This week we had a meeting to talk about whether we should change the way MoneyWeek looks. We wondered if you might like a glossier paper, or a different kind of cover – photos instead of cartoons. We wondered if we might use more yellow instead of pink. In the end, we decided (and I think most meetings should end like this) to do nothing. But that doesn’t mean the meeting was worthless – it was fascinating. Why? Because we poured over all the samples of potential covers produced for the pre-launch issue of the magazine in 1999.
We needed that issue to impress, so I gave it what at the time seemed to be not just a contrarian, but also quite a shocking headline: “Will oil go to $50?” How times change. Oil – which was knocking around in the $20s a barrel then – has soared since, even touching $100 a few weeks ago. $50 is now a distant dream: this week even BP – which, like most oil companies, is generally conservative when it comes to forecasting oil prices – has set its price assumption for project analysis at $60, up from its usual level of $40.
All this has led to endless whingeing in the West as our energy bills rise and our governments use raising oil and gas prices as an excuse to distort our markets with renewable energy subsidies.
Gulf oil exporters are rolling in cash
But, as Jithesh Gopi and Aneel Kanwer of Bahrain-based bank SBSC put it: “One man’s loss is another man’s gain”. We might be feeling the pinch at the pump but over in the Gulf the big oil exporters are rolling in cash. The Gulf Cooperation Council states (Bahrain, Kuwait, Oman, Qatar, Saudi and the United Arab Emirates) have generated an amazing current account surplus of $590bn over the past five years – more than even China has managed. Michael Hartnett of Merrill Lynch forecasts that it will grow this surplus at around $750m a day in 2008; and income per head is already running at an average of $20,000. That’s nine times higher than the emerging market average and 25 times higher than the average income in India.
Total GDP in the area has doubled since 2002 and, says Morgan Stanley, will be about the same size as the entire Indian economy this year. To put that in perspective, “the increment between 2002 and 2008 alone will likely amount to more than the entire current GDP of Turkey”.
No wonder that when the big – and let’s face it, almost bankrupt – US banks began to take on board the extent of their subprime losses late last year the first thing they did was to dispatch squadrons of corporate jets to the Persian Gulf to beg for a bailout, which they mostly got.
Unlike some of the world’s new rich the governments and residents of the GCC aren’t shy of splashing their cash about. We are all well used to the excesses of the leaders of some Arab states. Who was surprised when it took three hours to unload King Abdullah of Saudi Arabia’s suitcases from 22 limousines when he arrived in London last month?
What Gulf states are spending on
But Gulf state spending isn’t just about hotel bills, bullet-proof Rolls Royces and Chanel suits under burkas any more. It’s now about cutting debt – Morgan Stanley estimates that Saudi’s debt-to-GDP ratio has fallen by two thirds from 65% of GDP in 2004 to only 21% in 2007. And it’s also about infrastructure and development: Lehman Brothers estimates that there are currently around 2,000 projects – roads, railways, LNG pipelines and ports – worth £1.3trn under way. All of these are driving earnings forward for construction firms and banks and pushing incomes up.
This, says Christopher Wood of CLSA, is an infrastructure boom that makes what is going on in India and China “look like picnics” and a level of diversification that suggests the Gulf economies will soon be less oil-orientated than they are now. In Saudi Arabia there has been a particular focus on building railways and new cities, while in the UAE “the scale of the construction projects under way… and the sheer change to the physical landscape they represent, remain gob-smacking to the periodic visitor”, says Wood. Dubai’s efforts to diversify into sports tourism entertainment and financial services are also awe-inspiring in their scale.
These economies are also blessed with young populations (50% under 30), all hoping to earn more and keen to spend what they earn: that’s good news for companies involved in everything from personal loans to mobile phones and mopeds. Add it all up and economic growth is expected to run at 5%-6% a year for the foreseeable future, with some economies moving even faster: Morgan Stanley sees Qatar growing at 10% to 2009, thanks to its heavy infrastructure investments. And that’s the case even if the oil price tumbles: note that the big economies such as Saudi and the UAE have set their budgets for this year on oil prices of $45-$48 a barrel so they’ve given themselves a lot of leeway.
So the economies look good. What of the markets? Think India and Brazil in the early 1990s, say Gopi and Kanwer: limited presence of foreign investors, low institutional investment, limited research coverage (only three firms in the region are covered by more than three brokers and most aren’t followed at all, making information a premium product) and, of course, low prices.
Back in 2005 general excitement about rising oil prices and corporate earnings growth pushed most of these markets too far too fast, with the Saudi, UAE and Qatar markets ending up on p/es of more than 40 times. They then fell dramatically in early 2006 – Dubai fell 68% in a matter of weeks – and even after picking up nicely last year (by an average of 44%) stocks remain pretty cheap on average p/es of around 14 times.
Given average earnings growth expected to be about 15% this year that isn’t bad: Dubai, one of the region’s fastest growing hotspots, is on a p/e of 13 times, making it look practically free compared with the 45 times you have to pay if you want to be invested in China or the p/e of 22 times for India’s Sensex.
Another reason why Gulf markets look good
But there is another reason to look at Gulf markets (and North African ones): they are less influenced by what’s going on in US markets than most. Other emerging markets (those in Asia and Latin America) are around 70% correlated with the US, says strategist Michael Hartnett of Merrill Lynch. But head for the Gulf and that number falls to more like 30%. Finally, note that anyone invested in the Gulf states is more than likely to see a kicker from the region’s currencies: with Western economies weakening and carrying huge trade deficits, we can expect to see relative strength in GCC currencies, now mostly pegged to the US dollar.
Nick Price, who manages a Middle East equity fund out of London for Fidelity Investments, says he would only expect a move away from the pegs to come in “small increments”. But Kuwait depegged completely in May last year, citing inflationary pressures and is now linked to a “basket of major world currencies.” There’s no reason why other countries shouldn’t follow, particularly given the US dollar isn’t showing signs of perking up. This all works for Hartnett, who says the Middle East “is the best frontier market” there is. Morgan Stanley analysts are also enthusiastic, rating Middle Eastern equity markets as a “clear overweight” (this roughly translates as “a good thing to buy”).
Wood agrees. Last month he advised fund managers to “use any short-term correction to build positions”. Now might be a good time to take his advice: after months of relative tranquility the past week has seen Middle Eastern markets getting nervy. Most fell 6% or so on Tuesday and while they are still up year to date (unlike most other markets) they aren’t up much and Saudi Arabia is now down around 15%.
The risks of investing in Gulf states
So what are the risks? The obvious one is geopolitical, but either something horrible happens or it doesn’t. This isn’t forecastable. Next is a sudden fall in the oil price. This is possible – we’ve already said this year that we expect recession in the US to hit the oil price in the short term. But even so it does seem unlikely that price falls would last for long enough, or go far enough, to derail growth in the Middle East. Morgan Stanley forecasts that between 2006 and 2015 China alone will demand an additional 8.5 million barrels a day – that’s more than Russia’s entire production.
Finally, we might worry about volatility. Many of the Middle East bulls claim that these markets are less volatile than those in the West, but we suspect that might not really be the case. They don’t have high levels of long-term institutional investors and are heavily dominated by retail investors who, as analyst Oliver Stoenner points out in Forbes, “take fright easily”. If you are going to get into these markets – for details on how see below – don’t do so with all your life savings. Oh, and don’t do it via the new-build property market – see: Move over Dubai – Hong Kong property is better value for more.
Ways to invest in the Middle East growth story
So how can you get into these markets? It isn’t as easy as we would like it to be. One option is the $500m Alpha MENA (Middle East and North Africa) Fund launched late last year by Algebra Capital, a Dubai-based investment firm partly backed by fund giant Franklin Templeton. The fund – which unfortunately insists on a minimum investment of $100,000 and is aimed mainly at institutional investors – focuses on financial services, construction, oil, fertiliser and transportation companies in the region.
Elsewhere you might look to the Khaleej Equity Fund run by SICO Asset Management (it also has a minimum $100,000 investment requirement). The managers of this one see financials as the “best proxy to capitalise on buoyant growth, impressive project finance opportunities in the region and the relatively underpenetrated demand for personal finance”. At the end of December the average p/e of the funds’ holdings was a mere 13 times, while they – the top three being Emaar Properties, Gulf Finance House and Saudi’s SABIC – yielded 3.5%.
T Rowe Price also runs an Africa and MIddle East fund that has about 20% of its holdings based in the Gulf. However, more focused and more accessible is the Arab Gateway Fund recommended by Killik & Co Research as a buy (although with a high risk rating). It mainly invests in the GCC states but also “has the flexibility to invest” in Morocco, Tunisia, Lebanon, Jordan and Palestine. It is currently heavily invested in Saudi, the UAE and Qatar, but also has 4% of its money in Eqypt. Performance has been impressive over the past five years and while the fund does charge a performance fee (20% of returns over 10% a year) it does not charge an upfront initial charge – which we like.
Also of interest, particularly to those with a lower risk tolerance, might be the UK Aim-listed Advance Frontier Investment Trust (AFMF), a fund of funds from Progressive Developing Markets Limited, investing in a variety of “frontier markets,” or as Merrill Lynch likes to put it “emerging emerging markets.” Its co-manager, Tunisian-born Slim Feriani, is as David Stevenson puts it in the FT “one of those enthusiastic types.” He’s invested all over the place from Bangladesh (he sees value in their banks) to Nigeria but one of his biggest bets is on Egypt.
Around 26% of the fund’s assets are in the Middle East in one way or another: the Arab Gateway Fund and the Alpha MENA fund feature in its top 10 holdings as does the EMM Middle East fund. Add in North Africa and the fund’s exposure moves to 40% or so. The fund hasn’t been going long but it has already been rated AA by S&P for its “team of good fund selectors” and “solid common sense approach to portfolio construction”, which is encouraging.
Next up for those who want to go rather more mad with the Middle Eastern theme, says Stevenson, is a fund from the “brave investment professionals” at Turquoise Partners. Give them a minimum of $250,000 and they’ll use your cash to play “two big Iranian trends”: a strong resources sector and “the inexorable growth of the consumer sector”. There are obvious risks with this one, but as non-executive director Marcus Gerhardt told Stevenson, when Iran “finally gets its act together and is better run, it will explode”.
This may not be the best possible choice of words given the key risk in Iran (military action of some sort against its nuclear enrichment facilities) but it is true, says Stevenson, that Iran has a “thriving capitalist sector” with banks such as Bank Karafin growing fast thanks to “no queues, decent products and female staff serving nice cups of coffee”.
The Gulf markets are not necessarily the best places for retail investors to think about buying individual stocks in – liquidity outside a few big names is poor and there are myriad restrictions on foreign investment (foreigners can’t buy in Saudi, for example). However, stock-pickers might like to look at stocks listed elsewhere that have exposure to the Middle East.
Forbes points to Korea’s Doosan Heavy Industries, which is “involved in big Gulf projects” and Bedlam Asset Management’s Ian McCallum, who runs an emerging markets fund in the UK, likes Japan’s Komatsu, which makes and sells mining equipment in the Middle East as well as Isuzu Motors.