DUBAI: Rattled first by political instability in the region and then by Europe’s debt crisis, investors in the Middle East will remain on edge in the coming months, seeking out sparse opportunities obscured by numerous risks.
Since the Arab Spring — a series of revolts against authoritarian regimes stretching from Tunisia in north Africa to Bahrain in the Gulf — started sweeping across the region, investors have taken flight.
A sharp equities sell-off was followed by stabilization after investors realized that regional heavyweight Saudi Arabia had bought stability with a set of populist measures.
But the seemingly interminable sovereign debt crisis in Europe and a worsening global economic outlook have replaced armed revolt as the top worry on investors’ minds.
To this backdrop, speakers at the four-day Reuters Middle East Investment summit, which begins on Monday, will provide a gauge of sentiment at a critical time.
"If the region were in isolation, investors would be buyers of MENA right now. If you were to take sovereign balance sheets, you’d be a buyer. And on currencies since most of the GCC (Gulf Cooperation Council) is linked to the dollar, you’d be a buyer," said Daniel Broby, chief investment officer at Silk Invest.
"But global markets are ignoring that; people are looking at financial contagion from Europe, and are not going to make that call."
The evidence that investors are now looking past the Arab Spring is the correlation with global shares.
"People understand that the Arab Spring is something that will be with us for a while, whereas the euro zone crisis keeps lurching from one stage to the other," said Abdul Kadir Hussein, CEO of Mashreq Capital.
"The environment is risk-averse. We are looking at cash and fixed income asset allocation as opposed to being overweight equities."
Most stock markets across the region have fallen by 8 to 20 percent, roughly in line with a 14 percent fall in European stocks and a 20 percent fall in the MSCI World Frontier Market index.
Investors worry about Gulf financial institutions’ exposure to European debt and any tightening of liquidity.
Egypt — where markets were shut for seven weeks amid protests that culminated in the ousting of long-time leader Hosni Mubarak — is the worst performer with a fall of 40 percent.
The standout performer in the region is gas-rich Qatar — the world’s richest country per capita — where stocks are down just 3 percent.
The tiny nation, surprisingly chosen as host for the 2022 soccer World Cup, is expected to see an infrastructure boom and its aggressive sovereign wealth fund is often linked with European assets that may be on the block.
Regional vs. sectoral
With macro factors dominant, there is a shift in the way asset allocators view the region.
"Unlike in the past when one used to look at sectors, one looks at geographies in the short term," said Florence Eid, Chief Executive at research firm Arabia Monitor.
"Because of global factors and regional political change, one needs to think about which are the more stable countries and discount for global regional factors."
The region’s top markets, Egypt and Saudi Arabia, are key.
Any sign that the old discredited elite that enriched itself during Mubarak’s three-decade rule could return to dominate parliament may reignite mass protests, while a strong electoral showing by Islamists may worry Western investors.
Eid said she expected "headline news damage" but no rollback of economic reforms in the event of a strong showing by Islamists.
Egypt is hungering for the return of foreign investors because the government is paying sky-high interest rates to borrow from local banks to fill a budget inflated by the uprising in February.
"The military still makes the key decisions," said Capital Economics Middle East Economist Said Hirsh.
Analysts say it will take time for Israel to recover from the MSCI upgrade to developed market status last year — it went from 3 percent or so of the emerging markets index to less than 0.5 percent of the developed index. Higher corporate and other taxes are also making the environment tougher.
Top oil exporter Saudi Arabia is looking to diversify its economy away from oil. It is spending over $400 billion by 2013 on infrastructure projects, potentially a rich investment opportunity.
A few silver linings
Political risk consultancy Geopolicity said in a recent report that the countries most affected by the Arab Spring had incurred costs to gross domestic product and public finances of nearly $56 billion, with Syria the worst hit.
But a rising oil price has acted as a support — major producers such as the United Arab Emirates, Saudi Arabia and Kuwait saw their GDP grow. Oil rose from around $90 a barrel of Brent crude at the start of the year to just short of $130 in April before retreating to around $109 now.
Bank of America Merrill Lynch said in a note that it believed the region was better positioned to weather the global slowdown than in 2008.
"Progress on corporate deleveraging, more robust banking systems, higher but broadly still reasonable breakevens, a heavy infrastructure pipeline and sovereign wealth are likely to cushion the global downturn," it said.
Debt issuances by the stronger nations are also doing well.
"MENA bonds, both sovereign and corporate, are being seen as much more attractive than equity. Qatar and Abu Dhabi issues are extremely well subscribed," said Habib Achkar, managing director, Middle East and North Africa at Morgan Stanley.
Equities, for their part, are cheap, so an improvement in the macro situation could provide opportunities.
"Average price-to-earnings for UAE stocks in our fund is below 10 and Kuwait is the most expensive with averages between 11 and 13 times — those are not expensive unless there’s an earnings collapse, and we don’t see that happening," said Broby.
"Unlike other parts of the world, assets are not being impaired, but everything is getting thrown out with the bathwater." –Additional reporting by Tom Pfeiffer in Cairo, Steven Scheer in Jerusalem and Asma Alsharif in Riyadh.
