Egypt’s stock exchange hit an unwelcome milestone on 7 October, when the Case 30 index of the country’s biggest companies lost 16 per cent of its value – the largest one-day drop since the index started on 1 January 1998.

Having hit a record high on 5 May, the Egyptian Exchange, which changed its name from the Cairo & Alexandria Stock Exchanges in June, has fallen faster than any other Gulf exchange during the current market downturn.

Part of the reason for this decline is that the Egyptian market was the last to open after the Eid holiday.

The Abu Dhabi Securities Exchange and the Dubai Financial Market both opened on 5 October, and Saudi Arabia’s Tadawul reopened on 6 October. B

ut because Egyptians had a national holiday that day, the backlog of sell orders from foreign investors was a day or two longer than in the other major markets.

Foreign funds, often based in London or New York, were responsible for the steep declines in every major Arab stock market in the week following Eid.

In Cairo, foreign investment funds sold £E88m ($16m) worth of shares on 7 October. Investors from other Arab countries sold another £E13m worth.

Although the value of shares sold was relatively low, its impact was dramatic because the overall value of trading was also low.

Just £E745m worth of shares were traded on the day, far below the 90-day average of £E1.2bn a day.

In the first five months of this year, as the Case 30 raced towards its peak, the market turned over £E1.9bn a day.

Underperformance

The Case 30 closed on 9 October at 5,667, more than 52 per cent below its peak value of 11,936 on 5 May.

Although the Tadawul All Share Index (Tasi) is currently trading at 70 per cent below its peak of 20,635 points, reached in February 2006, the Egyptian Exchange’s 52 per cent drop has all taken place in 2008, making it the worst performer in the region so far this year.

The Egyptian sell-off began when President Hosni Mubarak included a few unexpected tax measures in his birthday speech on 5 May.

He removed a tax exemption for companies operating in free-trade zones, handing those companies a 20 per cent tax on profits.

Energy-intensive industries also lost their access to heavily subsidised fuel, further hitting profit margins. Within eight days of Mubarak’s speech, the Case 30 had lost 10 per cent of its value.

The speech made investors question the government’s commitment to economic reform and investor-friendly measures, says Hashem Montasser, head of asset management at Egyptian investment bank EFG-Hermes.

“Many of the changes are positive in the medium to long term in that you are moving closer to real prices,” he says.

“But taxing the tax-free zones we felt would not go very well with investors in the equity markets or with investors in Egypt. The government is not sticking to its prior commitments.”

According to Montasser, the tax changes are having an impact on investors’ attitudes to Egypt, but others downplay the effect of the speech.

The market has long since discounted the tax changes, says Angus Blair, head of research at Beltone Financial, another Egyptian investment bank.

“It is not an issue any more,” he says. “This happened half a year ago.”

The Egyptian stock market has more problems than just the tax changes, but they were undoubtedly the trigger for the current downturn.

By 16 July, a little more than two months after Mubarak’s speech, the Case 30 had fallen more than 20 per cent below its peak, meaning it was technically a bear market.

Foreign funds have continued to sell Egyptian shares throughout the summer, with many fund managers taking the view that the Egyptian Exchange would underperform relative to other countries in the region, especially Saudi Arabia.

EFG-Hermes’ $1bn Middle East & Developing Africa Fund, one of the largest funds investing in the region, cut its exposure to Egyptian equities from 30 per cent of its portfolio to 9 per cent over the summer months.

Some foreign funds have moved their money into cash, while others have increased their exposure to Saudi shares to take advantage of their low price-earnings ratios, which measure a company’s share price relative to its earnings.

Regional success

Although direct foreign investment in the Tadawul is still prohibited, foreigners can invest in the kingdom through mutual funds.

“Saudi Arabia, from a valuation perspective, is at its most attractive level for more than five years,” says Montasser.

“The market is almost at single-digit price-earnings ratios for 2009. Saudi Arabia has a very large infrastructure development programme in place.

Six or seven companies are well placed to benefit from that process in the piping, mining and petrochemicals sectors.”

Egyptian companies have fallen so far that the book value – the value of assets minus liabilities – of most Case 30 companies is roughly the same as their share price.

Even the largest stocks in the Case 30 are worth a fraction of their previous value. Orascom Telecom, for example, was worth $15.5bn on 4 May. Today it is valued at $6.3bn.

Foreign funds are setting the direction of the Egyptian market by selling the Case 30’s most liquid securities.

This could take some time as they had built large positions in the Case 30 during the previous boom.

Between September 2007 and January 2008, non-Arab buyers invested more than £E1bn a month in Egyptian equities. In September 2007 alone, they invested more than £E2.5bn.

However, other foreign funds could yet step in to take their place.

Fund managers and investment banks around the world set up funds dedicated to making investments in the Middle East & North Africa (Mena) region in the first half of 2008, and will soon have to start investing their money.

The Case 30 could benefit if those funds decide that the recent turmoil marks the bottom of the downturn, according to Simon Kitchen, chief economist at EFG-Hermes.

“We expect that recently established Mena and Africa-focused funds will build positions in Egypt, offering some support to the market over the rest of 2008 and into 2009,” he says.

“However, a broad rebound in the index will require a positive reassessment of Egypt’s top-down picture by foreign investors.”

The next major test for Egyptian equities will come in November when the majority of the Case 30, including bellwether stocks Orascom Construction and Orascom Telecom, are expected to announce their third-quarter results.

If those results indicate that the economy in Egypt is showing signs of weakness, the stock market will find it harder to recover.

Slowdown fears

Egypt’s runaway inflation problem – prices were up 23.6 per cent in the 12 months to the end of August – has raised concerns that the domestic economy will slow down.

The country’s cheerleaders insist the stock market turmoil is temporary and has only happened because of the market problems in the West.

The economy as a whole will continue to prosper, they say, because the government of Prime Minister Ahmed Nazif, who was appointed in July 2004, has steadily opened the economy to further investment.

“I think we will be pleasantly surprised by the foreign direct investment that will come into Egypt as a manufacturing base,” says Blair.

One reason why Egypt may survive the credit crunch in a better state than the Gulf economies is its lack of a mortgage sector.

“We have been massively protected by the loan-to-deposit ratio, which is only 56 per cent,” says Blair. “Total mortgages are only $500m.”

Unlike the Gulf economies, where credit has been widely available, the absence of a regulator for Egypt’s mortgage sector has held back the development of credit in the country.

Coincidentally, the Egyptian government is planning to create a single, non-banking financial services regulator in the first half of 2009, which will overhaul mortgage finance regulation.

The credit crunch means the new regulator will be likely to insist on stringent conditions for banks wanting to lend money.

“We will not be giving mortgages to people who cannot afford to repay them,” says Blair.

But Egypt has undergone a stock market crash even though its banks have not issued a glut of home loans.

Instead, Egypt needs commodity prices to come down sharply if investors’ nerves are to be calmed.

Wholesale prices for both food and fuel have fallen in recent months. If this trend continues and stock markets in the West begin to stabilise, the Egyptian market should recover.