A Port in the Storm: MENA Equities are a Safe Haven in a Tumultuous Year
Recent political instability in Ukraine has once again reminded investors of the risks of investing in emerging market economies. Russian equities have fallen sharply, and the central bank has had to aggressively raise rates. This had followed months of broader volatility in mainstream emerging markets in which currencies have weakened – particularly in the so-called ‘Fragile Five’ of Indonesia, Brazil, India, South Africa and Turkey. Sovereign and corporate balance sheets are under scrutiny amidst slowing emerging markets growth
In such an environment, many equity markets in the Middle East and North Africa region (MENA) represent a safe haven, despite their outperforming emerging markets over the past year. Countries in the Gulf Cooperation Council (GCC) have USD-pegged exchange rates backed by strong sovereign balance sheets. Stock markets in these countries are liquid and feature well-managed banks and companies with high dividend yields. Unsurprisingly, GCC markets have seen significant capital inflows during this period of EM turmoil, and in aggregate they now trade at premium to the benchmark MSCI Emerging Markets (EM) Index.
Two GCC countries – Qatar and the UAE – will be upgraded to the MSCI EM Index in June 2014, joining Egypt which has been a member since 2001. The two countries had previously been major members of the MSCI Frontiers Markets Index, but they will together account for around 1% of the emerging markets benchmark from the middle of this year.
Both countries are oil exporters with fixed exchange rates, and are less vulnerable than their regional and EM peers to sudden changes in global liquidity flows. They are not, however, your traditional emerging markets. Qatar and the UAE have small populations and are among the richest countries in the world in per capita terms, and so some traditional emerging market themes – rising incomes, credit penetration, and demographic trends – won’t find much traction.
However, the two countries are home to well-managed companies with a global reach, and their market cap to GDP ratios are low in the UAE and middling in Qatar, and should rise over time. We see six broad catalysts for stock market performance in both Qatar and the UAE:
MSCI EM status
IPOs and increases in foreign ownership limits
Event-driven spending, such as the Expo 2020
Development of the non-oil economy
Changes in IPO rules in the UAE
Pension and financial sector development
For those investing in it now, Qatar is already acting as a short-term safe haven from turmoil in emerging markets and uncertainty about global liquidity flows and US Fed policy. We see stronger medium-to-long term prospects in the UAE, which is in the middle of a strong cyclical upswing. The UAE has an increasingly diverse economy, and growth across the UAE will be driven by domestic catalysts including Dubai’s hosting of the Expo 2020.
Critically, the strong UAE recovery is driving positive earnings surprises that can continue to drive strong stock market returns. Dubai, like Egypt and Morocco, has few energy reserves, yet the Emirate’s investment recovery is likely to continue on the back of the upcoming Expo and its role as a regional entrepôt.
Outside of Qatar and the UAE, we think Egypt has room to grow after years of uncertainty, supported by both a diverse economy and the largest consumer market in the region. Corporate sentiment points to a better second half of 2014, buoyed by the recent passage of the new constitution and presidential and parliamentary elections scheduled for the first half of the year. Political stability remains a wild card, and any delay of action on subsidy reform will be a brake on growth.
Morocco has recently been downgraded by MSCI to frontier market status due to poor liquidity, but like Egypt this economy offers something closer to an emerging market story – a large, relatively poor population, with the potential for export-driven growth subject to a Eurozone recovery. Morocco’s government has been making significant fiscal reforms over the past year, cutting fuel subsidies and introducing a tax on agriculture – both should create room for private sector growth.
The Arab world’s largest economy, Saudi Arabia, is home to its largest and most diverse stock market. We see Saudi Arabia as falling between mainstream emerging markets and its GCC peers. It is rich, but not too rich, and its relatively large population means that some traditional EM themes – credit deepening, rising incomes - are still relevant. The stock market includes many well-developed private sector businesses as well as regional and global giants such Almarai, a food producer, and SABIC, a petrochemicals producer.
Despite the absence of clarity on when the market may directly open up to foreign portfolio investors, we see Saudi Arabia as one of the region’s best hunting grounds for EM growth stories for those able to invest there now. Banks are a good play on continuing credit growth and there is still value in the consumer and industrials sectors.
Earnings multiples for MENA stocks have expanded significantly over the past year. Falling discount rates contributed to strong performances and rising fair values in 2013, particularly in Dubai, but with US bond yields likely to rise again in 2014, risk-free rates in the GCC are close to bottoming out. We believe that company performance will be a critical factor in market performance this year - the UAE currently offers the best momentum in terms of earnings surprises. Egypt could see further falls in discount rates in 2014, and we could see positive earnings surprises should the economic recovery take root.
Management quality remains a critical factor in assessing the potential for sustainable earnings growth, and EFG Hermes continues to offer investors in MENA equities unequalled access to C-suite executives at major listed companies. We will hold our 10th Annual EFG Hermes One on One Conference- the largest MENA-focused investment conference - in Dubai on 9-12 March. The event is known as the best opportunity for equity investors, high-level executives, industry professionals and government officials to meet and discuss investment opportunities in the MENA region.