AMMAN, 12 July 2004 — What are the prospects of Arab stock markets in the second half of the year? How optimistic can one reasonably be following the solid performance of these markets in 2003 and the first half of 2004? The fundamentals suggest that the outlook remains positive. The same bullish factors that underpinned the excellent performance of the region’s stock markets in the past year or so are still in place.
These include double digit growth in corporate earnings of listed companies for the first half of 2004 across markets and firm oil prices with an average price this year of Brent crude around $35 a barrel, its highest yearly average since the 1980s. Excess liquidity conditions are likely to prevail supported by higher government expenditures and more bank lending. All this in an environment of low interest rates even after taking into consideration the recent small rise in US dollar and domestic short term rates in line with US dollar rates.
Our region is growing this year at the impressive rate of more than 5 percent, generating a “pull factor” for increasingly more Arab funds to be invested locally, while the lackluster performance of stock markets in the US and Europe and the rising restrictions on investments and travel to the West are acting as a “ push factor” encouraging more funds to be repatriated from abroad. It has become clearer recently that the pool of wealth that is floating amongst the region’s stock markets has grown substantially. It is coming mainly from Saudi Arabia and Kuwait and its destination is primarily the UAE and Oman and have started to target markets in Jordan and Egypt to take advantage of the lower valuation currently prevalent in these markets.
The top performer in the first six months of the year was Qatar, with the index for the Doha stock market up an impressive 33.7 percent on top of the 70 percent recorded last year. Lebanon followed with a rise of 30 percent, reversing the slight decline of 2003. Saudi Arabia and Oman were the next best performing stock markets in the region posting gains of 28.7 percent and 26.8 percent respectively.
The UAE market also attracted considerable buying interest during the first half of the year and closed up 26 percent. Egypt ended the first six months of the year up 19 percent, followed by Morocco up 14 percent, and Kuwait up 13.9 percent. Only Palestine ended the first six months of the year in negative territories, down 3.5 percent. Jordan, Bahrain and Tunisia lagged behind their regional peers, closing the period up 6.9 percent, 5.8 percent, and 5.9 percent respectively.
Going forward we believe the best opportunities in the second half of the year lie in the stock market of Oman, UAE, Bahrain, Morocco and Tunisia due to the relatively attractive valuations of these markets compared to other regional exchanges. We are also positive on the stock markets of Jordan and Egypt and opportunistic on Kuwait, Qatar, Saudi Arabia, Lebanon and Palestine.
Corporate results for the first half of the year are expected to be good, reflecting the region’s strong economic growth conditions across sectors. Early indications suggest that listed companies operating in the banking, insurance, telecommunications, utilities, manufacturing, and trade sectors should see double digit growth in their mid year earnings compared to those of a year ago. This is especially the case because activities in the first four months of 2003 suffered because of the war on Iraq. There is a boom in the real estate and construction sector activities across countries of the region.
This should reflect positively on the earnings of listed companies producing steel, cement, ready mix concrete, cables, pipes, furniture and other construction and housing related supplies and products. Shares of real estate companies will also do well. The surge in regional tourism should support higher earnings of transport, hotels and tourism companies especially in Jordan, Egypt, Dubai, Tunisia and Morocco.
Domestic interest rates which rose by 0.25 percent in line with the increase in US dollar rates are likely to witness only modest hikes during the second half of the year. From the perspective of the Federal Reserve of the US, every reason to be more aggressive about raising rates seems to be balanced out by an equally compelling reason to go slow. For one, the US central bank does not want to disrupt the financial markets, as had happened in similar periods in the past.
In 1994-95, the Federal Reserve doubled short-term rates to 6 percent in a year leading several hedge funds to go bankrupt. More recently, in 1999-2000, the Fed boosted interest rates by 1.75 percent over ten months, only to slash rates the following year as the economy went into recession.
While it is very difficult to predict movement in interest rates, it looks like dollar and domestic interest rates will be raised at measured pace. Even if short-term rates double ending the year at 2 percent, they would remain at historically low levels.
Most Arab stock markets have reasonable valuation taking current prices and expected 2004 earnings. Whether measured by price earning multiple (PE), price/book value, or dividend yield, Arab equities remain in general attractive compared with both developed and other emerging markets. With the surge in share prices recorded so far this year, the average PE ratios in the various Arab stock markets have risen to levels considered to be historically quite high. Nevertheless, they are still lower than the more volatile US stock market index the S&P 500 of 22, UK, or the German benchmark indices of 18 and 20 respectively. Even with an average PE ratio of 13 for Bahrain, 14 for Oman, 15 for Kuwait, 16 for Egypt, 18 for Jordan, 19 for the UAE, 21 for Qatar, and 22 for the Saudi stock market, these ratios are not considered to be exceptionally high given current interest rate levels. A company with a PE of 20 has an earning yield of 1/20 or 5 percent. When interest rates were at 7 percent — 8 percent, a PE of 20 would clearly be high. But with deposit rates below 3 percent, PE of 18 to 20 would still be acceptable. Furthermore, these are trailing PE ratios, i.e they measure current share prices to last year’s earnings. If we take prices to expected earnings 2004, then the multiples would become much more compelling.
Our strategy is to stay fully invested in the region but allocating more funds to Oman, Bahrain, UAE, Jordan, Tunisia and Morocco, Jordan’s stock market should do better in the second half of the year compared to the first half. A slowdown in the region’s stock markets should not be ruled out in the summer but a major correction is not expected. Many investors are becoming jittery as valuations have crept up toward historical highs in certain markets compounded with uncertainty regarding the security situation in Iraq, Saudi Arabia and Palestine. Some market participants would exit, but the unfolding strong fundamentals and corporate results would keep the uptrend intact. (Henry T. Azzam is chief executive officer at Jordinvest.)