International equity investors are beginning to take notice.
The MENA region witnessed record inflows in January 2018: $1.1billion, mainly led by Saudi Arabia at $619 million, followed by Egypt at $219 million and the UAE at $185 million.
This is the second highest monthly inflow recorded since 2009, after an inflow of $1.25 billion received in May 2014.
In Saudi Arabia, Al-Rajhi Bank topped the rankings with foreign fund inflows of $284 million last month.
It is not easy to pinpoint what is driving the demand for MENA — and in particular Saudi — equities.
Certainly, a good chunk of this demand has come from the anticipation of the Tadawul’s inclusion in the MSCI EM index. Deutsche Bank’s base case remains an expectation of an additional $40 billion of inflows should this happen. We also believe that the constructive commentary and actions taken by the authorities — regulators, the CMA and Tadawul for example — is laudable and a positive step when it comes to the MSCI’s decision-making process.
The future direction of the market is however hard to predict. One must remember that current foreign ownership in the Tadawul remains very small on a relative basis. Today, foreign active ownership of local Saudi equities sits just under $7 billion — which is less than 2 percent of total market capitalization. How foreign money behaves over the coming weeks and months therefore will not be a barometer of full market performance.
There are two schools of thought currently prevailing in the markets when considering the future outlook for Saudi equities. On the one hand, one might look at the most recent equity inflows and suggest this is the beginning of something more sustainable when it comes to foreign institutional money interest. We are therefore likely to see more interest in the entire region with further inflows expected as we approach the MSCI decision in June and subsequent index inclusion a year later in 2019.
On the other hand, a more skeptical market commentator could point out that we have seen instances in the past where MENA equities have experienced a spike in foreign interest in anticipation of a major positive market catalyst being announced, only to see these flows reverse as disappointment sets in when the market realizes that this catalyst may not eventuate.
Saudi Arabia continues to make headlines in its drive to modernize its economy and implement the structural reforms needed to realize Vision 2030.
At Deutsche Bank, we buy the MSCI inclusion story. We see the probability of inclusion into the index in 2019 as being high. Our recent client meetings with authorities from the CMA and Tadawul in London at the end of 2017, then with SAGIA in Davos just a few weeks ago, have shown strong institutional and real-money interest in the Saudi story. As the authorities continue to focus on the broad-set social and economic reforms via the Vision 2030 National Transformation Plan, this only augers well for the future of the local bourse.
To balance this view, we remain mildly cautious on the economic outlook this year. Economies going through significant reform, be it via subsidy rebalancing, new taxation policy and other micro reforms, will undoubtedly feel the short-term stresses of these decisions. For the government these reforms are an immediate source of revenue but for those businesses and individuals in the real economy, it is without question a painful process.
In the long-term however, we firmly believe these decisions will lead to positive economic outcomes for Saudi Arabia.
In conclusion, we know in this region that equity flows, which often act independent of economic fundamentals, are a major driver of equity markets. While the underlying economics in 2018 will remain challenging, we think there is value in following the money when it comes to the possibility of MSCI inclusion.
Investors that fail to grasp this in the coming months may just miss that new metro train leaving the station.
- Aleksandar Stojanovski is an equity research analyst with Deutsche Bank