It has generally been a positive year for the region’s bourses, with US ratings provider Standard & Poor’s GCC composite and large cap index rising 20 per cent by the start of December. That contributed to higher valuations of companies’ shares, which on average traded at a price-to-earnings ratio of 14 times in December, up from 12 times a year ago.

Much of the rise comes on the back of corporate profit growth and the expectations are for that to continue as economies strengthen following the financial crisis. Corporate earnings in the GCC increased 7 per cent year-on-year to $46bn in the third quarter of 2013, according to Kuwait-based Global Investment House.

UAE leads

The UAE accounted for the largest part of the growth, followed by Qatar and Bahrain. Saudi Arabia’s earnings were lacklustre in comparison, rising only 1.6 per cent year-on-year, due to declining net income from the chemicals sector.

The combined market capitalisation of GCC bourses was $910.6bn by November, of which the biggest contributor was the Saudi Stock Exchange (Tadawul) at $451.9bn. The UAE markets accounted for 17.2 per cent with a combined total of $156.9bn, while Qatar made up 16.8 per cent with $153.1bn. Kuwait, Oman and Bahrain together amounted to $148.7bn.

Dubai was by far the region’s best performer. It made a strong start to the year when companies posted solid earnings growth and anticipation built up towards the emirate’s World Expo 2020 win. The Dubai Financial Market (DFM) is up 80 per cent year-on-year.

The announcement that index compiler MSCI would upgrade the UAE and Qatar to emerging markets status from May 2014 also added to the positive sentiment. The upgrade is expected to bring about further reforms to the markets, as well as attract about $400m from foreign exchange-traded funds.

Part of the DFM’s spectacular rise can also be attributed to the fact that it had been stuck at a low level in recent years. Investors had been cautious about Dubai’s economic outlook, while the emirate dealt with the aftermath of the financial crisis. Because that factor has now disappeared – most firms are no longer considered undervalued – it is unlikely the index will continue to rise at the same pace. Still, there remains significant potential for solid growth as Dubai’s economy picks up further.

Abu Dhabi’s stock market, which tends to follow trends in Dubai, saw similar movements. The Abu Dhabi Securities Exchange (ADX) was up 50 per cent year-on-year at the beginning of December, led by growth in real estate, banking and telecoms. A merger between the Abu Dhabi and Dubai exchanges, which government officials have said is still on the cards, would boost the UAE capital markets. A combined entity would create a bigger pool of liquidity, help investors diversify and tackle some of the operational issues that prevent more foreign investment from flowing in. But while a merger has been spoken about for years, there is no clarity yet on when it might actually happen.

“I think next year we’re going to see a continuation of the strong trends we had in 2013,” says Talal Ghandour, Middle East and North Africa head of equities at the US’ Bank of America Merrill Lynch. “We’ve just come out of a three, four-year bear market, so we may not see the same in percentage terms as we have in 2013, but I think continued strengths in the UAE markets will see us through 2014.”

What remains unclear is how willing the authorities are to address the issues that are causing local firms to list abroad instead of domestically. The DFM’s and ADX’s limited pool of liquidity as well as stringent listing regulations, such as the requirement to float at least 55 per cent of the company when it goes public, are seen as major hindrances to local initial public offerings (IPOs). Until the markets become deeper, large firms in particular are expected to look at bourses elsewhere, as Damac Properties and Al-Noor Hospitals Group did when they listed on the London exchange this year. “Companies look for the best valuations they can get,” says Ghandour. “No one wants to sit on an exchange and not be traded. Asia is a natural destination for a lot of these firms, as is London.”

Qatar activity

The Qatar Exchange, meanwhile, has risen 24 per cent year-on-year as the economy has benefited from public infrastructure spending plans ahead of the Fifa World Cup in 2022. Improvements to its trading platform were rewarded in June with the long-awaited MSCI upgrade, but it still has work to do if it wants to attract higher levels of foreign investment.

The government plans to address this through a host of initiatives. Although exact details remain unclear, the authorities have announced they will introduce new legislation to improve liquidity, as well as setting higher foreign ownership limits for some firms. There are also plans to launch IPOs of state-owned entities, including four units of Qatar Petroleum that could be worth $50bn in the coming years.

Saudi Arabia, on the other hand, has a much more established market. The region’s largest stock exchange, the Tadawul, which rose 21 per cent year-on-year, offers a wide variety of stocks and sees high trading volumes.

“[Riyadh] is a stable, steady player, and the past year’s banking and petrochemicals sectors’ performances have been reasonable,” says Saleem Khokhar, head of equities at National Bank of Abu Dhabi’s asset management group. “Its domestic market is strong – the consumer sector demographic is relatively young, the population is starting to spend and the government’s infrastructure budget is quite large. Petrochemicals companies have been impacted a little bit by the global environment but the recovery should bode well for them.”

At the same time, a pipeline of IPOs is said to be in the planning, although the firms are still awaiting regulatory approval. Companies include hospitality provider Al-Hokair Group and private developer Acwa Power.

Foreign investors

Further opening up the Tadawul to foreign investors, who can currently only trade in stocks through swap agreements, could lead to additional market growth. However, it is unlikely this will immediately lead to massive inflows, says Jahangir Aka, head of the US’ SEI Investments in the Middle East. “Saudi Arabia is portraying a sense of openness and alignment to the global economy. I don’t think every global fund manager will jump on it as it opens itself up more to foreigners, but they will dip their toes in it.”

While steps are being taken towards welcoming foreigners, it remains to be seen how soon that will happen. For the moment, there is no need for the authorities to hurry as the exchange is highly liquid.

Khokhar says the UAE, Qatar and Saudi stock markets show the most potential for the future. “Dubai has had a great run, though when compared to the rest of the region, it is slightly more expensive than Saudi Arabia. It’s usually the other way around, so the question is if those valuations are justified. Doha has risen 24 per cent in 2013, but probably needs to do more in terms of liquidity. Hopefully that will develop over time as foreign limits are addressed.”

Another mainly domestic market with good prospects is Kuwait, although politics once again suffocated the business climate in the past year. Delays on government spending approvals meant the largest companies were unable to register significant growth. As a result, the stock market’s 32 per cent year-on-year rise was mainly driven by speculative activity, with investors betting on the situation improving.

The GCC exchanges that witnessed the least amount of growth, the Bahrain Bourse and the Muscat Securities Market, remained largely illiquid in 2013. The region’s smallest markets rose 12 and 18 per cent respectively, with only a handful of listings by smaller companies.

More challenging conditions could be seen in Egypt and Iraq, which struggled amid political instability and a lack of security. The Egyptian Exchange plunged in May and June, ahead of the demonstrations against then president Mohamed Mursi. Its benchmark index, the EGX30, dropped 12 per cent year-on-year just before the protests started. Lack of foreign currencies added to investors’ concerns.

But the bourse’s fortunes improved in the second half of the year, as an interim government took over and billions of dollars in aid from the GCC started pouring into the country. At the start of December, the EGX 30 was up 15.9 per cent year-on-year. As the country’s debt problems are addressed, the bourse will likely remain stable in the near term, although uncertainty remains over the political situation.

Compared with Egypt, Iraq’s stock exchange will likely need much longer to get back into positive territory, as the security situation there continues to deteriorate. The illiquid bourse is down 9 per cent year-on-year and is awaiting more companies to list. Expectations are for trading activity and stock market performance to pick up in the medium term, however.

Looking ahead, regional markets are expected to continue to grow as governments step up spending on infrastructure. Regulatory changes and the MSCI upgrade of Qatar and the UAE are also set to help draw in more investment. Simultaneously, the region’s lowered risk premiums are making it less expensive for companies to raise capital. That could boost the number of flotations after a year of low IPO activity and help to diversify and expand the region’s current offering.