The year 2001 was a great one for investors in Amman stock market, where the index recorded its best performance in eight years rising by 30 percent. Russia’s stock market was up 53 percent in dollar terms, Qatar’s surged by 37 percent and Kuwait by 27 percent. However, most investors in Jordan and the region also have exposure to the US market, where stocks fell for the second year in a row, the first time we had two successive years of decline in the broad index since the mid-1970s. The 20 percent annual gains that were common place in the US stock market and later in the European stock markets during the 1990s, seem now to be ancient history.
Bonds outperformed stocks last year. According to Merrill Lynch bond indices, investment grade bonds including US Treasuries and other dollar denominated corporate bonds had an average return of 8.3 percent in 2001 (after being up 12.9 percent through Nov. 7). This has been the second year in a row that US bonds have outperformed stocks. Emerging market bonds, excluding Argentina, had total return (capital gain plus interest paid) of 19.8 percent in 2001. But Argentina’s bonds, on which the government has defaulted declined by 67 percent last year, bringing the overall performance of emerging market bonds to ñ0.8 percent.
Will 2002 make it three down years in a row for Wall Street? Will bonds outperform stocks this year as well? Will Amman stock market repeat its stellar performance of last year? And what is the outlook for the regional and international stock markets in 2002? Predicting the direction of financial markets is always tricky, and the track record of economists and analysts in this respect is disappointing. Economists have rarely succeeded in correctly forecasting the future, although, they have been more convincing when explaining why their predictions were wrong.
We will confine our analysis to directional movements rather than predicting specific levels of stock market indices one year down the road. The relevant message from history is that it is extremely rare for stocks to perform poorly for more than two years. The Standard & Poor’s 500 index declined 9 percent in 2000 and 12 percent in 2001, the NASDAQ fell 39 percent in 2000 and another 21 percent in 2001, while the Dow Jones Industrial Average fell 5 percent both years. Since 1941, the S&P has fallen in 14 years, and in 11 out of those cases, it rose in the subsequent year by an average of 24 percent. Besides last year, the other two exceptions where we had back to back yearly losses were in 1973-1974 and 1980-82. The 1973-74 featured a war in the Middle East, quadrupling of oil prices, the resignation of the US president and a US economy suffering from stagflation. Stocks lost 37 percent of their value in these two years, but were up by 70 percent in the next two years. The S&P declined for 18 months in 1980-82, but over the next two years the index made up for the losses and more.
In the past, recessions used to be deeper and recoveries would take longer to come through because the manufacturing sector accounted for more than 50 percent of the economy. When an economy slows and households and companies start to reduce their spending, they often cut back most on manufactured goods, because services are harder to do without. The implication is that the services sector does not shrink or grow as fast as the manufacturing sector and if the services sector accounts for a larger percentage of the economy, as it is the case with the US, the downturn is likely to be shorter. The short recession and weak recovery of the early 1990s has now become the reference point for the current recession and the likely economic rebound for 2002.
Two recoveries are under way right now in the US. One is the sharp bounce back from the Sept. 11 attacks, and the other is a more gradual rebound from the demand slowdown and inventory overhang that began a year ago. While uncertainty about the future has increased since Sept. 11, the basic logic of investing remains in place. It is during periods of economic slowdown that seasoned investors start buying again. During the last recession in the US that started in July 1990 and ended in March 1991, the S&P index declined by 15 percent from June to October 1990, then at the midpoint of the recession, stocks began to rise strongly. Between November 1990 and December 1991, the S&P index gained 43 percent. The US economy is expected to benefit from a sizable loosening of monetary and fiscal policy. Interest rates on the US dollar have been cut to their lowest levels since the early 60s. Meanwhile, the total fiscal stimulus, including tax cuts and spending increases could amount to 1.5 percent of GDP this year, the biggest annual fiscal boost since 1975.
The hope that recession in the US will be mild will undoubtedly bring around an upturn in stock prices. However, the recovery is unlikely to be as robust as many are hoping it will be. The S&P 500 is still considered overvalued with a price earning ratio of 25 compared to a historic average of 15. Besides, the declining quality of financial reporting could undermine investors’ confidence. If other companies besides Enron and Kmart file for bankruptcy or are suddenly denied access to credit, this will undermine the US stock market.
Bonds are unlikely to outperform stocks this year. If the recovery of the US and Europe proves to be moderate and given the absence of any worrying inflationary pressures, it would make it unlikely for the Fed to reverse its easing policy any time soon. In a low interest rate scenario, and with liquidity surging in the world economy, stocks are a better investment asset than bonds. Historically, share prices have moved in step with the rate of growth of excess money (growth in a money supply less nominal GDP growth). Those who want to have exposure to the bond market, will be seeking higher yielding securities including bonds issued by the emerging countries. Bonds issued by credit worthy sovereign Arab borrowers, such as Egypt, Qatar, Tunisia, Oman and Morocco will be in demand. Investors in these bonds could be rewarded this year with higher prices (capital gain), on top of the high interest coupon that these bonds pay. Existing Eurobonds issues from the Arab region (with the exception of Lebanon) are considered to be an asset class that merits an added exposure this year.
A combination of lower returns abroad, fears over asset freezing particularly in the US, and the sound investment rule of diversification should encourage the repatriation of some private offshore wealth to the domestic Arab stock and bond markets. The stock markets of Jordan, Kuwait, UAE, Qatar and Saudi Arabia have outperformed the international stock markets last year, recording annual gains of 30 percent, 27 percent, 26 percent, 37 percent, and 8 percent respectively. With the possible exception of Egypt and Lebanon, most Arab stock markets are expected to outperform this year as well. If only 1 percent of the estimated $1,300 billion of private Arab wealth held abroad is repatriated back home, it will greatly enhance the outlook and liquidity of the region’s stock markets whose total market capitalization did not exceed $170 billion in 2001.
(The author is chief executive officer of Jordinvest).
