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The series of protest movements and uprisings that erupted across the Middle East in 2011 dubbed the “Arab Spring” have not yet resulted in the fundamental political and economic reforms that so many wished to see. Last year, pockets of strife and social unrest were still dominating the headlines in some countries in the region, proof that progress can be painful. Nonetheless, some savvy investors realized that there was another story beyond the headlines, and stock markets in the Middle East/North Africa (MENA) region generally performed well—several in fact among the world’s best. Two members of our Local Asset Management Team based in Dubai, Bassel Khatoun and Salah Shamma, co-heads of MENA Equity, share their perspective on why they think the prospects for the region—and its markets—appear attractive for long-term investors.
Bassel Khatoun, Co-Head, MENA Equity, Local Asset Management
Salah Shamma, Co-Head, MENA Equity, Local Asset Management
The past year has generally been a very fruitful one for MENA equities. The S&P Pan-Arab Composite Index recorded a healthy return of 21.74% (in US dollars),1 well ahead of the MSCI Emerging Markets Index (-4.98%).2 The MENA region was also home to the second best-performing market globally (behind Venezuela); the Dubai Financial Markets General Index rose a staggering 117.07% (in US dollars)3. Meanwhile, the ADX General Index, in neighboring Abu Dhabi, also rose from unsustainably depressed levels, increasing by 63.08%.4
Among the global macro-economic factors behind the region’s strong performance last year was the continued abundance of liquidity supplied by central banks, most notably the US Federal Reserve (Fed) through its quantitative easing program. Moreover, many central banks globally signaled that interest rates would remain low so long as inflation was subdued. In a low interest-rate environment, we think investors’ search for extra yield certainly encouraged them to look again at MENA countries where fundamentals appeared generally strong. In addition, from May 2013 onward, the peg between Gulf Co-operation Council (GCC) currencies and the US dollar helped ensure equities in the GCC avoided much of the currency volatility experienced by some other emerging-market economies during the third quarter, as talk of potential Fed “tapering” began to heat up. The GCC represents a political and economic cooperative unit of six countries in the MENA region: Saudi Arabia, the United Arab Emirates (UAE), Qatar, Oman, Bahrain and Kuwait. Only Kuwait does not maintain a US dollar peg, although it is pegged to a currency basket, albeit likely weighted heavily to the US dollar.
Economic growth throughout the MENA region has remained strong, thanks in part to continued efforts to diversify GCC economies away from dependency on hydrocarbons. The International Monetary Fund (IMF) forecasts oil-related growth in GCC countries to be only 0.4% in 2013 and 1.5% in 2014, but non-oil growth is forecast to be 5.0% in 2013, rising to 5.3% in 2014.5
Looking ahead, we believe that there is a strong investment case for MENA equities as the region continues to establish itself as a single, identifiable subset within the general emerging market universe. Thanks to the steep rise in oil prices over the past decade, the economies of the GCC have become among the richest and fastest growing in the world. Windfall budget surpluses have allowed oil-exporting governments to pay down debt and build up massive currency reserves. Consequently, their credit ratings have been converging with those of the strongest developed economies. A supportive oil price environment has also enabled pro-growth fiscal measures through record government budgets and accelerated bank lending. These factors set a positive tone for 2013, very different to conversations on austerity measures and deleveraging that echoed through much of the developed world.
Liquidity in the MENA markets also improved significantly in 2013. The region witnessed strong investor inflows to the region of around US$4 billion, while the same period saw net outflows of some US$19 billion in the emerging markets.6 Moreover, equity market turnover increased more than 75% in 2013 (ex-Saudi Arabia),7 as both local and foreign investors finally began to recognize some of the regional opportunities available.
Qatar and UAE in the Global Spotlight
A key milestone was also achieved with index provider MSCI’s decision to upgrade Qatar and UAE to emerging market status from frontier status in its equity indices, effective in May 2014. This move certainly bolstered the status of GCC equity markets and should attract additional portfolio flows from foreign institutional investors and passive or index-tracking investors.
Both countries seem to be gaining broader attention globally, on many fronts. The 168-nation International Expositions Bureau selected Dubai as the first Middle-Eastern locale ever to host the World Expo, in 2020. Two years later, Qatar will host the 2022 FIFA World Cup. The events will serve to focus ambitious spending plans that were already underway for the most part, which we believe could present potential opportunities for equity investors.
While there have been continued pockets of strife in some countries, a generally stabilizing political environment has contributed to MENA equity performance in 2013. The civil war in Syria appears to be largely contained right now, with the threat of imminent US military action quickly dispelled last year, reducing the risk of wider contagion across the region. Likewise, as 2013 ended, the tensions surrounding Iran’s nuclear program seemed to ease, thanks to top-level international negotiations. These factors were behind a reassessment in the equity risk premium associated with the region that also provided support for the equity markets.
A Strong Macroeconomic Story in a Challenging Global Context
We believe the Arab Spring and many of the uncertainties it brought are now mostly behind us, and in our view, MENA markets are finally on steadier ground to stage a long-awaited revival. The favorable 2013 performance of MENA equities supports our long-held view that the region offers one of the strongest macroeconomic stories in a challenging global context. It’s also a marked break from recent years of underperformance. The increased liquidity in the market and growing confidence in the political environment suggest local and international investors are becoming increasingly aware of the opportunities MENA equities can offer.
The broad range of market performances within the region also serves to highlight an important point. Despite the wide-ranging intra-regional economic, political and cultural ties, the MENA region still consists of 11 diverse countries at different stages of economic development, and with varying economic dynamics. That characteristic will continue to allow for interesting intra-regional diversification opportunities.
Investors should note that the MENA region may still harbor some potentially unfavorable and unforeseeable geopolitical risks. Despite that, we believe the region could continue to benefit from the ever-increasing liquidity of markets and the probability that interest rates here will remain low for some time to come. We believe the investment case for MENA equities is a convincing one, and many countries in the region appear to be on a positive long-term trajectory.
The potential for the region’s equity market is evident to us, when you consider that even in light of 2013’s gains, many MENA markets are still trading at historic discount levels, suggesting they continue to hold potential in an environment of sustained growth in corporate earnings.
Analysis further shows that MENA equities generally have low correlations to global indices. They show much lower correlation with developed-market equities (0.23 during last three years) than EM stocks show with developed-market equities (0.70 during last three years8). We therefore think MENA equities represent an interesting way for investors seeking to diversify their portfolios.9
Mr. Shamma”s and Mr. Khatoun”s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.
What Are the Risks?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Generally, those offering the potential for higher returns are accompanied by a higher degree of risk. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with their relatively small size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets.
1. Source: ©2014. FactSet Research Systems Inc. All Rights Reserved. The information contained herein: (1) is proprietary to FactSet Research Systems Inc. and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither FactSet Research Systems Inc. nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. Copyright © 2014, S&P Dow Jones Indices LLC. All rights reserved. Reproduction of the S&P Pan Arab Composite Index in any form is prohibited except with the prior written permission of S&P. S&P does not guarantee the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions, regardless of the cause or for the results obtained from the use of such information. S&P DISCLAIMS ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. In no event shall S&P be liable for any direct, indirect, special or consequential damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with subscriber’s or others’ use of the S&P Pan Arab Composite Index. Indexes are unmanaged and one cannot directly invest in an index. Past performance is no guarantee of future results.
2. Source: ©2014. FactSet Research Systems Inc. All Rights Reserved. The information contained herein: (1) is proprietary to FactSet Research Systems Inc. and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither FactSet Research Systems Inc. nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. © 2014 Morgan Stanley Capital Index (MSCI). MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI. Indexes are unmanaged, and one cannot directly invest in an index. Past performance is no guarantee of future results. Price returns on 1-year annualised basis, for the period ended December 31, 2013.
3. Source: ©2014. FactSet Research Systems Inc. All Rights Reserved.Indexes are unmanaged and one cannot directly invest in an index. Past performance is no guarantee of future results. Price returns on 1-year annualised basis, for the period ended December 31, 2013.
4. Source: ©2014. FactSet Research Systems Inc. All Rights Reserved. Indexes are unmanaged and one cannot directly invest in an index. Past performance is no guarantee of future results. Returns on 1-year annualised basis, for the period ended December 31, 2013.
5. Source: IMF World Economic Outlook, October 2013. Copyright © 2013 International Monetary Fund. All Rights Reserved.
6. Source: Deutsche Bank Research.
7. Source: Ibid.
8. Source: ©2014. FactSet Research Systems Inc. All Rights Reserved. Three-year period ending December 31, 2013.
9. Diversification does not guarantee profit nor protect against loss.