|Bedrock economy strong despite Arab markets' slide|
|While Arab stock markets have been correcting downward bringing valuations to more realistic levels, the economies of the region have been enjoying a period of growth and prosperity unprecedented in their recent history.
Usually surging stock markets are leading indicators of firm economic growth conditions, while strong economic performance and higher corporate earnings are the basic fundamentals for higher share prices.
Nevertheless, there are times when share prices correct downward, especially following periods of excessive valuations, while at the same time economic growth remains firm.
For example, when the NASDAQ index of technology stocks in the U.S. dropped by 78 percent during the period from March 2000 till June 2002, the US economy was enjoying strong economic growth. China's economy kept growing at the rate of 8 percent to 10 percent annually during the period 2001-2005 while its stock market was adjusting downward. From 1994 till June 2001, the Chinese stock market index rose by 700 percent and valuation soared with price-to-earnings ratios reaching an average of 60 before the correction took hold. An extended period of sideways trading with a downward bias followed, bringing valuation to more reasonable levels.
The Middle East today is the world's fastest growing region. Double digit nominal GDP growth rates are here to stay. In real terms, GDP growth in the region is expected to exceed 6 percent in the foreseeable future. Oil prices are unlikely to drop below $60 a barrel, with a $50-$80 a barrel trading range over the coming 5 years. By 2010, GCC countries will be producing 20 million barrels per day (bpd) up from 16 million bpd in 2005, an increase of 25 percent. As the region's oil revenues continue to rise from $350 billion in 2005 to around $450 billion by 2010, the Gulf governments will be more confident to spend increasingly higher percentage of their oil revenues. Annual budgets are likely to grow by 20 percent to 30 percent annually, with emphasis on raising oil production and refining capacity, upgrading infrastructure (roads, water, electricity, transport, airports, sewage systems etc.), and boosting expenditure on operations and maintenance, health, education and training. Because of the availability of cheap gas and other hydrocarbon resources, most bulk petrochemicals, fertilizers and basic metals will be produced in the region, encouraging the private sector to establish various downstream industries associated with these commodities. Other private sector activities that would do well include banking, contracting telecommunications, media, real estate and light industries.
The non-oil Arab countries will undoubtedly benefit from the economic boom in the Gulf both directly - from higher remittances, more regional tourism, greater exports to the Gulf countries and larger capital inflows - and indirectly, by emulating the development path followed by Dubai. That city, which is running out of oil, is transforming itself into a global center for transport, finance, trade, tourism, aviation, media and entertainment. It is planning to quadruple its economy and triple its population by 2020. Dubai is seen as a success story able to offer invaluable lessons to other non-oil Arab countries.
The decline in the region's stock markets from their respective peaks attained either in the fourth quarter of 2005 or in the first quarter of 2006 varied from one country to another. The drop averaged 53 percent in Dubai, 42 percent in Saudi Arabia, 34 percent in Qatar, 30 percent in Jordan, 23 percent in Egypt, 20 percent in Lebanon and 18 percent in Kuwait. This signaled an end to the "easy money era" and brought valuations of listed companies to more realistic levels. Price-to-earnings ratios dropped from the highs of 45 for Saudi Arabia and 25 to 35 for most other Arab stock markets to 25 currently for Saudi Arabia and less than 20 for the remaining stock markets of the region. However, other valuation benchmarks that caused the initial alarm, such as market-capitalization-to-GDP and price-to-book values, have not yet fully adjusted to acceptable levels. While the average market-capitalization-to-GDP for emerging markets does not exceed 75 percent, it is still above 200 percent for most Arab stock markets. Price-to-book value remain high for Saudi Arabia (7), Qatar ( 3.6), Egypt (4.5), U.A.E. (3.5), Jordan (3.1) and Kuwait (3), compared to an average of two for the other emerging markets.
The euphoria and enthusiasm that were so visible in the region's stock markets have now subsided and the public appears to have lost the "blind confidence" seen in 2003-2005. The scale and nature of the declines convinced market participants that the party is over and an early return to the highs attained last year has become highly unlikely.
Governments who tried to intervene in their respective stock markets to support prices, either implicitly or explicitly, realized that they have succeeded only in delaying the inevitable. The intervention failed to boost investors' confidence and was perceived as a sign that governments are worried that conditions could deteriorate further. We all know that markets will stabilize only when prices reach a level where willing buyers and willing sellers are ready to transact.
Markets that overshoot on the upside due to excessive leveraging have a tendency to overshoot on the downside as involuntary margin liquidation triggers more selling. Invariably, markets will eventually find their equilibrium level. Are we there? No one knows, but we are definitely heading in that direction. Sooner or later pragmatic investors compelled by the laws of economics and fair value analysis will take the lead and start buying. Speculators will follow and markets will eventually stabilize. To expedite the process, regulatory authorities need to put in place urgent reforms aimed at rooting out structural constraints, increasing transparency and addressing some of the imbalances that contributed in the first place to the formation of the bubble and later towards the bursting of this bubble.
The ultimate support for the region's stock markets will be the strong economic performance currently visible in the various Arab countries. Rising oil revenues, translating into expansionary fiscal policy will boost demand for private sector activities leading to higher earnings growth. Earnings of listed companies are expected to start accelerating in the fourth quarter this year. Last year aggregate profits for the Shuaa Capital Arab composite index rose around 49 percent compared to the year before. However, half-yearly profits have slowed considerably from 65 percent in the first half of 2005 to 35 percent in the second half, and not more than an estimated 20 percent in first quarter 2006. The deceleration in corporate earning may continue well into the third quarter this year before they start accelerating in the fourth quarter or in early 2007.
The strong economic growth conditions in the region and the sizable correction recorded so far suggest that the current down cycle might be shorter than many expect. Fundamental analysis will eventually over take market dynamics and bring an end to the correction phase. By year end, Arab stock markets could well find an equilibrium point from which to consolidate and rebuild.
Beirut,05 15 2006
Henri T. Azzam
The Daily Star