UAE market rally could scare off bargain-hunting investors

Stocks could be shunned by fund managers in favour of cheaper alternatives in the developing world.

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As the UAE inches closer to its upgrade to the MSCI Emerging Market Index in May, a recent rally may make its stocks shunned by fund managers in favour of cheaper alternatives in the developing world.

Dubai’s equity benchmark has soared 51 per cent this year, making it the world’s best performing stock index. Last week it advanced 5 per cent and passed the 5,000 points mark, closing on Thursday at 5,088.48.

“There is a risk that we might get into bubble territory as we get closer to the date of the upgrade,” said Rami Sidani, the head of Middle East and North Africa investment at Schroders Investment management in Dubai. “This is due to a combination of retail investor enthusiasm and international investors that have not yet entered this market. They will rush in via a tiny door at the same time.”

About US$1 billion will flow into UAE stock markets from foreign index trackers alone as a result of the upgrade to emerging market, according to HSBC.

Last year, the Dubai Financial Market Index doubled in value, propelled in part by anticipation of the inclusion of the UAE in the MSCI Emerging Markets index.

Abu Dhabi’s benchmark is up 20.5 per cent this year.

The MSCI Emerging Markets index, which includes stocks from developing nations including Brazil, Egypt, Turkey, India, Russia, China and Indonesia, has lost 0.9 per cent so far this year.

Last year it dropped 5 per cent amid political and economic turmoil in many of these countries, leaving many bargains in its wake. That may make active fund managers – those who do not have to follow benchmarks – more keen to look for cheaper stocks than those in the UAE.

Qatar is also being upgraded to emerging market status and is considered less expensive than the UAE by a number of analysts.

The Dubai index has a price-earnings (PE) ratio of 21.3, versus 16.2 for Qatar’s index, 15.6 for Abu Dhabi’s and 11.7 for the MSCI emerging markets gauge.

The PE ratio is an important gauge for investors. It measures stock prices in relation to earnings – the higher the ratio, the greater the gap between stock prices and underlying profits.

On a broader scale, the UAE market is underpinned by the country’s strong economic fundamentals. GDP growth exceeded 4 per cent last year. Government infrastructure spending and low interest rates have lifted corporate earnings.

Still,

While recognising the qualities that mark the UAE from other emerging markets – such as a current account surplus and a currency that is pegged to the US dollar – banks including HSBC, which has a neutral rating on UAE stocks, are worried that the economy may be at risk of overheating in the long run.

“While valuations seem stretched, the environment remains supportive, with very strong growth having scope to drive positive earnings revisions,” said John Lomax, the head of global emerging market equity strategy at HSBC. “MSCI reclassification could enhance near term performance. Longer term, very easy monetary policy continues to create the risk that Dubai could experience another boom-bust cycle.”

Fahd Iqbal, the Dubai-based head of Middle East research at Credit Suisse Private Bank, also mixed optimism with caution.

“We recommend investors take a more stock selective approach since valuations have become fairly rich in a lot of the names,” Mr Iqbal said. “When you do look at the aggregate multiples for the UAE you need to be careful how you interpret it. Firstly it’s skewed by Dubai Financial Market, DP World and more recently Arabtec, which trade on a high price to earnings ratio. Second, the UAE is still in the early stages of its earnings recovery. That’s not to say that the UAE would be dirt cheap if you adjusted for this, but you have to be a bit careful how you interpret it.”

DP World’s price-earnings ratio is 24.7. Arabtec’s is 49.0.

Mr Sidani noted that many property companies such as Emaar, that sell units before they are built and get their money in instalments over a number of years, will not recognise the revenue until the units are built. For those companies, he said, PE ratios can be deceiving.

mkassem@thenational.ae

jeverington@thenational.ae