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Correction in a young market

posted on 02/12/2006: 1523 views

From its position as one of the best performing share markets in the world in 2005, the UAE experienced growing pains in 2006.

The UAE markets had doubled in value in 2005 – Dubai rising by 135 per cent and Abu Dhabi by 70 per cent. As company profits jumped, the economy was robust and liquidity was ample from record high oil prices and bank lending. UAE banks, which make up some 45 per cent of the market capitalisation in the UAE, mostly reported a doubling of profits in the year helped by gains on their investment portfolios and IPO-related income. Emaar Properties, UAE's biggest company by market value and the most important influence on local stocks, reported a 180 per cent rise in annual profits to Dh4.73 billion.

Flush liquidity, driven partly by bank borrowings against shares, pushed the markets to record highs, where it was trading at price-earnings multiple of more than 29 to previous year's earnings. But the warning bells had begun to ring by the last quarter of 2005. After robust results in the first quarter of 2005, earnings growth slowed progressively through the year.

Banks recall loans

A partial decline in the market price in December led banks to recall their loans given against shares. The forced selling by banks sparked a decline that has now wiped out some 40 per cent of the index value overall in 2006. "There were two factors. The failure of corporates to give us the spectacular returns that they delivered last year and then there was the pressure on liquidity due to the margin calls by banks," Shehab Gargash, managing director of Daman Asset Management, told a news conference in August.

Emaar Properties, which led the UAE stocks rally in 2005, was a big worry. After a 537 per cent jump in profits in the first quarter of 2005, earnings growth slowed in successive quarters. Earnings were especially disappointing in the last quarter when the part sale of a stake in state-owned Dubai Bank propped up profits.

Already jittery after Emaar's earnings disappointments, the Dubai market dived nearly 12 per cent on March 14, its largest fall in a single day in years, as a sharp decline in Saudi Arabia and across the Gulf region triggered panic selling by local investors.

Abu Dhabi dropped more than four per cent, with 21 stocks hitting the lower limit.

Investors began selling in anticipation that Saudi investors, who have poured billions of dollars into UAE stocks, would pull out of the local market.

"This (2006) will be a period when the foot comes off the accelerator a little bit and a pause of breath is probably a good thing for some of these Gulf markets," Michael Hartnett, Merrill Lynch's chief global emerging markets equity strategist, told a news conference in February. That is the way it turned out as well.

Investors realised that the exceptional corporate results of 2005, especially banks which had their best ever year, was a one-off and not likely to be repeated.

Two large IPOs in February-March, even though they drained liquidity and pulled markets down, helped bank results in the first quarter. But fewer IPOs in the remainder of the year did not help either.

Israel's attack on Lebanon in July further hurt investor sentiment as investors rushed for cover fearing prolonged instability.

Summer holidays, when some investors are away, further weighed on the market and reduced trading volumes to about a fifth of the average.

Besides, the sustained market decline dented retail investor interest, which wiped out a great deal of speculative froth that dominated the markets in 2005.

Fall in oil prices

But how low could the markets fall? From trading at PEs of about 29 at their peak, valuations in the UAE fell to about 13-14 by mid-year, making them one of the most attractive in the region. In August, it seemed, the markets had turned as the Dubai index rose 12.6 per cent and Abu Dhabi by 5.24 per cent. But the rally was short-lived as the markets began a retreat again by mid-September after oil prices.

From their peak of US$78 a barrel, oil prices fell to US$60 a barrel following signs of a slowing US economy and as the tensions surrounding Iran's nuclear programme began to ease.

In early November, a sharp sell-off in Saudi Arabia spilt over to the UAE and dragged the market down as well.

What about fundamentals? They still look good. The UAE economy, the Arab world's second-biggest, is poised to expand 11.5 per cent in 2006 and by 5.8 per cent in 2007, according to IMF forecasts. Corporate results, even though down from their 2005 peaks, are still heartening.

"On the face of it the results are poor but if you strip out the market related investments, the underlying growth is very robust – about a 30 per cent year-on-year rise for 25 companies in the first nine months," said Fahd Iqbal, strategist at EFG-Hermes.

Analysts expect fourth quarter company results to be relatively strong, partly because the share market did not do well in last year's fourth quarter.

"I think 2007 looks respectable," Philip Khoury, head of research at EFG-Hermes told Gulf News recently. "Obviously the underlying (growth) for a lot of businesses looks good. I would keep an eye out on the cyclical businesses, which are real estate. What we have seen this year at the banks is that non-interest income has come down dramatically but net interest income has gone up."

Analysts say the correction in the market will help it free up from the speculators and help bring back investors. However, as any emerging market, the 35-year-old country witnessed what was almost inevitable in a high-liquid environment. Government's further regulation will help the market to regain investor confidence. (Gulf News)


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