It’s time to embrace Saudi equities

Regional tensions this year have compounded an already challenging Saudi economic outlook marked by spending re-prioritization, tighter liquidity conditions, and declining real estate values.

The International Monetary Fund has downgraded its growth projections for the Kingdom from an optimistic 3.4 percent to a more sobering 1.7 percent.

Yet it is crucial to distinguish between these cyclical pressures and the profound structural transformation that continues to reshape the Kingdom’s economic landscape.

The structural story rests on strong foundations of a young population, a reforming state, deepening capital markets and an expanding non-oil economy.

Conflating the two is a mistake, especially given the supportive backdrop and historical perspective.

Twenty years ago, the Saudi stock market reached its 20,635 all-time high before embarking on one of history’s most devastating bear markets.

The Tadawul All Share Index would eventually lose 80 percent of its value, joining the ranks of legendary market collapses alongside the 1929 Wall Street crash and Japan’s lost decades.

Throughout these years, the fundamental case for maintaining a cautious stance has remained intact. Today, however, the structural foundations that justified those doubts are finally shifting.

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Market	Peak	Drawdown	Trough	Recovery	Peak to Recovery
S&P500 Great Depression	1929	86%	1932	1954	25 Years
Nikkei 225 Asset Deflation	1989	82%	2009	2024	34 Years
Nasdaq Dotcom	2000	78%	2002	2015	15 Years
Great Arabian Bubble	2006	80%	2009	?	20 Years and counting

Source: Bloomberg/@tarekfad

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The Great Arabian Bubble of 2005/6 was never merely about inflated stock prices, although they were certainly extreme. The real problem lay deeper, in the fragility of the earnings base supporting those prices.

Corporate profits were artificially inflated by a combination of generous subsidies, monopoly pricing, protective barriers and an absence of meaningful competition.

The TASI’s aggregate net profit margin reached an absurd 30 percent while the MSCI World index operated at approximately 9 percent.

Dairy companies, for example, boasted 20 percent margins in an industry that was barely profitable elsewhere, sustained by subsidized feed, water, electricity and fuel, rather than just operational excellence.

This earnings mirage was compounded by financial engineering, with an estimated quarter of total profits derived from asset gains that created the illusion of high and sustainable profitability.

Companies functioned primarily as vehicles for recycling government spending to the private sector, adding little genuine value while maintaining high dividend payouts.

Maintaining a contrarian stance on the Saudi market for the past two decades has been vindicated but many of the reasons that justified this stance have been systematically addressed through painful but necessary reforms.

Vision 2030, ironically, delivered a crushing blow to the status quo by dismantling many of the distortions that had propped up artificial profitability.

Corporate profits today are more transparent, defensible and anchored in genuine business performance within a deregulated environment where companies must compete on merit rather than protected market positions.

Every riyal of profit is more credible than ever. This higher-quality earnings base, combined with lower prices has enabled Saudi stock valuations to converge with emerging market peers to create a more compelling investment proposition.

The index composition has undergone equally dramatic improvement.

Twenty years ago, the Saudi exchange consisted of fewer than 80 listed companies heavily concentrated in state-owned enterprises across utilities, telecoms, petrochemicals and financials.

Today’s market encompasses over 265 stocks spanning technology, healthcare, retail, entertainment, logistics and consumer goods, reflecting the Kingdom’s economic diversification goals.

New listings typically bring specialized companies with stronger fundamentals, fewer legacy issues and growth-oriented business models positioned to benefit from demographic trends and structural change.

Furthermore, the capital market ecosystem has evolved from a concentrated, pro-cyclical funding model dominated by banks, government and retail investors into a sophisticated, multi-channel system including institutional funds, private equity, venture capital, and alternative sources of opportunistic private capital.

Foreign capital is also providing crucial counter-cyclical stability, while new investment products like REITs offer investors convenience and liquidity previously unavailable.

These developments have not eliminated all the challenges. Oil still accounts for far too much of trade exports, foreign direct investment continues to fall short of ambitious targets, and corporate governance standards, while improved, remain below international best practices.

Management quality, particularly below the C-suite level, still constrains organizational performance, while market fragmentation persists across sectors that would benefit from consolidation.

However, these remaining issues no longer constitute the existential threats they once represented.

The trajectory is clear, and for the first time in decades, the structural headwinds that defined the structural bear market are giving way to tailwinds that could support a sustained upcycle.

The mathematical case for optimism is compelling. A moderate recovery to the TASI’s all-time high over the next few years would generate attractive double-digit annual returns, well above expected inflation and risk-free rates.

It’s rare to find a major market trading at such a discount to its historical peak with such clear catalysts for recovery.

The journey is incomplete, but for patient investors willing to look beyond historical scars, this economic transformation suggests the next decade may be considerably more rewarding than the previous two.

• Tarek Fadlallah is CEO of Nomura Asset Management Middle East. The views expressed in this article do not necessarily reflect the views of his employers or its affiliates.