A double-edged sword

Category: Asia, Middle East, Global

It is estimated by fund managers that more than US$2 billion in foreign institutional capital could flow into Middle East equities this month when the United Arab Emirates and Qatar, two of the region’s deepest markets, are upgraded to Emerging Markets status by MSCI.

On the face of it, the numbers look good for adventurous investors seeking to broaden their international allocations. The Qatar Exchange and Dubai Financial Market boast a combined market capitalisation of more than $300 billion, with their indexes up more 20% and 50% in the year-to-date, respectively. These stock market rallies have been supported by real estate booms in both countries, partly as a result of capital flight elsewhere in the Arab World, as well as consistently high oil prices – always a bonus in the region.

The countries also shrugged off the impact of the recent emerging markets sell-off, prompted by the US Federal Reserve’s unwinding of its massive bond-buying programme, primarily because of their currencies’ long-standing peg to the US dollar and deep current account surpluses.

To top it all off, it is anticipated that hundreds of billions of dollars of infrastructural spend will be made ahead of the World Cup 2022 in Qatar and Expo 2020 event in Dubai.

As far as emerging markets go, it almost sounds too good to be true – but don’t crack open the (non-alcoholic) champagne just yet.

In February this year, BlackRock said it “substantially” cut its exposure to UAE equities in its Frontiers Investment Trust fund, which has around $300 million in AUM. The asset management giant made the decision on the back of what it described as “speculative excess” when it came to Emirati equities. Dubai, in particular, is no stranger to speculation, which was arguably the main factor behind the dramatic bursting of its housing bubble in 2008.

Both countries are eager to attract more institutional capital ahead of the MSCI upgrade, with both markets currently being retail dominated. The long-term indicators for the two countries, however, do not necessarily lend themselves well to the long-term positions favoured by this breed of investor.

The International Monetary Fund, for example, has warned as recently as December last year that the UAE needs to cool its property market if it is to avoid another crash. Two of the four equities included in the MSCI upgrade, Emaar Properties and Arabtec Holding, are intrinsically linked to the success of Dubai’s real estate market.

Qatar, meanwhile, seems to be doing its level best to isolate itself politically in the region by pursuing an overwhelmingly unpopular foreign policy.

Despite the optimism, it seems like both markets have some growing up to do.