Arab stock markets have had a relatively stable summer, despite the war in Lebanon, the recent 25 percent drop in oil prices and the threat of economic sanctions on Iran. Most markets have been trading side ways after experiencing major selloffs in late 2005 and early 2006. Egypt, Oman and Dubai enjoyed a late summer rally from the lows attained in mid-year. While the markets are still vulnerable to sudden declines, they appear to be establishing a base and a new trading range.
The down risks have become considerably lower from last year’s unsustainable levels, nevertheless, a return of bull market conditions should not be expected any time soon. Markets that over shoot on the upside have a tendency to experience a longer consolidation period. Under these unstable conditions only nimble investors and those who are able to successfully trade the market are likely to do well. This requires both luck to buy at the right time and the discipline to implement tight stop loss strategies.
The unraveling of stock market bubbles tends to be a complex and long process. For example, after reaching a peak of 1,527 on March 26, 2000, the S&P index of the US stock market dropped by 47.6 percent in the following two and the half years instigated by the burst of the technology stock bubble. The index reached a low of 800 on Oct. 6, 2002 and then traded sideways, staying below the 1,000 level till the end of 2003. The US stock market has moved gradually higher in the following three years although the S&P index is still 12 percent below its previous peak.
It took the UK stock market more than three years to reach a trough of 3,491 on March 3, 2003, down by around 50 percent from the highest level attained on 2 January 2000 of 6,930. Today the market has not yet regained its previous peak. The correction in the Shanghai A index of the Chinese stock market was swifter. It dropped 60 percent in 9 months from the peak attained in 2001 and stayed in a trading range in the following four years before starting a new uptrend.
The region’s stock markets have experienced a steeper and swifter decline from their respective peaks attained in November 2005 for Jordan, Dubai, and Kuwait and in February 2006 for Saudi Arabia. Amman stock market for Example, lost 40 percent in 8 months reaching a trough of 5,609 on July 17, 2006, from the 9,370 peak attained on Nov. 8, 2005. Since then it has been in a trading range of 5,600 to 6,500.
The index of the Dubai stock market lost 69 percent in 8 months, hitting a low of 393 on July 29, 2006, down from a peak of 1,274 attained on Nov. 9, 2005. It then assumed a trading range of 400 — 500. The Saudi stock market which reached a peak of 20,966 on Feb. 25, 2006 has been in a trading range of 10,000 to 13,000 over the past 5 months.
The huge drop in share prices over the past year did not leave regional markets cheap or grossly undervalued but brought them closer to the internationally acceptable levels.
While the MSCI index for the emerging markets is trading at a trailing price-earning ration of 12, the corresponding ratio for Saudi Arabia is still high at 24, Qatar 19, Jordan 17, and UAE 16. Trailing PE ratios for other Arab stock markets are lower. (Kuwait, Oman, Egypt and Bahrain all have PE ratios of 12-14).
The fact that Arab stock markets have not yet entered undervalued territories and given the usual post bubble uncertainties and the reduction of global risk appetite for emerging market assets, make it difficult at this stage to come up with a compelling case for the return of bull market conditions to the region’s equity markets. That said, there are few positive developments that should help dampen any remaining downside risks. Furthermore, easing regional tensions and a slowing global economy could bring Brent oil prices down to the $50 a barrel range next year.
Macroeconomic conditions in the region remain strong. Annual current account surpluses of $150 billion ($450 billion for 2005-2007) for the six Gulf countries are larger than those of Japan ($437 billion), and not much lower than China’s surpluses of $520 billion projected for the same period. Gulf petrodollars are an important source of liquidity for global and regional markets. Their sheer size have been very supportive of regional real estate, private equity and stock markets. With domestic interest rates pegged to the US dollar rates peaking for the current cycle, and given the ongoing significant investment boom in major sectors (e.g. energy, basic material, construction, tourism, logistics, finance, consumer services and real estate), the economic activities of the region’s private sectors will remain firm, growing at rates ranging between 5 percent and 10 percent. Contrary to what had happened in Southeast Asia following the burst of the stock market bubble there, the financial crisis did not unfold into a banking crisis. Banks in the region continue to be as solid and prosperous as ever.
Against this background of sound macro-economic fundamentals and lingering post bubble uncertainties, the dilemma becomes: “What to do next in these markets?” Buying Emaar or EFG Hermes after a 25 percent —35 percent rally from their respective lows is a difficult call. Waiting on the side lines for a further consolidation and “parking” one’s money in bank deposits giving annual returns of 5 percent — 6 percent is one option but it will accentuate the underperformance of invested funds. Taking profits now and waiting for the market correction to complete its course might deprive investors from potential profits. No matter what one does caution is advised. As we have seen elsewhere in the world, the unraveling of stock market bubbles could prove to be a tortuous process.
The way forward is to pick those equity markets with relatively low price earning ratios and un-inflated price to book value. Using annualized first half results and estimates for stock market averages, Saudi Arabia, Morocco and Qatar remain on the expensive side compared to emerging markets averages. Egypt, Oman, Kuwait and Bahrain are properly valued. UAE and Jordan are border cases while adverse political developments in Lebanon and Palestine render the stock markets there quite risky to invest in. For those who want to trade the regional markets, the focus should be on the largest and most liquid stocks in each market. This may not yield the best returns but would allow investors to exploit trading opportunities. Timing, patience, and selectivity will be crucial for performance in markets characterized by prolonged periods of side ways trading. Under such market conditions, implementing stop loss strategies is as important as taking profits.
(Henry T. Azzam is founder & CEO of Amwal Invest.)
