Macro fundamentals in the UAE economy support equity markets in the long term and an asset allocation shift to strong governments and low inflation economies should make the UAE equity market outperform in 2010, says a research report by HC Brokerage, which has also upgraded its underweight position on the UAE market to overweight.
In the near term, the UAE market remains significantly oversold by international investors, but the clarity on the Dubai debt situation and strong company fundamentals are a catalyst to equity markets, said the report titled 'Navigating the UAE', which was e-mailed to Emirates Business.
"We believe the equity market in the UAE has found a floor and the recent increase in volume supports a long-term rally and provides an entry point for investors. We are bullish on the UAE market due to the macro situation in the country's economy with its cash-rich government, its low inflation and dollar-pegged currency, and the removal of the macro overhang. Clarity on the Dubai debt situation will remove the short-term speculative nature of hedge funds and return more stable and long-term buying power of institutional money," the report noted, making a strong investment case for the UAE equity market.
The report said burgeoning budget deficits and the need to rein in fiscal expansion in some economies pose a threat to investors at one end of the spectrum. At the other end, rapidly expanding domestic economies and the need to tighten monetary policy pose an alternative risk to investors. A reversal of the US dollar carry trade, which was leveraged in many emerging markets in 2009, is a risk in non-dollar denominated markets.
The UAE economy, however, is protected from these factors due to its strong fundamentals, which include ample resources to support fiscal expansion, low inflation rates and the dirham's peg to the dollar. As such, we believe the UAE economy is a sweet spot for equity investors, it said.
An asset allocation shift by investors away from non-dollar-denominated assets, which have been a leveraged, play on the global economic recovery and the risk of tightening monetary and fiscal policy in developed and emerging markets will see equity outflows to defensive markets, it added.
The removal of uncertainty surrounding Dubai debt after the positive announcement by the Dubai government is a strong near term catalyst, but is also supported by strong macro fundamentals that have yet to be fully discounted by the market, it said.
Ample resources and rising oil prices allow the UAE government to continue supporting the domestic economy through increased expenditure, reducing the risk of a W-shaped recovery, the report said.
The UAE federal government announced on October 27 its 2010 budget of Dh43.6 billion. This is the largest budget in UAE history and is yet to be discounted by the market. Given the fragile nature of the global economic recovery, this announcement from the UAE highlights the ongoing willingness of the government to support domestic growth.
The UAE's status as a creditor nation to the rest of the world means there are few concerns over the position of the government's budget or its ability to support the domestic economy. While other, more developed nations such as Greece, the US, and the UK struggle with large budget deficits, the UAE enjoys an abundance of natural resources and has been able to expand its fiscal support to the domestic economy without threatening its economic stability, the report observed.
Government spending continues to be directed towards improving the foundations of the domestic economy. Some 41 per cent of the total budget will be directed towards the social sector to be spent on education, health and labour. Some 17.5 per cent will be directed towards infrastructure spending. This will support construction and property development activities – major drivers of the UAE economy.
Although the budget surplus decreased considerably to 0.4 per cent of gross domestic product in 2009 (IMF estimate) due to reduced oil revenue and increased government expenditure, the rally in oil prices and expected recovery of global economic activity will boost the budget surplus again in 2010–2011, allowing the government to continue supporting the economy.
Despite the improved macro outlook for the UAE economy, the equity market has lagged behind those of other GCC countries. The UAE equity market has performed the worst among its GCC peers in 2010 so far, reflecting the unwillingness of investors to allocate their funds to the UAE until they receive clarity on the debt situation. We now expect equity markets to respond more to fundamentals and rally significantly from current levels as positive news emerges on the debt issue, namely the March 25 announcement. It will be a positive catalyst that will cause local markets to catch up with international equity markets, it noted.
MACRO STABILITY OFFERS OPPORTUNITIES
The report by HC Brokerage said the UAE equity market offers investors an opportunity to capture near-term upside and long-term macro stability. It added the UAE equity market has underperformed the GCC by 30 per cent and is trading at attractive multiples compared to its regional peers.
The UAE has developed into a regional financial centre and a trading hub. Its geographical location and trade interconnectedness with Asia will ensure that it benefits from global recovery. The UAE's strong fiscal balance enables it to invest significantly in its domestic economy and insulate it from any contractions in global economic growth in 2010. Given the fragility of the global economic recovery, governmental support remains essential as high unemployment, high savings and tight credit limit the private sector's ability to take over the baton of growth.
We believe that in 2010 investors will shift away from the leveraged carry trade that has seen many emerging equity markets with floating currencies relative to the US dollar outperform, to markets that underperformed in 2009 despite strong fiscal balances, the report noted.
GCC equity markets underperformed Middle East and North Africa markets but are outperforming in 2010. Also, nervousness about the ability and willingness of governments to maintain stimulus measures is apparent. The rise in interest rates by a number of fast-growing economies in Asia (namely China, India, and Australia) was met by a negative equity market reaction. Burgeoning deficits of many developed and emerging markets pressure governments to raise taxes and lower spending. High unemployment and savings rates by consumers and the tight availability of credit pressures the private sector to lead recovery in 2010, it noted.
The report said the equity market has yet to discount the strong macro fundamentals of the UAE. Corporate earnings and news reports that have been delivered by UAE-based companies over the past quarter have been ignored due to the macro overhang of the Dubai debt situation. However, the strong fiscal balance of the UAE government, which will enable it to drive economic growth in 2010 through increased spending without the risk of fiscal tightening, have not been rewarded by equity investors, it said.