FT Alphaville has featured a series of bearish articles on the Emirates of late (see related links for examples), so here’s a bullish counterpoint: Merrill Lynch believes the region is “a compelling trading buy for investors looking for laggards.”
Dubai is the best trade, and Saudi Arabia the best investment, according to Michael Hartnett, Merrill’s chief global equity strategist:
Hard to find much that has underperformed US banks in past 3 years. But Dubai has, thanks to its real estate and oil bust. It’s now cheap, unloved and the combo of oil>$60/b and improving credit spreads are powerful drivers, in our view. We believe the best investment case in the region remains Saudi Arabia.
Merrill’s case for the “tactical outperformance” of Gulf equities vs emerging markets as a whole runs thus:
Oil prices: Oil prices now exceed $60bbl, good news for the oil-producing Gulf. And our commodity strategists now see risks that the oil price rises to $75-80 in the next few months. As the front page chart shows the relative performance of the Gulf markets tends to lag movements in the oil price by three months. So the Gulf markets should outperform in coming months.
Russia: Russia has oil; the Gulf has oil. Russian equities are up 67% in 2009; Gulf equities are up 1% in 2009. Note the chart below. We would also note that EM small cap stocks, a group of stocks that like the Gulf are often deemed “risky and “illiquid” have started to significantly outperform EM large cap stocks in the past month. Gulf equities have room catch up with the rally in correlated assets such as Russian equities and small cap.
Valuation: MSCI GCC (ex Saudi) index trades at a 13% discount to the MSCI EM index on a 12 month trailing basis, and trades at a discount of 26% on a price to book basis. Gulf markets are cheaper than emerging markets.
Flows: The Gulf region has experienced significant outflows in recent months as chart 4 shows. But the chart also shows that this period of outflows has come to an end. Indeed, outflows in the past 4 weeks have been the smallest of the year. Positioning: Gulf markets are an out-of-benchmark investment for EM investors. We calculate that long only EM funds have a current allocation of 0.3% of AUM in the Middle East, well below the allocation of 0.8% last October when oil prices were about the same price as today.
As for Dubai specifically, Hartnett argues that Dubai is the cheapest market in all emerging markets, and that its financials – which comprise 65 per cent of the market – are oversold.
The case for Saudi Arabia, on the other hand, he distills as follows:
Cash: Vast oil reserves; world’s second-largest oil producer.
Size: Saudi Arabia accounts for nearly half of the GCC’s US$1tn of GDP and two-thirds of its 37 million population.
Diversified: More diversified than many believe: non-oil sector accounting for 70% of growth since 2003.
Underleveraged: Saudi Arabia has the region’s second-largest banking sector and a large deposit base in a very under-penetrated market.
Underleveraged: Public debt fell from >100% of GDP in the ’90s to 13.5% in 2008; Sovereign Wealth Fund SAMA holds US$456bn of assets.
The catalyst: opening of Saudi equity market to non-GCC investors and eventual inclusion in the MSCI Frontier or Emerging markets index. potential of Saudi Arabia see: GCC Strategy, 20 February 2009
With the following caveat:
As access improves we would expect further gains in the Saudi market, so long as oil prices remain reasonably strong
Related links:
Two tales of a city – and Dubai’s luxury car giveaway – FT Alphaville
Shakeout in Dubai – FT Alphaville
Atlantis, we have a problem – FT Alphaville
UAE bail out Dubai to the tune of $10bn – FT