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Economic reform in Saudi Arabia and Egypt will boost corporate earnings
Saudi MSCI upgrade may bring inflows of USD 45 billion from global investors
Dubai, United Arab Emirates: With structural and economic reform in full swing in the MENA region, equities in Egypt and Saudi Arabia are capturing the imagination of Emerging Market (EM) investors, according to a co-authored white paper from Emirates NBD Asset Management (Dubai) and Jupiter Asset Management (London). The paper, titled “Emerging Market Equities: Index Upgrades and the Middle East”, provides an analytical overview of the regional equity market in 2018, focus markets and sectors for asset allocation, and what an MSCI upgrade really means for Saudi Arabia.
The picture for emerging economies globally is now more robust, as EM equities continue to benefit from long-term tailwinds, such as demographics and rising penetration of products. These positives, against a backdrop of continued earnings growth, make a strong case for investing in emerging and frontier market equities. In the MENA region, Saudi Arabia and Egypt currently demonstrate the most significant upside potential.
Ross Teverson, Head of Strategy – Emerging Markets at Jupiter Asset Management, said:
“EMs had a strong run in 2017, and this outlook remains positive. This year, only 1% of the MSCI Emerging Markets Index by country weighting have a fiscal deficit likely to be over 3% of GDP. Additionally, countries are now less reliant on US dollar-denominated debt. Looking at EMs from the bottom-up, there are plenty of stocks that offer compelling long-term return potential, especially within travel and tourism, financials, and technology.”
The joint white paper, which highlights data over a 30-year period, suggests that if investors purchase EM stocks in the current Price-to-Book (P/B) range of 1.6x to 1.8x, this has typically resulted in approximately a 50% upside over the subsequent five years. The paper further argues that while EM indices are skewed towards large-cap companies and have high concentrations in certain countries and sectors, the opportunity for investors lies in building a portfolio that covers small- and mid-caps.
In 2018, anticipation of the now-confirmed MSCI upgrade for Saudi Arabia has driven the Tadawul All Shares Index (TASI) up 15% YTD, in stark contrast to the MSCI EM Index itself, which is down 2% for the year. At a weighting of approximately 2.6% and with 32 securities selected, the importance of the upgrade as a catalyst for the Saudi capital market cannot be ignored.
Salman Bajwa, Senior Executive Officer at Emirates NBD Asset Management, commented:
“With a raft of socio-economic changes taking place in the Kingdom of Saudi Arabia – from women driving to the opening of the first cinemas – we are seeing huge opportunity for EM investors in 2018-19. While the country has been able to plug forex leakage with issuance of US dollar-denominated debt, a great deal more can be achieved through its stock market, especially after inclusion on the FTSE Russell and MSCI EM indices. The Tadawul All Share Index is up by double digits year-to-date, and our own Saudi Arabia Equity Fund has exceeded 18% returns, as investors have become increasingly bullish on the Kingdom. Pre-upgrade, smart fund managers from the US, UK and Asia have already dipped into the Saudi market, with foreign inflows passing USD 3 billion by May 2018, which is equivalent to all inflows to the UAE and Qatar for the whole of 2014, when they were upgraded. We expect this momentum to continue as the year progresses.”
Teverson continued:
“A number of sectors in Saudi Arabia may seem attractive at first glance, but investors should be selective and avoid blindly following indices. Additionally, economic reforms such as the introduction of VAT and the removal of fuel subsidies may initially inhibit growth. However, top sector targets including healthcare, consumer and insurance are set to benefit from both structural reforms and the Kingdom’s initial EM index weightings.”
The white paper also emphasizes the stabilisation of the Egyptian economy, which is expected to experience a period of relief over the next 12-18 months, with a range of factors supporting growth in the medium- to long-term. After peaking at 33% in July 2017, inflation has started to normalise, decreasing from 13.1% in April 2018 to 11.4% in May (year-on-year). With a stable EGP supported by strengthening foreign reserves, other factors supporting Egypt’s economic growth will include improved performance of the local stock market and the country’s recent move to secure gas self-sufficiency. Meanwhile, lower interest rates will lend support to the local equities market, particularly in sectors such as real estate.
The outlook for Egyptian equities is positive, with the EGX30 index expected to trade back to its 2014 high, offering potential returns of 40-50% over the next two years. In addition, as the EGP strengthens, companies reliant on imports are set to benefit from improved earnings.
Bajwa continued:
“Looking ahead, we think Egyptian banks will continue to do well, taking excess liquidity by loading up treasuries generating substantial net interest margins (NIMs). The consumer sector is also set to benefit from falling interest rates and rising wages, and real estate companies will take advantage of falling interest rates, improving affordability. Meanwhile, industrial companies will attract increased FDI as the next phase of growth, which will see exports kick into full gear. However, investing in Egyptian stocks is not without risk, as rising oil prices are likely to create upside pressure on inflation. A further sharp devaluation of the EGP will negatively impact USD-based returns, while escalated geopolitical risk may hamper investor sentiment.”
The white paper’s conclusion is that MENA, among other global Emerging Markets, offers considerable opportunity for 2018-19, and none of the region’s markets show greater potential than Saudi Arabia and Egypt. Egypt is on an increasingly strong footing, while Saudi Arabia, a market that is already both substantial, and highly liquid, is now set to deliver on the anticipation of global investors ahead of its upgrade. With continued earnings growth, increased political stability, and the rising penetration of consumer products, equities across cap sizes are likely to offer attractive long-term returns.
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