Home Money MattersThe numbers issue #18

MOROCCO

The Moroccan equity market rallied strongly in

September, drawing strength from reports of oil and gas

discoveries in the kingdom. The findings, which are

expected to dramatically change the face of the

Moroccan economy, would help to lessen the country’s

heavy dependence on the agricultural sector and make of

Morocco a net exporter of oil in a few years. Blue chip

stocks across the board reacted positively to the news and

investors’ enthusiasm was apparent in the substantial

increase in trading volumes.

Egypt

Sentiment was mostly positive in Egypt; however, the stock

exchange failed to uphold some gains realized in the month

of August with most blue chips witnessing consolidation.

Among the most demanded stocks were CIB, MobiNil and

OT, which together captured the bulk of trading activity.

Despite signs of improving domestic conditions, particularly

on the macro level, the market remains clouded by

uncertainty and tight liquidity condition. Nevertheless, investors

are bracing for the partial privatization of Telecom Egypt,

which is anticipated by the end of the year. The offering,

which will also include a GDR, is expected to rejuvenate

activity on the local bourse

JORDAN

Mixed semi-annual results for most listed concerns on the

Amman Stock Exchange kept sentiment subdued, with

the index hovering below the 140-psychological level.

Losses remain concentrated in the industrial and the

banking sectors, and to some extent, in the services sector.

Foreign investors continued to shun the market with

their sell orders outnumbering buy orders by JD5.9 million

in the first eight months of 2000. Accordingly, the

share of non-Jordanians in the listed companies stood at

41. 9% of market capitalization at the end of August, out

of which 36% is held by Arab investors and 5.9% by

non-Arab investors.

External debt under control in the Arab region

Successful debt management policies

have enabled several Arab countries

to reduce their external debt over the

past few years, most notably Egypt,

Morocco and Algeria. On the other hand,

other Arab countries, such as Lebanon,

Tunisia, Qatar and Oman, have been

accumulating higher levels of external

indebtedness. Among the indebted Arab

countries, Qatar and Jordan exhibited the

highest levels of external debt as a percentage

of GDP. at around 98% in 1999 for

both countries, while Oman and Egypt

enjoy the lowest levels, at 29% and 32%

respectively. Total external debt for the

eight Arab countries surveyed declined

from$118 billion in 1996to$113.8 billion

in 1997, but rose again in the following

two years toreach$117.9billion in 1999.

Those Arab countries that have a history

of debt rescheduling and those with a

high external debt burden will find it difficult

to attract foreign investment.

Capital always goes to those countries

who live up to their commitments and

where the risk of non-payment is low.

Besides, servicing large external debt eats

up a good portion of a country’s export

revenues, adds to its external imbalances

and puts pressure on the country’s foreign

reserves and its monetary stability.

Following the Gulf War in 1990, all of

Egypt’s debt to Arab creditors was cancelled,

as well as military debt owed to the

US, in recognition of the country’s support

to the UN coalition formed to liberate

Kuwait. This was followed by the cancellation

of half of the net present value of

the debt owed to the Paris Club ($22 billion)

and the rescheduling of the remaining

balance. As a result, foreign debt

declined from more than $46 billion in

1986 to about $28.2 billion in 1998/99,

representing 32% of GDP. Debt structure

is favorable and debt service/ exports

at less that 10% in 1999.

Lebanon’s external debt is expected to

rise in the foreseeable future as the government

gradually replaces part of the

expensive domestic debt, which stood at

a high of 126% of GDP at the end of

1999, with relatively cheaper dollar dominated

borrowing. Lebanon

tapped international markets in

September 1994 with the launch of its first

Eurobond, providing the government

with access to non-resident Lebanese,

Arab and foreign capital. Following a

series of Eurobonds, external debt rose

from a low of $772 million in 1994 to

$5,538 million in December 1999, representing

only 35% of the GDP and 25% of

the total debt outstanding. At the end of

June this year, the Lebanese Government

successfully issued a five-year Eurobond

for $500 million and is planning to issue

$500 million worth of 20-year

Eurobonds in the coming few months.

Total outstanding external debt of

Jordan at the end of 1999 stood at

JD5,186 million (US$7,312 million), or

98% of GDP, down from JD 6,052.5 million

(US$9,121 million) in 1990. By July

2000, total external debt dropped to

JD4,874 million (US$6,872 million).

Jordan• s largest creditors are the industrial

countries with whom the government is

negotiating debt rescheduling and debt forgiveness

agreements, and swapping some debt into local investment.

This should help reduce the country’s

debt burden, and with higher

growth in GDP this year, debt to

GDP ratio should drop below 90%.

Qatar’s LNG investment program,

financed by a huge stock of

external debt, led to the reversal of …_

the country’s position from a net

creditor up until 1994, to a net

debtor starting from 1995. The

country’s external debt (including

government guaranteed debt and

QGPC debt) reached $11.2 billion in

1999, accounting for 98% of GDP.

 A new $500 million sovereign loan will be

launched this month, coming at the heels

of Qatar’s second Eurobond issue, which

in mid-June raised $1.4 billion. Debt

ratios are expected to improve beyond

the year 2000 on the back of sustainable

economic growth driven by growing natural

gas exports and higher oil revenues.

Total external debt in Tunisia stood at an

estimated $13 billion last year, equivalent

to 62% of GDP. The country’s external

indebtedness is manageable in light of

Tunisia’s easy access to external borrowing

and international bond markets. In

Morocco, prudent external borrowing

and active debt management policy has

substantially reduced the country’s external

debt from a peak of 130% of GDP in

1985 to $19.2 billion or 54% of GDP in

1999. The stock of external debt in

Algeria has declined from a peak of

$34.4 billion in 1996 to an estimated

$29.7 billion in 1999, equivalent to

62.1 % of GDP, and is further expected to

fall to $28. 7 billion by the end of the year.

It is imperative for the indebted Arab

countries to take all possible measures to

reduce their debt burden. Buying one’s

debt from the world’s secondary market at

a fraction of the nominal value and using

privatization proceeds to retire existing

debt are well-known measures for the countries of the region to follow

Global research

Highlights

Economic focus

United States

• As the presidential campaign heats up, both candidates have

released broad outlines of their fiscal plans, which would

drastically reduce the federal debt during the next decade. The

question is, would either candidate blow the surplus? Probably

not. Even assuming that federal spending rises faster than

the candidates expect, their fiscal goals could still largely be

achieved because the economy will probably perform better

than they expect.

• Both Bush and Gore use the budget baseline developed by the

Congressional Budget Office (CBO) to cost out their respective

plans. On that basis, accumulated surpluses over the next

decade would total nearly $4.6 trillion, more than enough to pay

off the existing $3 .5 trillion federal debt. Roughly half of that

sum, $2.4 trillion, reflects the Social Security surplus.

• Looking at the candidates’ figures, Gore’s proposals would

pay down about $2.8 trillion of federal debt by 2010, eliminating

80% of the currently existing debt by that time. Bush’s proposals

would pay down about $1.4 trillion of debt, eliminating 40%

of the existing total, plus accumulating about $1 trillion in self

directed Social Security accounts.

• Of course, candidates are traditionally unduly optimistic

about budget effects, and both Gore and Bush have undoubtedly

underestimated the cost of their spending programs. For

example, more than half of the extra spending in both plans is for

healthcare, an area of notorious cost overruns.

• Beyond the specifics of their policy proposals, both Bush and

Gore use a CBO baseline that assumes that real discretionary

spending will be flat for the next ten years, an assumption that

we think is too optimistic. The CBO also assumes that GDP

growth will average 2.75% during the net decade; the Fed now

appears to believe that the economy’s non-inflationary growth

potential is 4% a year. We think it’s even faster.

• If growth were to average 3.5% a year-still less than the Fed’s

estimate of potential, leaving room for a recession to occur –

federal revenues would be roughly $1.5 trillion more than

assumed in the CBO baseline. That means that higher revenues

from stronger economic growth would likely offset even sizeable

cost overruns in the candidates’ spending plans. In short,

the fiscal goals of Bush and Gore may actually be achievable,

at least over the ten-year period used in their budget planning.

• In our view, the net economic stimulus of either plan would

be too small to worry the Federal Reserve very much. Indeed,

if the new President were to carry out his tax and spending plans,

fiscal policy would actually become increasingly restrictive during

the next decade because federal spending as a share of GDP

would continuously shrink. We doubt that spending would be

quite that restrictive.

Bruce Steinberg, chief economist

Global view

• It stands to reason that economic growth is the ultimate

source of profits growth. It is also logical to think that investors

will probably see stronger growth in corporate earnings and

stronger equity-market trends in countries where economic

growth potential is high rather than low.

• With that in mind, we recently conducted a study – our Global

Ranking Systems (ORS) – that ranks 35 countries by their

economic growth potential. The goal is to help investors recognize

profitable opportunities in countries that might not

look particularly attractive today.

• What method did we follow? We identified five categories of

variables that help to gauge a country’s economic growth

potential. They are capital supply (which measures savings rates

and the performances of capital markets), people (the supply

and quality of human resources), technology (scientific and technological

capacity), government policy and social structure (the

growth orientation of government policy; social cohesion) and

risks (potential sources of economic instability). Each category

has five variables; for each variable, we ranked each country

from most-favorable to least-favorable, assiging an equal

weight to all variables.

• What did we find? Sweden had the highest total score. Singapore,

Australia and the US were in a virtual tie for second

place. At the other end of the spectrum, Russia beat Indonesia

and Pakistan or last place. OECD members accounted for ten

of the top 12 spots on the list; the lowest-scoring countries represent

a di verse collection of economies in Latin America, South

Asia and Eastern Europe • Not surprisingly, we found that the technology category had

the strongest effect on a country’s ranking because it displayed

the greatest variation among the economies we examined. The

people category displayed the least variation, primarily

because high scores on some variables tended to be associated

with low scores on others (for example, countries with poorly

educated and comparatively unhealthy populations generally had

rapid labor-force growth rates and low labor costs).

• The GRS would be of no use if it did not have a strong correlation

with GDP growth and equity-price increases. Our back testing

indicates that the GRS does a good job of explaining potential

growth over time. The correlation between country total

scores and GDP growth is very strong, after controlling for initial

per-capita GDP. Looking at equity-market performance, the

situation is similar: countries with high total scores showed higher

growth in equity prices.

•Fora full discussion of this topic, see our August 30 report, GRS:

Ranking the World’s Fast-Track Economies.

Michael Hartnett, senior international economist

Matthew Higgins, international economist

Strategy fOCUS

United States

• Style often equals substance, at least when it comes to investing

in stocks. That’s one of the messages that the market has

been sending during the past few years, when investment

style decisions have been among the most important influences

on performance.

• One style that investors always seem to keep in mind is small cap

investing. Right now, the small-cap sector seems to have

reached a kind of noisy equilibrium. The unusually wide performance

gaps between opposing investment styles have recently

moved closer to their normal relationships. We tend to think that

dramatic divergences in performance are probably a thing of the

past, but in the case of small-cap issues, valuations alone are unlikely

to trigger a sustained period of outperformance. In our view, a

new bull market in small-cap shares is in a state of arrested development;

whether and when it blossoms probably depends on factors

that go beyond matters of valuation or profits.

• A look at the past may provide some insight into the future.

On a long-term basis, returns on small-cap stocks showed an

enormous acceleration from 1973 to about 1983, and they have

generally underperformed since then. What accounted for the

surge? In a nutshell, investors in the 1970s and early 1980s had

only two obvious choices: watch their savings erode, or withdraw

their savings from low-return regulated accounts and participate

in the then-prevailing inflationary trends by owning

small-cap energy and mining shares. The choice was fairly clear,

and investors quickly rotated into the few areas of the economy

that prospered from the structural inflation that was building

up at the time.

• What’s going on now? If inflation were to reappear at some

point, investors have many more alternatives than they did 25

years ago. As a result, we doubt that another period of outsized

small-cap relative returns is likely now that the menu of financial

choices is much broader than it used to be.

• With the exception of the great run-up of 1973-83, small-cap

bull markets were cyclical affairs. We think that that is the kind

of revival that will eventually develop in the sector.

• History shows that most small-cap bull markets emerge in the

aftermath of a recession or painful soft economic landing.

Recessions often create the mix of factors needed to encourage

rotation back into small-company shares, including deep-discount

relative valuations (as investors rotate first into safer large cap

companies), easier monetary policy (creating upward

pressure on multiples and confidence in an earnings revival) and

easy comparison as the profits cycle finally turns.

• Monetary policy is an especially-important element in the outlook

for small-cap stocks for the rest of 200 and 200 I, in our

view, particularly because investors appear to think that profits

are peaking. An extended decline in interest rates has usually

been a prerequisite for a period of sustained outperformance

by small-cap benchmarks. For that reason, a buoyant economy

may deal a major revival in the small-cap sector of the market.

Another consideration is this: the weakness in technology

stocks has been much more pronounced in the leading small cap

indexes than in the S&P 500, and the same holds true for

financials. Those two areas must do better before small-cap

measures can outpace the S&P 500.

• Other factors may also contribute to delays in a small-cap

revival. One is that size may indeed matter, even within the

small-cap universe: a look at the Russell 2000 shows that the

fundamentally stronger companies appear to be bigger ones in

terms of market cap. In addition, the IPO market and, more

broadly, IPOs, secondaries and shares coming out of lock-up

translate into supply; that could also be a key element in the performance

of the small-cap indexes in the months ahead. As

usual, the underwriting calendar slowed down for the September

Labor Day weekend. The pipeline for the rest of the third quarter

and the fourth appears to be fairly heavy.

• On balance, our view of the small-cap sector’s prospects is this:

a major small-cap bull market will likely be delayed into next

year, but we think that the current low valuations of many stocks

offer attractive entry points for patient investors. In the climate

that we foresee, careful stock and sector selection will probably

become the main driver of returns for small-cap portfolios.

Christine A. Callies, chief US investment strategist

Technical focus

United States”

• The stocks market’s major averages rose by 4% to 8% for the

July-August period, but the advance appears to be maturing. A

fall correction may be more severe in the technology sector than

in the technology sector than in the market as a whole. We continue

to favor accumulating issues in the value areas of the market

during an expected fall setback.

• Whether the market’s recent upswing is the start of a durable

advance from the major averages’ spring lows or merely an

interim recovery from those lows that will be followed by

renewed weakness may depend on the sector of the market to

which one is referring. In the case of the technology sector, we

continue to believe that its summer performance sequence was

an interim recovery, or “B-wave,” that will likely be followed

by a second phase of weakness, or ”C-wave” decline, in coming

months before the entire correction is complete.

• The non-technology/growth “rest of the market” consists primarily

of a wide array of mid-to-small cap value stocks,

although many large-cap basic-industry/capital-goods issues

could also be included. Those stocks, in general, have been out

of favor or correcting for the past two to three years, but now

appear to be stabilizing or recovering on a gradual or nation- al basis.

 The improvement in that wide array of stocks has lifted

the NYSE’s 25-week advance-decline ratio to its highest

level (1.27) since April 1998 and raised the percentage of NYSE

common stocks trading above their 200-day moving averages

to 63%, also the highest level since early 1998. A key difference

between now and then: in 1998, those figures were

declining from higher preceding levels; now they are rising from

lower levels and showing improving momentum. Although a

market reaction during the next couple of months would certainly

have some effect on those stocks, it would be part of an

emerging major uptrend rather than a reversal of it.

• Meanwhile, the recent catch-up in the previously laggard technology

sector may be the latest indication that the market’s

spring-summer recovery trend is in a mature stage. Moreover, if

that were to be followed by signs of a faltering in the recent leaders

(financial, energy, utility stocks), it would increase the evidence

that a fall pullback or corrective phase was unfolding.

• Against that background, we continue to recommend that trading

accounts raise cash reserves in coming weeks and that

longer-term investors buy on a price scale-down basis.

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