and excitement can be gained. But, the swings will move more reliably to be within those ranges that macro planners need and analysts love to chart.