Economic Overview and Outlook
In light of the global financial crisis, several parties started to question the ability of MENA region economies to stay solid and continue on their growth trajectory. We strongly believe that the region enjoys a solid economic base with robust fundamentals; the IMF has recently issued revised estimates of various economic indicators for countries across the globe, most developed economies growth expectations were cut significantly estimating that many of them will face recession in the 4th quarter of this year and in 2009 while others will achieve growth rates marginally above zero; IMF aggregate GDP growth estimate for advanced economies was 0.1 percent according to its World Economic Outlook report published last month. In contrast, and even after the revision, GDP growth outlook is still strong in GCC and wider MENA for 2009 estimated at 6.6 percent and 5.9 percent respectively, this makes the region rank on the higher end of the range for other emerging markets reflecting its resilience to external crises even among emerging markets.
One of the distinguishing economic characteristics of the region is the increasing role of private consumption in growing and stimulating economic activity, this is strongly supported by the expectation for GDP per capita to grow at 5 percent for 2008 (compared to 3 percent in early 2000s) reflecting the rise and deepening of the middle class driving private consumption in MENA region, and as inflation is expected to ease (in GCC to decrease from 11.5 percent in 2008 to 10 percent in 2009 and from 14.4 percent to 12.7 percent in MENA) in the 4th quarter and throughout 2009, this shall re-stimulate consumer spending after it witnessed a temporary slowdown this year, and shall also mitigate the effects of decreasing exports of commodity-based products.
MENA region broad money supply is still expected to show healthy growth reaching 21.6 percent in 2009 which will insure the availability of adequate liquidity for financing infrastructure projects and expansion plans. We believe that the financial system in MENA countries is much more solid than that of other developed and emerging countries due to its minimal exposure to international markets and toxic assets, and most notably its focus on core banking activities while applying prudent credit standards, this is clearly evident by its low non-performing loans percentage (mainly in GCC) compared to other world markets. In addition, GCC aggregate current account surpluses are estimated to reach $368bn in 2008 and $312bn by 2009 which also insures that adequate liquidity is available and the effect on government spending will be minimal.
Although oil prices experienced a sharp decline from their earlier highs this year, they are still reasonably higher than budgeted levels; actually, 2008-2009 fiscal year average budget oil price for GCC countries is $47 a barrel, and if we take a longer term view, Middle East captures a share exceeding 60 percent of world oil proven reserves amounting to 742 billion barrels; these reserves, if valued at $50 a barrel, implies that over $37 trillion future cash flows are still available to be gained by the region's economies in the future; those cash flows are actually equivalent to around 88 percent of world market capitalization as at the end of September 2008.
Foreign currency reserves currently stand at their historical highs in most of MENA countries even outside GCC as in Jordan, Egypt and Morocco which further strengthen their economic situation and make them better able to weather the current crisis.
Furthermore, the economic structure of the region's countries (mainly GCC) witnessed dramatic changes; the windfall oil revenues resulting from the oil price boom in the past four years have been used more wisely by oil exporting countries in the region compared to previous booms.
All of the above have also been reflected recently in a wave of sovereign and corporate rating upgrades in most GCC countries, highlighting the strong economic prospects, and solid fiscal and monetary positions. In conclusion, we believe that the economic prospects of the region will remain intact and the effect of the world financial crisis will be limited and contained.
Impact on MENA
MENA markets have outperformed other emerging markets on a YTD basis, we believe this is attributed to the structural differences between MENA and other emerging markets; MENA is still less integrated with international markets than other emerging markets like China and India, which further explains why it is less susceptible to economic downturns of developed countries.
According to a recent study by the IMF, financial distress usually serves to lengthen the duration of cyclical downturns, making them deeper and longer than other slowdowns; the foreseeable impact of this phenomenon on MENA markets is the expectation that commodity-based products prices might stay at lower levels for a longer period, however, if we look at the bright side, it is highly probable that a reverse of the outward direction of portfolio flows (witnessed in the second half of 2008) will take place, channeling funds back to the region's markets as uncertainty starts to fade away and the full potential of the region's economies become more apparent to foreign investors particularly institutional ones.
On another note, the financial sector stocks in MENA weren't affected as severely as their counterparts in other advanced and emerging markets, which also goes in line with the sector's different environment and fundamentals as previously demonstrated; it also provides more comfort to know that the financials sector in MENA has a very solid capital base considered to be among the strongest in the world as measured by Basel capital adequacy ratios.
Institutional investment
MENA markets have been historically dominated by individual investors, which naturally led to high volatility and herd behavior; for instance, the recent market declines have been triggered by a wave of sell-offs by foreign investors in several markets like Dubai, Egypt and Qatar, and most domestic investors did follow the trend without proper consideration for the major differences between the economic situation in MENA and other advanced and emerging economies, nor for the value metrics showing that prices have reached unjustified levels.
In a market environment like the prevailing one, the importance of institutional investors appears clearly, as the need for better informed decision-making processes, market insight, proper diversification and professional attitude free from personal and behavioral biases is paramount; institutional investors usually play an important role in developing capital markets and maintaining their stability, in addition to the fact that they help to mitigate volatility as they follow prudent investment methodologies and processes leading to investing based on long-term asset allocations, where those allocations tend to be stable even in a market environment similar to the one currently prevailing. The current market situation, high volatility prevailing, and the several calls by financial experts and investors for intervention by governments, SWFs and other institutional investors just highlights the stabilization role they play and call for more incentives to encourage institutional investing; we believe that a set of incentives should be provided to encourage individuals to invest for the long term, this could be achieved through regulations that encourage investing in long-term saving schemes, pension plans and mutual funds offered by professional asset managers and insurance companies. In addition, governments and SWFs could help develop institutional investing by directing their investments through mutual funds rather than investing directly in the markets which would help grow and develop the industry.
Long-Term Investors
It is well documented in the behavioral finance literature that during extreme financial conditions either in bubbles or crises, market participants tend to lose sense of value, and large deviations from fair values of assets start to take place and possibly for longer periods than expected by conventional finance theories.
In financial crises, a different set of factors start to drive markets not usually existing during normal conditions; high levels of uncertainty, abnormally high risk aversion levels and liquidity pressures seem to dominate during such times, leading to collective downward pressures in stock prices of all stocks without any consideration to whether they are overvalued or undervalued, during such times, numerous opportunities emerge for the astute investor, and it becomes a fertile environment for M&A activity.
Moreover, the prevailing negative real interest rate environment calls for more emphasis on investment in asset classes providing long-term hedge (e.g. equities) against deterioration of purchasing power, as cash and money market instruments are earning much lower returns than inflation; for example Global GCC Large Cap Fund achieved an annualized return of 16.7 percent over the period from 2005-2007 outperforming its benchmark by 1.5 percent annually, and achieving an annual real return of 12.0 percent over the same period.
Generally, current valuations constitute an excellent opportunity for disciplined investors with medium to long term horizons, however, selling at current price levels would prove to be mistaken as the outlook is strongly leaning toward the upside, the current irrational behavior of investors comes to an end and more participation by foreign investors start to take place; the investor who has the right mix of investments in a properly diversified portfolio will be able to ride the wave up achieving positive returns on his/her capital.
We reiterate our expectation that foreign investors will strongly come back to the region's markets during the first half of 2009 boosting demand for equity investments as asset managers and other institutional investors will look to invest in solid economies (compared to their home markets) offering stability, room for growth and resilience to worldwide crises.
(Talal Samhouri is head of MENA Asset Management, Global Investment House, Jordan)