GCC STOCK MARKETS: FUNDAMENTALS, BUBBLES & GOVERNANCE IIF MENA Regional Forum Kuwait, 6-7 November 2006 Dr. Nasser Saidi Chief Economist Dubai International Financial Centre November 2006
Agenda Recent Performance of GCC markets Is there a Bubble or is it Fundamentals? Building Sound Financial markets: role of good corporate governance IIF-Hawkamah CG Survey Improving market performance: Reforms & Recommendations
Role of Financial Sector Development for GCC Invest, Manage and Control region s financial wealth of $2 trillion and growing as a result of high energy prices: Financial sector can be an engine of growth Strategic issue: security and safety of assets Role in Economic Development & Diversification Financing Infrastructure & Regional Economic Integration Develop new markets and instruments: Shari a compliant financial sector & market Bond market Enable & support economic and financial reforms: Enable separation of oil revenue management from economic policy Privatisation and Private sector Participation in Infrastructure Housing Finance & Mortgage markets
GCC Equity Markets Capitalization and GDP Market Cap (US$ Bn) Market Cap (% of GDP) No. of Co. Bahrain 2000 6.6 82.8 39 Qatar 2000 8.2 46.2 2001 6.6 83.3 43 2001 9.0 50.7 2002 7.6 90.3 41 2002 10.6 53.8 2003 9.7 106.2 44 2003 26.7 113.1 2004 13.5 125.5 46 2004 40.4 142.0 Kuwait 2000 21.6 58.6 80 Saudi Arabia 2000 67.9 36.1 2001 28.2 82.8 88 2001 73.4 40.1 2002 35.8 101.8 95 2002 74.9 39.7 2003 61.5 147.3 108 2003 157.5 73.3 2004 75.2 145.2 125 2004 306.8 122.3 Oman 2000 5.1 25.7 113 U.A.E. 2000 11.0 15.7 2001 4.5 22.6 119 2001 13.7 19.7 2002 5.2 25.6 127 2002 29.9 41.7 2003 6.6 30.6 139 2003 39.6 49.2 2004 7.6 30.9 166 2004 Source: IMF - United Arab Emirates: Selected Issues and Statistical Appendix 82.3 86.0 (http://www.imf.org/external/pubs/ft/scr/2005/cr05268.pdf) Market Cap (US$ Bn) Market Cap (% of GDP) No. of Co. 22 23 25 28 30 75 72 73 70 73 27 27 37 44 53
GCC Market Capitalization to GDP (2005) 250% 200% 150% 100% 50% Bahrain Kuwait Oman Qatar KSA UAE 0% 2005
GCC Markets Monthly Returns Statistics (Jan.2002-Sep.2006) Abu Dhabi Dubai Doha Kuwait Saudi Arabia Mean 2.06 3.84 3.48 3.56 3.08 Standard Deviation 1.15 3.43 1.99 1.98 2.07 Mean/Standard Deviation 1.78 1.12 1.75 1.80 1.49 Mean/Range 0.56 0.34 0.54 0.58 0.44 MSCI EM FTSE 100 NYSE Brent Crude Oil Mean 1.48 1.13 1.08 2.16 Standard Deviation 0.52 0.21 0.18 0.84 Mean/Standard Deviation 2.86 5.27 5.96 2.57 Mean/Range 0.84 1.49 1.75 0.75
GCC Markets Performance Benchmarks vs. Emerging Markets GCC Markets V/S MSCI EM Index January 2002 = 100 Source: Bloomberg 1200% 1000% 800% 600% 400% 200% 0% Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Abu Dhabi Dubai Doha Kuwait Saudi Arabia
GCC Markets Performance Benchmarks vs. NYSE GCC Markets V/S NYSE Index January 2002 = 100 Source: Bloomberg 1200% 1000% 800% 600% 400% 200% 0% Abu Dhabi Dubai Doha Kuwait Saudi Arabia Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06
GCC Markets Performance Benchmarks vs. Oil GCC Markets V/S Brent Crude Oil Index January 2002 = 100 Source: Bloomberg 450% 400% 350% 300% 250% 200% 150% 100% 50% 0% Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Abu Dhabi Dubai Doha Kuwait Saudi Arabia
GCC Markets Returns Correlation Matrix January 2002 - September 2006 Returns - Correlation Matrix Abu Dhabi Dubai Doha Kuwait Saudi Arabia MSCI EM FTSE 100 NYSE Brent Crude Oil Abu Dhabi 1 Dubai 0.716459 1 Doha 0.257497 0.292381 1 Kuwait 0.350896 0.38593 0.125092 1 Saudi Arabia 0.404707 0.382651 0.275512 0.347269 1 MSCI EM -0.183783-0.005042 0.146416 0.086279 0.10409081 1 FTSE 100-0.120361 0.02148 0.095622 0.228026-0.0353126 0.744749 1 NYSE -0.138201 0.006426 0.083799 0.174679 0.01756981 0.858698 0.866514 1 Brent Crude Oil -0.076076-0.120796 0.203807-0.214279 0.05707376-0.009783-0.03763-0.177449 1
Stylized Facts: GCC Markets Recent Performance, 2002-2006 Spectacular growth since 2003: in size relative to GDP, listed companies and equity valuations GCC markets out performed emerging and developed markets and oil High average returns were also highly volatile: risk-adjusted returns lower than in emerging markets, developed markets or un-hedged investment in oil! GCC markets show low or negative correlation with emerging and developed markets: offer potential risk diversification benefits GCC markets are becoming increasingly integrated (cross-correlated) Emerging and developed markets are more reliably correlated with oil than the GCC markets Have the GCC markets become more internationally integrated in the recent period and what are the dynamics? Look at rolling correlations
Brent Crude Oil Rolling 24m Cross Correlations II 0.4 Rolling Correlation with Brent Crude Oil Source: Bloomberg, Author's Calculations 0.3 0.2 0.1 0-0.1-0.2 02/02-01/04 06/02-05/04 10/02-09/04 02/03-01/05 06/03-05/05 10/03-09/05 02/04-01/06 06/04-05/06 MSCI EM FTSE 100 NYSE -0.3-0.4-0.5
Brent Crude Oil Rolling 24m Cross Correlations 0.5 Rolling Correlation with Brent Crude Oil Source: Bloomberg, Author's Calculations 0.4 0.3 0.2 0.1 0-0.1-0.2-0.3 02/02-01/04 06/02-05/04 10/02-09/04 02/03-01/05 06/03-05/05 10/03-09/05 02/04-01/06 06/04-05/06 Abu Dhabi Dubai Doha Kuwait Saudi Arabia Overall -0.4-0.5
Kuwait Regional Cross Correlation Measures 0.8 Rolling Correlation with Kuwait Markets Source: Bloomberg, Auhtor's Calculations 0.6 0.4 Abu Dhabi 0.2 Dubai 0 02/02- -0.2 01/04 06/02-05/04 10/02-09/04 02/03-01/05 06/03-05/05 10/03-09/05 02/04-01/06 06/04-05/06 Doha Saudi Arabia -0.4 Rolling Correlation with Kuwait Markets Source: B lo omberg, A uht or's C alculat ions 0.8 0.6 0.4 0.2 0-0.2-0.4 02/ 02-01/ 04 06/ 02-05/ 04 10/ 02-09/ 04 02/ 03-01/ 05 06/ 03-05/ 05 10/ 03-09/ 05 02/ 04-01/ 06 06/ 04-05/ 06 MSCI EM FTSE 100 NYSE Brent Crude Oil -0.6
Saudi Arabia Regional Cross Correlation Measures 0.8 Rolling Correlation with Saudi Markets Source: Bloomberg, Auhtor's Calculations 0.6 0.4 Abu Dhabi 0.2 Dubai 0 02/02- -0.2 01/04 06/02-05/04 10/02-09/04 02/03-01/05 06/03-05/05 10/03-09/05 02/04-01/06 06/04-05/06 Doha Kuw ait -0.4 0.3 Rolling Correlation with Saudi Markets Source: Bloomberg, Auhtor's Calculations 0.2 0.1 0 02/02- -0.1 01/04-0.2 06/02-05/04 10/02-09/04 02/03-01/05 06/03-05/05 10/03-09/05 02/04-01/06 06/04-05/06 MSCI EM FTSE 100 NYSE Brent Crude Oil -0.3-0.4
Globalization, Spill Over and Contagion GCC countries are becoming more integrated among each other Globalization has increased GCC country return correlations but must establish: Relative role of financial versus trade integration Regional versus global integration Role of industry factors Cross-Country or Cross-Market return correlations may be due to: Similar economic or activity composition and structure, e.g. oil & gas Common response to international or regional factors Caveat: Correlations do not imply causality, spill-over effects or contagion!
Fundamentals vs. Bubbles Value of an asset has 2 components: Fundamental component: discounted present value of expected future dividend stream Bubble component Problem is that expectations are not observable: we have to make assumptions about how they are measured. How can we distinguish between irrational exuberance and bubbles? Bubbles are not a new phenomenon: South Sea bubble Dutch Tulip mania US stock market boom and bust: 1929-1933 Great Depression In recent times, asset price bubbles are becoming a more common occurrence: Japan property bubble,1986-1995, US cities, Australia US techno boom and bust, 1997-2002 Asian Financial Crisis and property bubble in some Asian countries e.g. Thailand Bubbles often followed by economic underperformance (IMF WEO 2003)
GCC Strong Economic Fundamentals driving markets Strong macroeconomic fundamentals imply low macro risks: High growth rates driven by higher oil prices, diversification and economic liberalization policies imply high expected corporate profits and investment returns Investment-led growth with large infrastructure component increased productivity growth & private sector investment Conservative fiscal policies: more than 2/3 oil revenue increases have been saved, while debt has been reduced Large current account surpluses: 20-25% GDP Demographics: young, fast growing native populations; liberal labour migration policies Gradual Market de-segmentation & liberalization of access to real assets and financial markets, de jure & de facto: free zones, property freehold Safe haven: attracting capital and elites from neighbouring countries Expectations of GCC Regional Economic Integration: lower the cost of equity capital and lead to convergence of asset prices
GCC Equity & Real Estate Market Boom I Higher equity prices have driven investment and corporate borrowing based on strong expected rates of return, buoyant domestic demand, robust cash flows Higher real estate prices have driven construction boom, based on high current and expected rates of return, strong rentals Recent market correction appears to be due to unfulfilled expectations: performance and profits reported by companies were below expectations leading to fall in equity prices. Technical problems such as non-market based IPO pricing- led to market distortions Weaknesses in accounting and auditing standards imply lack of transparency and inadequate corporate disclosure: asset markets become open to manipulation and rumors and increased volatility
GCC Equity & Real Estate Market Boom II No evidence of banking system stress from either indebtedness or asset price risk: GCC corporations have low leverage Consumer and Corporate leverage remain low or moderate Exposure to commercial, housing/residential or equity markets is low Monetary authorities and bank supervisors have introduced or strengthened prudential measures to limit bank exposure and risk Capital market authorities have taken remedial/prudential steps to reduce volatility, increase liquidity or widen access Improved corporate governance standards will help improve transparency & disclosure, tighten listing requirements, lower volatility and restore investor confidence
IIF-Hawkamah GCC CG Survey & Assessment is the Start Hawkamah Institute for Corporate Governance partnered with the Institute for International Finance to assess the corporate governance environment of the GCC countries, from an investors perspective. GCC Task Force met with close to 100 regulators, Central Bank officials, accountants, auditors, investment firms in all 6 GCC countries. Analysis of the corporate governance environment focused on: > Minority shareholder rights > Structure and responsibilities of Board of Directors > Accounting and auditing > Transparency of ownership and control > Regulatory environment
GCC Corporate Governance Reforms are on the policy agenda
source will appear at the bottom
Comparison of CG frameworks in the GCC Countries with IIF Guidelines (on scale of 1-5 with 5 being fully compliant) II
Improving performance: Recommended GCC CG Reform Measures Develop a strong regulatory structure by clearly separating and defining the roles of the regulator and the stock exchange Increase effectiveness of regulators by making them fully independent of government Issue meaningful corporate governance codes and require mandatory compliance Build institutional capacity and strengthen surveillance and enforcement mechanisms to ensure compliance Strengthen the underlying corporate governance infrastructure by updating laws and creating specialized courts to deal with financial cases Promote training programs for directors of listed companies Promote investor education and enhance public awareness of good corporate governance principles and practices Introduce corporate governance best practices for state-owned and family-owned companies Grant foreign investors full access to equity markets and promote shareholder activism by foreign and domestic institutional investors and the media Create a regional level corporate governance task force to promote convergence and harmonization of laws and codes among GCC countries
GCC STOCK MARKETS: FUNDAMENTALS, BUBBLES & GOVERNANCE There is no evidence to suggest that the GCC equity or real estate markets are experiencing bubble conditions The GCC countries have strong fundamentals based on their sound macroeconomic conditions and developments, conservative fiscal policies, demographic dividends and higher wealth and permanent income GCC market volatility highlights need for institutional/regulatory reform and greater transparency & disclosure GCC countries should invest in improving Corporate Governance regimes & practices to build sound and efficient banking and financial markets, build investor confidence and attract capital into the equity markets
GCC STOCK MARKETS: FUNDAMENTALS, BUBBLES & GOVERNANCE Dr. Nasser Saidi Chief Economist Dubai International Financial Centre November 2006 nasser.saidi@difc.ae