AMMAN, 18 October 2004 — Stock prices throughout the region have been hitting record highs during the first three quarters of the year in line with the rise in oil prices and revenues. With their oil and gas earnings approaching $200 billion this year, the six GCC countries are likely to enjoy solid growth rates. The other Arab countries will also do well, benefiting from capital inflows, higher remittances and surge in regional tourism. These countries are expected to grow, on the average, by 5 percent this year. The IMF is forecasting average oil prices of $37 a barrel for 2005, about $8 higher than the average recorded in 2003, but well below the current price of over $50 a barrel. We also believe that oil prices have entered a higher range that is likely to prevail for the coming 18 months. With the strong correlation between oil prices and the region’s stock markets, it seems that the uptrend in share prices is likely to continue.
Concerns have recently been raised as to whether the surge in regional stock markets is sustainable and if corporate profits would keep up with the pace of the markets. Few even postulated that a speculative bubble is currently in the making in these markets and will sooner or later burst. We remain positive on the region because the same bullish factors that underpinned the excellent performance of the stock markets in the past 18 months or so are still in place. Both prices and production of oil have reached record highs and seem set to remain in the trading range of $35-$45 for the foreseeable future. The region is flush with liquidity, supported by higher government expenditures and more bank lending. Record cash flow levels are driving increased corporate activities.
Most listed companies across the regional market who have reported first half results showed an aggregate growth in profits in excess of 40 percent across sectors. The positive news on the corporate earnings side show that most Arab stock markets still have reasonable valuations, taking into consideration current prices and expected 2004 earnings. We believe that rising profitability and increased capital spending, both on the part of the government, as well as, the private sector should support additional stock market gains in the months ahead.
Low interest rate levels continue to be an important factor for regional investors despite the recent initiation of a tightening cycle in the US. Domestic rates which rose by 0.75 percent in the past few months, in line with the increase in US dollar rates, are expected to witness only modest hikes in the fourth quarter, possibly closing the year at 2 percent. Interest rates are likely to rise further next year but at a measured pace. The higher oil prices have slowed world economic growth and rather than fueling inflationary pressures, it may have moved it lower. Despite an uptick in commodities prices, the inflation outlook remains benign for most countries. Interest rates in the domestic Arab markets may rise for the next year by 1 percent to 2 percent, in line with dollar rates, but they will remain generally low and are unlikely to impact the high level of liquidity and strong corporate profitability in the region.
Corporate results for 2004 are forecast to be good reflecting the region’s strong economic growth conditions. Annualizing mid 2004 results suggests that listed companies in the banking, insurance, telecommunications, utilities, tourism, manufacturing and trade sectors should record sizeable increase in corporate profitability of up to 40 percent on a year ago level. 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, cables, pipes, ready mix concrete, furniture and other construction and housing related supplies and products. Shares of real estate and utility companies would also do well.
The surge in regional tourism should support higher earnings of transport, hotels and tourism companies especially in Egypt, Lebanon, Jordan, Dubai, Tunisia and Morocco. Banks in the region will benefit from the general decline in non-performing loans.
The increase in domestic interest rates, should also reflect positively on profitability of listed banks as most banks in the region have high component of low to zero cost deposits. Interest rates on deposits tend to be more sticky on the upside than higher margins on loans.
The top performer in the first nine months of the year was Egypt, with the index in local currency terms up an impressive 76 percent on top of the 152 percent recorded last year. UAE and Saudi Arabia followed with increases of 50 percent and 48.6 percent respectively. Qatar, Palestine, Lebanon and Oman came next posting gains of 41 percent, 38.7 percent, 34.7 percent and 28 percent respectively. Kuwait, Bahrain, Jordan, Morocco and Tunisia while lagging their regional peers, closed the period with good performances rising by 26 percent, 24 percent, 17.3 percent, 13.6 percent and 6.6 percent respectively.
Several Arab stock markets still have reasonable valuation taking current prices and projected 2004 earnings based on the first half results. For example, Oman has a projected PE of 9, Kuwait 12, Bahrain 12.5, Egypt 15, and Tunisia 13. 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 trailing PE ratios of several 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, or the German benchmark index of 20. Even with an average projected 2004 price earnings of 17 for the UAE, 19 for Jordan, 23 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 at 3 percent, PE of 18 to 20 would still be acceptable.
Our strategy is to stay fully invested in the region. Jordan’s stock market, led by the Arab Bank, should do well in the fourth quarter of the year and so would Oman, Kuwait, Bahrain 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 Egypt and Morocco and opportunistic on UAE, Qatar, Saudi Arabia, Lebanon and Palestine.
A slowdown in the region’s stock markets should not be ruled out during the month of Ramadan 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. 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.)