Saudi Arabia and Egypt have been identified by investment management firm Franklin Templeton as two of its three global market picks (with Colombia being the third).
Salah Shamma, a Dubai-based head of investments and MENA equities, also told journalists at a media event last week that the Dubai market had been oversold.
“We believe that we are in the midst of an early cycle recovery,” Shamma said, arguing that the rest of the developed market, and many other emerging markets, had been enjoying a boom in recent years, while the Gulf had experienced a down cycle.
“And we're just starting to come out of that. Fortunately for us, it's happening at a time when the U.S. Fed has decided to suspend increasing interest rates, or at least we are going lower for longer, which is going to be quite supportive for our growth within this part of the world,” he said.
In Saudi Arabia, for instance, he argued that there are much stronger investor inflows expected this year as a result of the kingdom’s stock market’s inclusion into emerging market indices created by index compilers FTSE Russell and MSCI.
FTSE Russell inclusion began in March and is taking place in five tranches. MSCI inclusion is set to take place later this month and in August when the index provider undertakes semi-annual reviews.
Shamma said that although inclusion had been a topic of conversation “for some time”, most of the expected flows have yet to materialise. In the final quarter of 2019, Saudi Arabia’s stock market witnessed a net outflow $1.89 billion of foreign investor funds following the killing of Saudi journalist Jamal Khashoggi in October last year.
“I think we saw a slight hiccup last year with the Khassoggi event, however things have normalised right now. We've seen almost $6 billion come into Saudi year-to-date. We still expect around $35 billion to come into the market within the next year,” Shamma said.
He argued that the Saudi market has increased in value by around 35 percent since FTSE inclusion began in March. By last week’s close, the market was up 19.7 percent, according to Eikon data.>
Which shares have been the best and worst performers in the UAE, Saudi and Egypt in the first quarter of 2019? Click on the infographic above for the details.
This increase has led to some analysts arguing that the Saudi market may now be overvalued. A note published by London-based Capital Economics last Thursdaystated that the index-fuelled rally would “lose steam and go into reverse over the rest of this year”.
The note from the firm’s Middle East economist Jason Tuvey argued that if global economic growth continues to disappoint, then “risky assets across the board” will come under pressure. Capital Economics also expects the oil price to fall back from its current high of $70.85 at 11.40 GST on Sunday, to nearer $60 by the end of the year.
“And past experience suggests that investors’ optimism regarding the upgrade to EM status is overdone,” Tuvey said in the note. “There’s also the lingering risk of a fresh spike in geopolitical tensions, which has historically weighed on Saudi stock prices. All told, we have pencilled in a 20 percent drop in the Tadawul by the end of this year to 7,500, from around 9,350 at present,” Tuvey’s note said.
Shamma’s more optimistic outlook is based on the fact that consumer confidence is reasonably strong (point of sale transactions increased by 19.9 percent year-on-year in March, and were up 21.8 percent month-on-month, according to Al Rajhi Capital Research) and that investor sentiment had also improved. He predicted that the earnings component of price-to-earnings ratios was likely to increase, making Saudi stocks’ valuations look less full.
Marcroeconomic conditions also underpinned Shamma’s bullishness for Egypt, with Shamma stating that Egypt “has done everything right” in terms of its performance under the International Monetary Fund (IMF) programme.
He said that over the past three years, Egypt has managed to embark on a free float of its currency and bring down its budget by widening its tax base and reducing subsidies.
“They've done that while still maintaining growth and infrastructure spending,” he said.
'Influx' into bonds
“We've seen a significant influx of foreign investment into the country, specifically into the fixed income space,” Shamma said. “We've seen that also materialise in equity - I think to a lesser extent in the equity space given liquidity is much lower within the market.”
He expects stronger inflows into Egyptian equities given that inflation is declining, which should lead to a fall in interest rates. Franklin Templeton expects Egyptian interest rates to drop by as much as 2 percent this year, from their current rates of 15.75-16.75 percent.
The IMF last week said that it expects GDP growth of 5.5 percent for Egypt this year, up from 5.3 percent last month. This would be its highest rate in a decade. However, Capital Economics’ Tuvey warned in a separate note last month that concerns remain over a lack of trade liberalisation, with tariff levels high by emerging market standards, which hampers the competitiveness of domestic producers. He said that Egypt’s manufacturing growth slowed sharply last year to 1.8 percent, down from 5.1 percent in 2017.
Shamma was also bullish on the prospects for the Dubai Financial Market (DFM), stating that following last year’s decline, when the index dropped in value by 25.8 percent, equity valuations were currently hovering at a price-to-earnings ratio of 7x, a level last witnessed in 2011 in the wake of the financial crisis. Average company profitability is currently much higher, said Shamma.
“Either profitability has to come down significantly, or the market is undervalued,” he said. “We think it's the right time to actually build positions... the reason being we do not believe the Dubai model is broken,” he said.
The valuations of real estate firms have been hit hardest, with investors concerned about overcapacity in the market. And although there has been a slight recovery in valuations in 2019, with the DFM index up 9 percent by close last Thursday, trading volumes have remained thin.
“I think.... the valuations are interesting enough that we're starting to see liquidity come back in. There are a lot of people who believe that valuations have priced in a lot of negativity,” Shamma said.
(Reporting by Michael Fahy; Editing by Mily Chakrabarty)
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