Investors plunge into emerging markets but avoid region because of uncertainty
Low oil prices and high stock valuations are expected to keep a lid on Arabian Gulf shares, which already are lagging behind a broad rally in emerging market shares.
The widely tracked MSCI Emerging Markets Index has risen from a seven-year low around 693 in January to close last week above 907, its highest level since July last year and a gain of 14 per cent since the start of the year.
Its Arabian Gulf constituents, Qatar and the UAE, have lagged behind that recovery, with year-to-date gains for the QE Index of 9 per cent, and for the Dubai and Abu Dhabi indexes of 12 and 5 per cent, respectively.
What’s holding the local bourses back?
The obvious factor is oil prices, which have drifted down by 20 per cent from their June highs as stuttering demand growth halted the strong rebound.
There is a broad consensus that oil prices will recover only slowly and uncertainly, leading to a sense among investors that shares prices in the region are expensive.
“We estimate GCC markets are trading at price-to-earnings ratios close to 12 times, based on 2016 numbers, with bigger markets including Saudi Arabia close to 13 times,” says Nishit Lakhotia, the head of research at Securities & Investment Company in Bahrain.
“This is not cheap considering that oil is struggling between US$40 and $50 a barrel levels and is unlikely to cross $60 in the coming two to three years,” he adds.
His is a common view among money managers. “I think the underperformance is justified,” said Jaap Meijer, the head of equity research at Arqaam Capital in Dubai. “The wheels are not coming off but there are still economic doubts and there is downside risk for the Gulf, so we continue to be underweight and very selective,” he adds.
The latest push behind emerging-market shares was a big wave of money last month from investors looking for better returns than those available in developed-country markets.
The latest data from the Institute of International Finance in Washington DC showed that about US$25 billion flowed into emerging-market securities last month, double June’s total and only the second time monthly inflows topped the long-term average.
Leading analysts are divided about the sustainability of the broad rally.
Caesar Maasry, the head of emerging-markets strategy at Goldman Sachs, sees a likelihood of a “meaningful pullback” in the second half.
Mohamad Al Hajj, a Dubai-based strategist at EFG Hermes, says “the key risk for a sustained emerging market rally is a Fed rate hike in September or December, in addition to a sharp correction in oil prices below $40 per barrel”.
He agrees that the regional market is one for selective stock picking rather than broad gains.
“Mena markets in emerging markets could be supported by individual stories that are uncorrelated to the global picture,” Mr Al Hajj says. “For example, Egypt could benefit from an IMF deal and a devaluation of the Egyptian pound,” while Dubai’s Expo 2020 will support infrastructure spending.
Efforts by regional governments to deal with lower oil prices, especially trimming spending by measures such as reducing government subsidies on transport and household fuel, are good longer term but may also be a factor in holding back companies’ performances in the short term.
“Subsidies removal is impacting both companies’ costs and leading to higher inflation and lower affordability for consumers,” says Mr Lakhotia. “And the increase in interbank rates because of liquidity tightening, especially in Saudi Arabia, will impact borrowing costs. In such an environment, the market lacks the necessary triggers to rally from here.”
There is also the government-driven reshaping of sectors, including energy and banking in the UAE. While that also should be good longer-term, it adds to the current uncertainty.
“There is ongoing consolidation across Abu Dhabi Inc and it will be very costly in terms of job-cutting,” says Sebastien Henin, the head of asset management at The National Investor. “So, investors are cautious and waiting for things to stabilise, as valuations are not cheap at all.”
Even some of the technical factors supporting shares argue for being selective in the regional markets until the oil price slump blows over.
amcauley@thenational.ae