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French Version

Can Arab stock markets maintain their upward trend ?

I remain positive on the region's stock markets this year, with strong corporate earnings for 2004 and upbeat expectations for 2005 helping to support higher market prices. But the easy money is behind us. Oil prices are unlikely to keep on rising; on the contrary, average Brent crude oil prices this year are likely to be closer to the $30 per barrel mark than the $40 per barrel of last year.

Higher domestic interest rates, in line with the expected increase in dollar rates, will slow down the surge in domestic liquidity and render margin trading more expensive. Several of the companies listed on the region's exchanges have become overvalued, especially those who enjoyed sources of revenues that may not be recurring this year and will not therefore be able to sustain current levels of profitability.

Investors should become more selective, choosing those markets that do not exhibit signs of overvaluation, and those stocks that still have strong profit growth prospects. These include shares of well managed companies with a solid track record whose earnings are expected to grow again this year, justifying higher share prices. Average increase in prices of 20 percent is still possible for 2005, but a repeat of the stellar performance of the past two years is less likely. A correction in certain Arab stock markets may prove inevitable, especially in the second quarter of the year. But if and when it happens it need not be a drastic one, it could be just long enough to allow corporate earnings to catch up with stock prices.

If you ask investors and analysts about their views concerning the regional stock markets you will get mixed responses. Some would say there is going to be a major reversal this year while others are still very bullish. Usually during major market peaks, the crowd, both professionals and non-professionals, tends to be biased to one direction, which is not the case now. All major peaks that occurred in the past, both in the local and international stock markets were accompanied by extreme optimism. The U.S. market in 2000, the Kuwaiti stock market when the Al-Manakh crisis hit in 1982, the Oman and U.A.E. stock markets in 1998, the Jordanian stock market in 2000, and the Egyptian stock market in 1997. During the early weeks of these episodes the majority believed the uptrend will continue and they were later proven wrong.

The Shuaa Capital composite index for the region's stock exchanges has gained 60 percent last year - almost equivalent to the gain recorded in 2003. Total capitalization of Arab stock markets reached $620 billion, of which $300 billion was accounted for by the Saudi stock market. The best performance last year was that of Egypt with the index up 110 percent. The U.A.E. came next with the index up 103 percent, while Saudi Arabia recorded a yearly increase of 85 percent on the back of SABIC's gain of 171 percent as well as broad-based strength across most major sectors, while Qatar ended the year up 65 percent. On the opposite side of the spectrum has been the Kuwaiti stock market, where the weighted index was up by a modest 10 percent and Oman recorded a yearly gain of 24 percent. So far this year Qatar is up 15 percent, Jordan 14.6 percent, the U.A.E. 4.9 percent, Bahrain 5.4 percent, Oman 5.1 percent, Kuwait 2.3 percent, and Saudi Arabia 1.9 percent.

This discrepancy in performance has resulted in a substantial difference in the average valuation of these markets. The estimated 2004 price/earning ratios of the Gulf markets currently varies from 30 times in Saudi Arabia, 28 times in the U.A.E., 27 times in Jordan, 20 times in Qatar, 15 times in Bahrain, 14 times in Kuwait and 12 times in Oman.

Several new companies went public last year. Kuwait led the region in terms of new listings with 19 companies issuing IPOs, followed by the U.A.E. (10), Saudi Arabia (three), Qatar (two), Bahrain (two) and Oman (one). If, as expected, many more companies issue their IPOs this year, this will deepen the region's stock markets and help absorb some of the excess liquidity that is available.

Excess liquidity conditions contributed their share to the rise in regional stock markets, with the total number of shares traded increasing by three times in Qatar, four times in Saudi Arabia and more than 20 times in the U.A.E. The region's strong economic growth rates, the surge in profits of listed companies and the easy credit extended by banks for margin trading were the "pull factor" that attracted increasingly more Arab funds to be invested locally. On the other hand, the lackluster performance of stock markets in the U.S. and Europe and the rising restrictions on investments and travel to the West acted as a "push factor," encouraging more funds to stay at home, with a smaller percentage being repatriated from abroad.

Based on 2004 earnings, several regional stock markets have clearly become overvalued with a P/E of 30-25 in the U.A.E., Saudi Arabia, Qatar and Jordan, while price to book ranges between three and five times. However, based on 2005 earnings, assuming corporate profits will grow at the same rate as the growth in the region's nominal non-oil GDP of around 7 percent, adding to it average dividends of 3 percent, the region's stock markets would still have room to grow this year by 10 percent. They could overshoot to 20 percent if the macroeconomic conditions remain supportive, i.e. oil prices above $40 per barrel, short term interest rates less than 3.5 percent and no major flare-up of hostilities in Iraq, Palestine or any of the Gulf countries.

There are supportive structural factors that need to be taken into consideration which did not exist in previous bull market rallies. Today we have better-regulated markets, much improved financial disclosure requirements, enhanced management of money supply and increased involvement of institutional money. The recently approved capital market law and the appointment of capital market authority commissioners is a historical turning point for the Saudi stock market, which will greatly enhance confidence of market participants. Starting 2005, Qatar will allow foreigners to own up to 25 percent of listed Qatari shares and the prospects that the U.A.E. and Saudi Arabia will follow suit will further boost activities in these exchanges.

If oil prices tumble, expect stock market prices to follow suit. Historically, there has been a lag of three to six months between major changes in oil prices and those of the region's stock markets. We do not believe oil prices will go back to $20 per barrel; they are likely to settle in the $30-$35 range for Brent crude. The performance of the region's stock market will be positive this year but not spectacular.

After exhibiting sighs of "irrational exuberance" for two years in a row, a correction in the region's stock markets cannot be ruled out. It is advisable at this stage to stay away from speculative stocks and to choose shares of companies that are well managed and have a proven track record for profitability. In a bull run market, investors should control their greed and listen to the advice of professionals in the field. They are well advised to keep their eyes on the exist and to follow closely developments in the world oil market. As the famous Warren Buffett succinctly put it, "Be fearful when the world is greedy and be greedy when the world is fearful."

Henry T. Azzam is chief executive officer at Jordinvest, Amman.

Amman 07-02-2005
Henri T. Azzam
The Daily Star

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