Conrad de Anelle reviews last year's market catastrophe, and looks ahead to reasons why investors can be optimistic.
Waiting for rebound
2008 may be remembered as the year with no place to hide. Half a decade of speculative excesses produced the worst global recession in two generations and steep declines in nearly every asset class deemed not to provide the utmost safety. Few markets anywhere escaped intact, but UAE investors, who benefited more than many during the boom, may have been left feeling especially exposed. An index of UAE stocks compiled by the research firm MSCI Barra fell 73.2 per cent on the year, far more than the 42.1 per cent decline of the MSCI World Index.
Such a dreadful performance is hard to imagine yet easy to explain at the same time. Every calamity that spread around the world in 2008 - the imperilling of the banking system, plunging property, commodity, stock and bond prices - paid a visit to the UAE and showed little sign of departing as the year ended. A decline of nearly three-fourths in the value of stocks might encourage investors to bottom-fish, and some portfolio managers and market strategists argue in favour of such an approach, but many others express extreme wariness. The global economy and financial system are not close to being repaired, they caution, and the difficulties that lie ahead could be particularly acute for the UAE.
"There is a lot of concern among investors about what's happening there," said Komal Sri-Kumar, the chief global strategist at TCW Group, a subsidiary of the French bank Société Générale. "Real estate in Dubai has been hit by the amount of leverage they have taken on," he commented. "The drop in the price of oil, combined with the drop in asset values, has created a double whammy. Both types of investment have been seriously hurt by what's happening globally."
The flashpoint for the worldwide crisis was a sudden withdrawal of credit as home prices began to fall and banks found themselves overexposed to borrowers with limited ability to pay. That pushed prices lower, leaving lenders holding still more bad mortgages and, even worse, mortgage securities that had been created by sharp operators on Wall Street and were difficult to put values on. That made banks reluctant to do business with one another, and the credit crunch was in full swing.
Home price declines accelerated, and the dearth of financing spread to corporate borrowers. That forced them to retrench, sending earnings and share prices lower and slamming the brakes on economic growth. That in turn sent commodity prices tumbling. The downward spiral produced the worst property markets for many years in much of the developed world. Prices were more resilient in the UAE, showing a clear downtrend only in the fourth quarter, but the consensus among analysts and economists is that prolonged weakness has merely been delayed, not averted.
The most breathtaking action last year occurred in commodity markets. It might be described best as a game of two halves between bulls and bears in which the bulls took a big lead into the locker room at half time and managed to blow it. The CRB Index of 19 raw materials set an all-time high in early July and then collapsed to a six-year low. For the year the index lost 36 per cent.
Crude oil followed a similar pattern. Futures traded in New York leapt to a record above $147 (Dh539.95) a barrel in July and ended below $45. The 54 per cent loss from start to finish made 2008 the worst year for oil ever. As for stocks, UAE investors suffered severely, but they were not alone. Not a single one of the 67 countries for which MSCI Barra compiles indexes ended the year with a gain. Tunisia, with an 8.7 per cent loss, came closest, followed by Morocco, with a 13.0 per cent decline. Performance across the Middle East and North Africa was conspicuously mixed. The UAE was the worst market in the MENA region and fifth worst in the world. Among nine Middle East stock markets, Lebanon did best, with a decline of 21.8 per cent. Losses for the others were clustered around 50 per cent. Global markets can hardly do worse this year, but much stands in the way of a recovery, too. The obstacles may be particularly challenging in the UAE, where energy, real estate and finance - the three big worldwide ifs - dominate the economy. All three could limit the alleviation of the debt overhang and other excesses left over from the boom years. Victoria Miles, an analyst at J.P. Morgan, described UAE debt as "one particular area of vulnerability" in a world in which the ability of borrowers to meet their obligations has been called into question. Downgraded credit ratings for state-controlled UAE companies will make further borrowing in the capital markets more expensive, to the extent that it is available at all. The plunge in oil, if it persists, may limit state funding. The UAE and other economies in a similar position "will have to adapt to slower capital inflows and a significantly reduced stimulus from domestic credit growth, at the same time that commodity prices are under pressure and recession risks are looming", Ms Miles said in a recent report. Mushtaq Khan, an analyst at Citigroup, warns that the reliance on demand from Saudi investors and others in the Gulf and elsewhere make Dubai especially vulnerable to cheaper oil. "The strong domestic demand that was driving Dubai's growth was based on the influx of expatriates, which filtered down to a booming financial sector and the sharp increase in real estate prices," he said in a recent note to Citi clients. "If the global oil surpluses shrink . . . it seems highly unlikely that Dubai will be able to sustain the growth momentum that has been in play since 2005." That does not bode well for property values, and it does no favours for investors in the UAE stock market. The overwhelming number of listed finance and property companies "doesn't leave many choices", said Josephine Jimenez, the chief investment officer for Victoria 1522 Investments, an asset management firm concentrating on emerging and frontier markets. It doesn't leave any choices at all for Jonathan Bell, a manager of emerging market portfolios for Pictet Asset Management, who said he has sold all of his UAE holdings. "Dubai is not going to run out of money," he commented, "but the appetite for property and the dream of Dubai will have to be stretched out longer." He has few positions elsewhere in the Middle East, although he continues to own telecommunication companies with exposure to the region, including MTN in South Africa and Orascom Telecom in Egypt. "The rate of deterioration is accelerating in the Middle East," Mr Bell remarked. "The news flow and macroeconomic numbers are going to continue to deteriorate." Ms Jimenez agrees. With the price of oil declining and food price inflation remaining high, it will have an "affect" on growth, she said, adding that the UAE's "current-account surpluses might not last for long". She too has no positions in UAE shares. Elsewhere in the region, she owns Industries Qatar, an exporter of fertiliser and other commodities, and Gulf Finance House, an Islamic bank based in Bahrain that specialises in infrastructure products in the Gulf, North Africa and Asia. Rami Sidani, head of investments for the Middle East and North Africa at Schroder Investment Management, prefers to look on the bright side - after taking full account of the dark side. "The situation is quite bad," he acknowledged. "The real estate sector was the main driver of the economic boom in the UAE and especially Dubai for the past four to five years, and the downturn will definitely produce a slowdown across different sectors, such as construction and building materials. The UAE economy will slow this year from 6.5 per cent to 4 per cent, but that will be one of the highest rates in the world. Many markets will experience negative growth." But it is not as though investors haven't seen the slowdown coming, he pointed out. After a loss in the stock market of nearly 75 per cent, he said, "the bulk of the bad news and the deterioration in the macroeconomic situation are priced in". What investors may not fully factor into their thinking yet is the ability and willingness of UAE authorities to provide a financial backstop as the downturn takes hold. "What is comforting today is the Government's ability to manage and weather this crisis," Mr Sidani said. "Keep in mind that real estate entities that have 70 per cent of mortgages are controlled directly or indirectly by the government. That is unique to this country." The market would be calmed, he said, by "a comprehensive bailout plan for the real estate sector tackling developers, construction companies, banks and mortgage finance providers." Some elements of this have been in place since October when the central bank issued a three-year guarantee on interbank loans and domestic bank deposits, a move that, according to Ms Miles, the JP Morgan analyst, "shows the commitment from the federal authorities to underpin the health of the UAE banks". That commitment was demonstrated again in November when the Ministry of Finance and Industry took over Dubai's two largest mortgage lenders, Amlak Finance and Tamweel, apparently to avert their collapse. Government involvement in capital markets is not ordinarily something that cheers investors, but Mr Sri-Kumar, the TCW strategist, finds that in the Middle East, particularly during difficult times like these, "it brings an element of comfort to the common citizen that the stock market is being supported by his government". "If I were a resident of one of these countries," he said, "I would probably feel a sense of support for my own investment." Mr Sidani finds the cushion sufficient to make UAE stocks worth a look, especially after their collapse last year seems to have left them with little room to fall. His emphasis is on blue chips in a variety of sectors. One selection is Emaar Properties, the largest listed real estate company, which is trading at such a steep discount to the intrinsic value of its assets that investors, he said, "are pricing in doomsday scenarios and a complete paralysis in the sector for the next two years". Other favourites include Air Arabia, a low-cost carrier with a lot of cash on its books, the global seaport operator DP World and Emirates Telecommunications. Mr Sidani predicts that demand for companies such as these will return once investors decide that it is safe to come out of hiding and buy shares again. "I would expect blue chips with healthy cash flow and robust balance sheets to lead the rebound," he said. "I'm not saying the market will rebound overnight, but the worst is already priced in and the down side is limited from here."