We remain positive on the region’s stock markets this year, and expect strong corporate earnings for 2003 to help support higher market prices. But the easy money is behind us, and investors should become more selective, choosing those markets that do not exhibit signs of overvaluation and those stocks that have strong profit growth prospects. An average increase in prices of 10 percent to 20 percent this year is still possible but a repeat of last year’s stellar performance is highly unlikely. Because markets have rallied so strongly, some have become overvalued, and a correction in those markets should be expected. Investors need therefore, to keep their eyes on the exit, choosing large liquid stocks that would be easier to sell if a correction actually materializes.
We have upgraded our expectations for earnings growth in most Arab stock markets, with net profits of listed companies to rise on the average by 35 percent in Qatar, 30 percent in Saudi Arabia and Kuwait, 25 percent in Jordan and Egypt, and by up to 20 percent in the region’s other stock markets. It is more important however, to analyze the quality of these earnings. There are companies, especially in the banking and finance sectors, who made more money out of investing in their respective stock markets than out of its core businesses. By stripping out the profits attributable to the market rally, annualized profits of several listed companies especially in the financial sector would have increased by much less than the reported figures.
Liquidity, interest rate and growth in corporate earnings of listed companies will shape this year’s outlook of the region’s stock markets. Firm oil prices are expected to prevail, although annual averages could be slightly lower than those of 2003. This will translate into higher government expenditures and strong growth liquidity. Domestic interest rates will remain close to their current low levels well into the second half of the year, in line with US dollar rates. It seems that the Federal Reserve will allow the recovery in the US economy to proceed for a while without raising interest rates. The future markets are pricing in a rate rise of only 0.25 percent by September. If the Fed does not act by them, it may end up putting off an increase in rates till after the November 2004 elections. Low interest rates would make borrowing relatively inexpensive, allow corporates and consumers to refinance their existing debt and encourage more margin trading in the region’s stock markets. Repatriation of funds from abroad and less capital outflows from the region will also boost domestic levels of liquidity, the bulk of which may well be directed to the local stock markets.
The good performance of listed companies last year is starting to show up in higher amounts of dividends distributed. For example, the combined net profits of the 69 listed companies on the Saudi stock market is expected to rise by over 30 percent to around SR26 billion ($6.9 billion) in 2003, against SR19.3 billion ($5.1 billion) in 2002. Based on an average market payout ratio of 70 percent, the dividend income to be distributed would exceed SR18 billion ($4.8 billion). The same applies to the region’s other stock markets. With an average dividend yield of 2 percent-4 percent, people will choose to invest in stocks rather than bank deposits where interest rates are at a low 1 percent-2 percent. Reinvested dividends will further boost liquidity in the region’s stock markets.
We are positive on the stock markets of Jordan, Saudi Arabia, UAE, Bahrain, Oman, Qatar, Tunisia and Morocco, bearish on Lebanon, and Palestine and opportunistic on Kuwait and Egypt. The Amman stock exchange ended 2003 up 53.7 percent, recording its best performance since 1981. Market turnover almost doubled last year to JD1.9 billion ($2.7 billion) with the heavily weighted banking sector advancing by 73.4 percent. The rise last year followed a drop in the market index of 1.56 percent in 2002, with an average rise for the past three years of 27 percent. We expect the Amman stock exchange to reach new highs this year, with 2003 profits reflecting better fundamentals. But with an average price to 2003 earnings (P/E) ratio rising above 20 and price to book value for certain shares exceeding 3, some share prices appear to be richly valued and may correct lower. However, for the market as a whole, the expected 2004 multiples present a more balanced picture. The projected earning growth of 20 percent will render current valuations more acceptable as average P/E drops below 18.
Even though the Saudi stock market rose by 76.1 percent in 2003, this followed three years of modest gains and market valuations remain acceptable at around 25 times price earnings ratio (P/E) of 2003 and 20 times the forward looking P/E ratio of 2004. With the exception of the electricity and agricultural sectors where there are significant overvaluations of shares listed, the banking, industrial, cement and telecom sectors still offer good value in terms of expected 2004 profits and market conditions. The existing ample liquidity in the market will get an additional boost from distributed dividends, expansionary fiscal policy, and rise of foreign investment. Saudi based expatriates will soon be allowed to buy Saudi stocks once the new capital market law becomes operational later this year.
UAE stock market rose 29 percent last year compared to 10 percent in 2002 and 28 percent in 2001. The market is expected to post moderate gains this year due to continued liquidity, stable oil prices and low interest rates. Given the ongoing construction boom in the country, we see construction, cement and financial institutions that are financing the expansion to outperform this year. The 28 percent and 42 percent increase in the stock markets of Bahrain and Oman last year, followed weak performances in the preceding three years. With average P/E ratios of 14 and 17 respectively, the two markets do not look expensive. High liquidity and healthy corporate results should support good performance this year as well.
Qatar’s stock market surged by 69 percent last year, following two consecutive years of strong growth. Doha is enjoying a construction boom, the oil and gas sectors are surging ahead, government finances are in great conditions and the economy is doubling every four years. Profits of listed companies are up 30 percent in the first three quarters of 2003 and are likely to exceed 35 percent for the year as a whole. While some stocks are trading at steep multiples, the macro economic picture remains conducive for another year of good stock market performance. Kuwaiti shares have become grossly overvalued with average P/E of 26 and average price to book of 3.6. With the exception of few prime listed companies, around 30 percent to 40 percent of last year’s earnings were generated from gains on investments in the Kuwait stock exchange. We would be quite selective in our choice of stocks this year, and concentrate on non-financial stocks with the exception of the National bank of Kuwait.
The stock markets of Morocco and Tunisia recorded gains of 49.8 percent and 18.9 percent in dollar terms respectively in 2003, following decline of 16.5 percent and 11.7 percent respectively in 2002. The recovery in these two markets is likely to continue this year supported by strong economic fundamentals and a rebound in corporate profits. Egypt was the second best performing Arab stock market in dollar terms last year rising by 88 percent.
The country’s booming stock market remains quite attractive but there are constraints in the exchange market that make it difficult for dollar based investors to repatriate their investments out of the Egyptian pound. Until concerns about availability of foreign exchange fade away, our exposure to Egypt would be limited. We remain bearish on Lebanon and Palestine this year as well.
(Henry T. Azzam is chief executive officer at Jordinvest)