In MENA equities we see opportunity along four themes: 1) reform (Egypt); 2) oil wealth (Saudi); 3) deep value (Dubai, Oman); and 4) stabilisation (Lebanon). MENA’s outperformance versus EM in 2018 has more to do with its insulation from global concerns and index flows rather than optimism on the region itself. Yet, after many setbacks over the over the past decade, MENA has emerged more robust fundamentally and closer to the mainstream for EM investors.
MENA outperformed EM in 2018 mainly due to global concerns. MENA equities have, in general, outperformed EM peers in 2018. This is because of all the negative top-down factors holding back EM (rising US yields, US$ strength, high oil price, US-China trade war and China FX rate and debt risks) and, for equities, fund inflows into some of MENA’s largest stocks, related to increasing weights in MSCI and FTSE EM indices, as opposed to positive MENA-specific fundamental factors (i.e. confidence in structural reform or cheap valuation). This safe-haven status is based on generally stable FX rates, counter-cyclical sovereign wealth buffers (or support from wealthier geopolitical partners) and higher (GCC) oil revenues; in other words, a positive reversal in global risk appetite will create a headwind for most of MENA.
Yet MENA is strucurally more robust compared to ten years ago. Like most frontier and small emerging markets globally, economic policy is generally more orthodox, political risks are generally lower (succession in the monarchies, political inclusion in the republics, suppression of dissent in both), geopolitics are no worse and capital markets are deeper and more accessible (post-privatisations, IPOs, foreign ownership liberalisation, improved trading processes in equities, and sovereign and corporate issuance in fixed income).
And more mainstream with Saudi in MSCI EM and GCC in JPM EMBI. The majority of MENA is now included in mainstream equity and fixed income emerging market indices. Egypt, Kuwait, Qatar, UAE and Saudi are already included, or have a timetabled path to inclusion in 2019-20, in MSCI EM, with a combined weight of c5%. All eleven of the MENA countries covered in this report are already included, or have a timetabled path to inclusion in 2019, in the JPM EMBI hard currency index with a combined weight of c15%.
Four themes for the future: reform, oil wealth, deep value, stabilisation. Opportunities do not exist in a blanket fashion across MENA: there is a lot of sifting to do in what remains a complex and fragmented region. And this filtering will matter more if investor concerns about the global environment recede. We define opportunity along four themes: (1) Reform: we prefer Egypt over Morocco; (2) Oil wealth: we prefer Saudi over Qatar, Kuwait and Abu Dhabi; (3) Value: we prefer Dubai and Oman over Bahrain; and (4) Stabilisation: we prefer Lebanon over Jordan and Tunisia.
Reform: Egypt over Morocco. Egypt’s macroeconomic policies are orthodox (the IMF loan runs until Nov 2019), security (tourism) and gas production are improving, legal reforms should encourage long-term investment, its export base is competitive post-devaluation, and its equities are attractively valued. Morocco has successfully reformed its politics (greater inclusion without compromising monarchic authority), cut its fiscal deficit, introduced some FX flexibility, and shifted from mainly commodity to mainly manufacturing exports, but this does not appear to be driving either rapid job growth or much higher corporate returns and, thus, equity valuations are not compelling.
Oil wealth: Saudi over Qatar, Kuwait and Abu Dhabi. Although efforts to diversify away from hydrocarbons are underway (and their success or failure determine the long-term trajectory of these markets), these markets will be driven, for at least the next couple of years, by three stems of the same root: hydrocarbon and petrochemical revenues, sovereign wealth and the public sector. All of these markets should benefit from higher oil revenues. Saudi is our preferred market because higher oil revenues are likely to translate into more impactful fiscal spend in the short-term: Kuwait lacks the centralised authority to implement fiscal stimulus as quickly, Qatar has already been spending aggressively in response to its embargo and Abu Dhabi has fewer domestic projects to spend on without exacerbating its duplication in non-hydrocarbon activities with Dubai. This preference for Saudi is de-risked too by the greater proportionate benefit from EM index-related inflow over the next year (as it assumes c2.5% in MSCI EM from a starting point of very low foreign ownership): Kuwait already has significant foreign ownership (unlike Saudi), Qatar is unlikely to repeat the large increases it made in 2018 to foreign ownership limits in its largest constituents (QNBK, IQCD) and Abu Dhabi may see another constituent weight increase after another bank merger (but less than seen in the case of FAB). In the long-term, reform will become a bigger driver of these markets. The need for that reform is most urgent in Saudi (given much lower sovereign wealth per citizen) and even partial success could be a powerful market driver in the medium-term.
Deep value: Dubai and Oman over Bahrain. Dubai and Oman equities are valued, respectively, at 20% and 40% discounts to last 5-year median P/B valuation and many stocks screen cheaply; risks in both appear well understood. Dubai’s excess real estate supply, uncompetitive cost of living and a less open door for all sources of refugee capital remain constraints on its growth, but it should ultimately feel the spill-over of higher regional oil revenues and more liberal visa rules; its role as the pre-eminent regional hub for expats and multinationals remains intact. Oman’s low sovereign wealth buffers, its succession uncertainty and its inability to source Iranian gas are all constraints, but its economy (fiscal spend) should be one of the most geared to higher oil price. Bahrain continues to enjoy full support from its geopolitical allies (underpinning its sovereign credit), however, its growth is constrained by the shift of commercial activity to Saudi and continuing competition from Dubai (despite Bahrain’s own visa liberalisation) and any ramp in oil output (following recent discoveries) is many years away.
Stabilisation (political and economic): Lebanon over Jordan and Tunisia. Lebanon, Jordan and Tunisia are all characterised by small population size with a large refugee component, reliance on external geopolitical and financial support, remittances and exports, and cheap equities. Jordan and Tunisia are both in IMF loan programmes; therefore, there is confidence that economic policy is orthodox. But Tunisia has elections in 2019 and the outcome is highly uncertain: the ruling party’s internal power struggle is unresolved, and the moderate Islamist party will again face the question of whether to maintain a gradualist approach. In Jordan, it is not clear what breaks the oft-repeated cycle of reform and austerity commitment, mass protest in response and the ultimate sacrifice of the PM. Lebanon has a large external finance package (CEDRE pledges) which has not yet been released: the formation of a government (with sufficient representation for those interests most closely aligned with the external providers of that finance) should act as a catalyst.