World-beating first quarter just too good to last

"Amazing" is how one chief economist describes the first part of the financial year for the region's indexes. However, analysts sound a cautious note, pointing out many of the recent gains have simply been clawing back lost ground.

Renewed global appetite for risk assets has helped send the DFM Index up 23 per cent since the start of the year.Jeff Topping / The National
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Dubai, Egypt and Saudi Arabia outperformed nearly all other financial markets in the world during the first quarter in a vigorous turnaround in investor confidence - but some analysts are warning that the surge now looks overdone and unsustainable.

Renewed global appetite for risk assets has helped to send the Dubai Financial Market (DFM) General Index up 21.8 per cent since the start of the year, paring losses it sustained during the Arab Spring. Saudi Arabia's Tadawul All-Share Index has gained 22 per cent, after it relaxed foreign listing rules in January, sending investor hopes soaring that the market is poised to open to a waiting flood of foreign direct investment.

In Egypt, the main EGX 30 Index - which reopened in March last year after closing for two months during the revolution that toppled Hosni Mubarak from the presidency - soared 38.5 per cent to be the quarter's second-best performer globally. It was outpaced only by a 67 per cent rise in Venezuelan shares.

All three indexes have left their closest benchmarks trailing. A more modest 12.6 per cent rise has taken place on the Dow Jones Mena (Middle East and North Africa) Index for the year to date. Similarly, the MSCI Emerging Markets Index is up 15.7 per cent.

"The only way to describe the first quarter will have to be amazing. What a comeback," says Steen Jakobsen, the chief economist at Saxo Bank. "Looking at the best-performing indices in the world, three of them are from the Middle East and North Africa."

The Abu Dhabi Securities Exchange (ADX), historically the more stable of the two UAE indexes, and which tends to lag behind the Dubai bourse, is up about 6.2 per cent since January.

"Rejuvenated retail participation in markets such as UAE, Egypt and Saudi Arabia has certainly been encouraging," says Bassel Khatoun, a portfolio manager at Franklin Templeton Investments.

However, some analysts are issuing strong notes of caution about the ability of the indexes to hold on to the gains, particularly in Dubai and post-revolution Egypt, which are regarded as lacking the stability of the Saudi financial market.

"We believe stock markets have overreacted and that the recent rally is unsustainable," says Khaled Akl, the head of research at Abu Dhabi Commercial Bank. "[While] we regard the performance of the Abu Dhabi market as more reasonable and less vulnerable to major corrections … we are more concerned regarding Dubai companies."

The Dubai construction company Arabtec, whose share price has jumped almost 90 per cent to Dh3.02 since the start of the year, reflects concerns that Dubai's gains are based on hope and speculation and are not underpinned by the fundamental soundness of the listed companies.

"The share price [is] unjustified by project wins," Mr Akl says.

UAE property companies were some of the biggest winners in the opening quarter. But Mr Jakobsen says he does not share the new-found optimism in the housing market. "The illusion of low interest rates has a tendency to create misplaced hopes for better markets," he says.

Volumes on the DFM, the Arab world's only listed bourse, nearly tripled at some stages during the quarter. Turnover for the period is expected to hit Dh17 billion (US$4.62bn), according to analysts at Al Masah Capital, the highest since the second quarter of 2010, when it was Dh22.5bn.

However, daily trading values on the DFM have recently fallen from about Dh500 million to between Dh200m and Dh400m.

"Trading volumes remain volatile," Mr Akl says. "While sometimes increasing rapidly, their recent decline suggests a potential slowdown going forward."

In Egypt, several leading secular political parties walked out of a panel drafting the country's next constitution at the end of last week amid a challenge to the committee's legitimacy, highlighting ongoing post-revolution structural uncertainty.

Deadly violence after a recent football game in Port Said also points to continued volatility in the country.

"The sporadic yet tragic outbursts of violence in Egypt serve as a stern reminder that the road to political stability will raise challenges and inevitable setbacks along the way," Mr Khatoun says. While gains on the Saudi Tadawul are generally accepted as being more solid than in other regional markets, good domestic performances by industrial and financial stocks have been boosted by government investment driven by near-record high oil prices, which analysts say could be due for a correction as global demand slows.

The price of Brent crude has increased 17.4 per cent so far this year, hitting US$126 a barrel at some points, as supply fears prompted speculative buying after political tensions with Iran led to a multilateral embargo against oil exports from the country.

Capital Economics is bearish on a continuation of this trend. "Given our view that demand from western economies will weaken, we don't expect a repeat of last year's 10 per cent rise in hydrocarbon production," says Said Hirsh, a Middle East economist at Capital Economics.

"Although pressures to increase production are currently mounting on Gulf Cooperation Council countries due to overheated energy markets, we still expect global demand to eventually slow this year," Mr Hirsh says. "In this case, Saudi and Kuwait will be most affected since there is a high correlation between their oil output and GDP growth."

A potential opening up of the Saudi market is also driving speculative gains there. Citigroup estimates foreign institutional investors could generate as much as $16bn in inflows into Saudi equities.

The Tadawul's inclusion on the MSCI Emerging Market Index could result in $3bn of inflows from passive investors tracking the broader index alone, according to Arindam Das, the regional head of HSBC Securities Services. However, there is no indication when either will take place, leaving question marks about potential rewards.

Huge positive returns this year can be partly explained by a dismal performance last year. Sovereign debt crises in Europe, rising unemployment in the United States, fears of a slowdown in China, and several revolutions in Arab states battered investor confidence, giving rise to the view that much of the first quarter's upside was catching up to previous losses.

The DFM declined by 17 per cent last year. The ADX closed the period down 11.7 per cent. The EGX 30 still has a total negative return of 28 per cent since the start of last year. In Saudi Arabia, the Tadawul lost 3 per cent. Qatar's index was the only regional bourse to gain last year, finishing the year 1.1 per cent higher.

This year, improving US economic data, indications from the US Federal Reserve that interest rates will remain near zero until late 2014, and signs that European sovereign debt pressures might be easing have prompted investors to reposition into riskier assets, particularly those that underperformed last year, says Mr Khatoun.

Graham Stock, the chief strategist at Insparo Asset Management, which focuses on frontier markets, says he expects Mena markets to be broadly supported in the near term, although this will depend on continued risk-seeking in core developed markets.

Mena markets will enjoy more stability by building strong local companies, analysts say. "The low point remains the region's inability to create and implement a reform programme which will decrease the dependence on oil and tourism," says Mr Jakobsen.

In sector terms, Mr Khatoun continues to see strong demand for businesses that address buoyant local markets as opposed to cyclical, export-driven investments with a high global correlation.

"We are encouraged by the positive signs of lending activity witnessed among banks operating in countries with a robust macro backdrop," he says. "Moreover, we continue to be tempted by consumer and retail plays wherein attractive demographics and retail spending trends underlie an exciting demand story."