There's something funny about this tale of two markets

The financial services, property and construction sectors making up a large part of stock markets' capitalisation. Ali Haider / EPA
The financial services, property and construction sectors making up a large part of stock markets' capitalisation. Ali Haider / EPA

Something funny is happening in the UAE. No, I don't mean the latest Laughter Factory event or the rising tribe of home-grown stand up comics.

Look at the correlation between debt and equity markets. From 2008 to last year, the Dubai Financial Market (DFM) and the Abu Dhabi Securities Exchange (ADX) fell and then languished with low trading and no initial public offerings.

Brokers went bust and many investors lost their garments. At the same time, the bond yields hit all-time highs, thanks to the property-driven financial crisis.

The bond yields have dropped a lot since 2010 but the equity markets are still flat.

Let's take Emaar, a major developer based in Dubai. The yields on Emaar debt have dipped over the past year. The coupon on the sukuk for last year was 8.5 per cent and the latest sukuk closed at about 6.5 per cent with an order book five times the issue size. The yield on the issue is now 5.7 per cent. Yet Emaar is trading at Dh3.30 per share, a small absolute change from the Dh2.95 it was trading in July last year. More importantly, the DFM is trading about 1,500, almost the same as a year ago. And the IPO market is almost dead.

Traditional finance theory says a drop in yield signals that investors see less risk in the market. That should translate to higher equity prices. So why the disconnect? I think it's a mix of factors.

The stock market in the UAE is mainly a retail business, with negligible institutional investment. Lots of people bought shares on very high leverage at stratospheric market prices. Now they are stuck with pieces of paper worth far less than they paid. They are selling off other assets to pay these bank loans. It's called deleveraging and it is excruciatingly slow and painful.

Even for the brave investor, the financing tap has been turned off. Most such financing was doled out by local banks that are still struggling with huge bad loans and investments. So even if the stock looks good, investors don't have the money.

The fact that corporate governance (including transparency) is not exactly a hallmark of many public companies in the UAE makes the markets even more nervous. Most investors have no clue about how badly indebted or badly run companies are, or how big the non-performing loans are on banks' books.

The UAE stock markets are also remarkably parochial with three sectors - financial services, property and construction - making up a large part of market cap and all badly hit by the crisis. The UAE markets do not reflect the composition of the economy. A major chunk of GDP comes from trade and tourism. How many companies in these sectors can you name on the DFM General Index or ADX General Index? In other words, nothing much should be read into stock prices.

So reduced risk appetite, low financing, sector domination and opaque financials pretty much explains the silent stock markets. The local debt market is another story. It is dominated by institutional investors, many of whom are sophisticated and/or based in United States and Europe.

A company typically depends a lot more on its bond holders than its secondary market stock investors. Add the fact that there are far fewer bond holders than shareholders and its easy to see why there is, to borrow from the renowned analyst Michael Porter, a lot of "buyer power" in the world of bonds. Plus bond holders have more rights.

The result? Companies are forced to be more open with bond holders. So when country or sector or company risk goes down, so do yields. In other words, while the bond market is smarter and is signalling lower risk, stock prices and the stock market remain dumb.

But this could also mean the overall UAE economic outlook is getting better. In the long term, the stock markets may not be a bad idea. At some point, market prices may hover near fair values. Just don't ask when. Third, in such a situation, bonds are worth looking at. As the US financier Andrew Mellon said: "Gentlemen prefer bonds."

Binod Shankar is a CFA charter holder and has spent 14 years in the region. He is the managing director of Genesis Institute, a financial training company in Dubai

Published: July 30, 2012 04:00 AM


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