Although the strong level of Western institutional involvement in UAE stock markets brings with it the risk of contagion from global market turmoil, the country's bourses are primed to outperform in the second half of this year, research has shown.
The effects of such a fallout can be "substantial", but such a correction will be temporary and will not affect the fundamental drivers of the region's markets, investment bank EFG-Hermes said in a report.
"We expect the UAE stock markets to pick up and gather increasing momentum over the course of H2-2008. Valuations remain moderately attractive at 13.8x 2008e and 10.2x 2009e, though this is no longer as cheap relative to emerging markets [or for that matter developed markets] as it was six months ago," EFG said.
"Indeed, the UAE has moved from being at a discount to emerging markets to being in-line/above as valuations elsewhere have corrected sharply. The UAE's attractive valuations are underpinned to a large extent by the very cheap valuations within Dubai real estate, particularly in 2009 when we expect a high delivery of real estate projects."
EFG expects the positive fund flows from Western institutions to continue as the underlying fundamentals for the UAE remain sound and earnings growth forecasts remain robust at a compounded annual growth rate of 17 per cent from 2008 to 2010.
Foreign and institutional investors have accounted for up to a third of traded value on the Dubai Financial Market in the past three months. These big-ticket investors have also been net buyers to a large extent.
Corporate earnings are also "well insulated" from a slowdown in US and European economies, EFG said. The correlation of the UAE to developed and emerging markets continues to be low in absolute terms and "continues to offer international investors excellent diversification opportunity".
"Most importantly, we see strong and rising support from the many GCC and Mena-centric long-only funds being established in the region. These funds are still at an early stage and their trading activity is therefore lower than their full potential.
"However, the size of funds established so far have been substantial and over the course of the year we expect these funds to help drive a marked increase in Western institutional trading activity, which at present is still dominated by hedge funds," EFG's analysts said.
"Without any near-term triggers, we believe the UAE stock markets are likely to drift sideways until the Q2-2008 results season approaches. The positive trend in Western institutional and long-only investor inflows should provide a floor to current levels and may even provide a modest uplift.
"We believe the gap between the Abu Dhabi and Dubai indices is unlikely to close completely in the near term, but H2-2008 offers a chance for the Dubai index to outperform. For this to happen, it is necessary for du to continue delivering strong results and, more importantly, for Emaar to deliver stronger earnings growth, which we believe will occur as earnings from its international ventures kick in.
"Although quarterly results provide the most reliable triggers for re-rating, we believe further clarity on the revised Companies Law would help trigger a rally also. We have little visibility on when this might occur. A lack of news flow before the summer time would imply that we would need to wait until late 2008, or even into 2009, for an announcement.
"That said, any regulatory increases in foreign ownership limits would also need to be accompanied by changes at the company level. We have seen how a recent change in laws – raising GCC nationals' ownership limits to 100 per cent from 49 per cent – has had a limited impact as the majority of firms have left ownership limits unchanged."