A few comments from the LHV Persian Gulf Fund Manager on the middle east equity market falls in the past few weeks and some macro notes on where we go from here.
Turbulence creates opportunities. And yes, we are seeing some turbulence also on the Arabian peninsula as a combination of falling oil prices, tumbling global equities and ongoing ISIS clashes in northern Iraq.
However, all the economic indicators coming from the GCC countries remain very strong, current oil price is more than sufficient to finance all the planned GCC long-term investment projects (despite GCC countries continuing to ramp up their expenditures -> e.g. Qatar’s infrastructure project spend to be ready for football WC 2022 was around $10-$15 bln a year during 2010-2012, it was $23 bln in 2013 and is set to be around $30 bln in 2014) and still end up with a surplus budget and companies operating in the GCC that we are speaking to (Joel met with more than 15 management team’s in London last month) remain very optimistic about earnings growth potential and future business opportunities that all makes for a very strong case to buy the dip on this correction. One of Qatar’s most prestigious banks Qatar National Bank just reported their Q3’14 financial results and they grew their earnings by +21% yoy (vs analysts expectations of +7% gain).
During the last 3 years corrections in the GCC region have been short-lived and quite shallow (LHV Persian Gulf Fund’s unit value movements):
13.01.2011-03.03.2011 -> total -13,0% (Arab Spring)
11.05.2011-05.10.2011 -> total -10,0% (Beginning of the euro-zone crisis)
04.04.2012-28.06.2012 -> total -9,9% (Escalation of the euro-zone crisis and Iran oil sanctions)
13.06.2013-26.06.2013 -> total -4,9% (General sell-off in the emerging markets)
22.08.2013-09.09.2013 -> total -11,0% (Syria conflict)
02.06.2014-30.06.2014 -> total -8,5% (ISIS in northern Iraq)
18.09.2014- 31.10.2014 -> total -3.9%
Additionally, there are some short-term catalysts on the horizon. For example on November 6th MSCI has its semi-annual index review and it’s possible that after some reforms done in Qatar during summer to address foreign ownership limit issues and improving liquidity in the UAE both of these countries’ allocations in MSCI Emerging Markets Index might increase (effective as of November 25). Local brokerage and research house EFG Hermes estimates that we might even see $1 bln (!) flowing into UAE and Qatar after this index reclassification as UAE’s part in the MSCI EM index might rise from 0.6% to 0.8% and Qatar from 0.6% to 0.9%. Also, Saudi Arabia’s stock market is set to open in H1’15 and this is already almost around the corner and will lure in lot of new investors into the region. Very interesting times for the GCC markets indeed.
Strategic asset allocation analysis
Global Emerging Market (GEM) funds continue to be underweight UAE and Qatar relative to MSCI Emerging Market weight. On November 6th MSCI will have its semi-annual index review and it’s possible that after the removal of adjustment factors imposed on multiple UAE and Qatar securities on the inclusion of those two countries in the MSCI EM index in June 2014 both of these countries weights can increase in the MSCI EM (effective as of November 25) index. EFG Hermes estimates that UAE’s weight might increase from 0.57% to 0.77% and Qatar’s weight from 0.64% to 0.92%. If that’s the case then GEM fund’s (incorrect) underweight positioning to these two markets will automatically increase even further.
To adjust this imbalance we expect to see continued foreign inflows, with occasional bumps in the road of course, to the GCC countries going forward:
Commentary from EFG Hermes Research below:
Passive flows in November, potential FOL increases next year, and a likely FTSE EM upgrade Qatar is taking further steps to improve market access that are contributing to continuing weight changes in the EM benchmark – these, in turn, can drive passive flows. Earlier in June, the exchange changed the way it calculated Foreign Ownership Limits (FOLs) to be a percentage of total market cap rather than free float market cap – this automatically boosted FOLs for a number of Qatari companies including IQ and QNB.
This move also supports the removal of the adjustment factor of 0.5x which MSCI applied to certain Qatari and UAE stocks at the time of the May Semi-Annual Index Review (SAIR). We have already highlighted our expectation that this adjustment factor will be removed in the upcoming November SAIR, leading to passive flows of cUSD588 million in Qatari equities (mainly into QNB and IQ) – see our note published on 13 October for details.
We see weight increases for Qatar in the MSCI EM Index continuing in 2015, as a law passed by the Emir earlier this year allows companies to raise FOL to 49%. Currently, only Masraf Al Rayan has an FOL of 49%, and we think it is likely that we will see more companies following suit sometime next year, amidst a push by the Qatar Exchange and regulator to increase liquidity in the stock market. Such an event will automatically impact Qatari names weights in the MSCI EM Index during index reviews, and result in more passive money flowing into Qatar. In addition, broad increases in FOLs could lift Qatar’s weight in the EM Index to over 1%, which, in our view, could lead active GEM managers to take more interest in the market, potentially turning their current underweight position to a neutral (or maybe even an overweight), given that Qatar offers a good hedge against volatility, EM currency weakness, and offers a high dividend yield.
FTSE upgrade likely next year
Finally, the Qatari market is currently on FTSE’s watch list for potential upgrade from Frontier to Secondary Emerging Market status. We believe FOLs were the key obstacle to a FTSE upgrade, and recent changes in the way FOL is calculated, and potential for further FOL increases mean that we expect FTSE to promote Qatar to EM status. FTSE has said that it will provide a formal interim update in March 2015, and that the next Annual Review of FTSE Watch List markets will take place in September 2015. FTSE EM status would be a further support for the Qatari market, in our view, as it would drive flows from FTSE trackers six months after the results are announced. We estimate that USD64 billion of passive money tracks the FTSE EM Index.