Located in the West Bank, historically one of the most unstable places in the Middle East, the performance of the Palestinian stock market has always tended to be cyclical, moving in peaks and troughs.

With the added impact of the Arab uprisings, the Palestine Exchange (PEX), which lists 49 firms with a combined market capitalisation of about $3bn, is facing even more challenges.

In 2005, the exchange was the world’s best-performing market with returns of more than 300 per cent. In recent years, however, that growth has contracted.

As investors have lost confidence in the market, liquidity is now about 45 per cent lower in 2013 compared with three years ago. Last year, the stock market’s index performance was almost flat. By June this year, the volume of trades was down 25 per cent at 1.2 billion, compared with 1.5 billion in the same period last year.

Dwindling interest

“We’ve had a terrible year,” says Ahmed Aweidah, chief executive of the PEX, which was established in 1995. “We’re still seeing a fall in investor interest. We continue to count on investors that look for the long term and understand the market is very cyclical. Retail investors don’t really understand that, so we will be going on road shows in London, Jordan and other places to meet institutional investors.”

The main challenge is finding investors willing to take on the risk associated with the Levant area. Fears of the war in Syria spilling out beyond its borders and transforming into a wider conflict have led to a decrease in investments across the region.

The Palestinian territories face problems of their own. The Palestinian Authority is almost $4.2bn in debt, with $1.2bn owed to banks and $400m to suppliers. While they do eventually get paid, it is often with considerable delay.

The reason is the economy is highly dependent on money from donors, which can take much longer to arrive than promised. This forces businesses to borrow money from banks, incurring interest that needs to be repaid and putting further pressure on revenues.

In order for the stock market to advance, firms already listed on the PEX need to grow further, as new listings are unlikely to make a huge difference when it comes to liquidity, says Raed Massis, deputy general manager of Ramallah-based Lotus Financial Investment Company.

“Companies that recently went public, including Ramallah-based Pharmacare, operate in already illiquid sectors on the PEX, such as pharmaceuticals or real estate, and these companies are not big enough to bring about significant change,” he says.

The largest companies in the West Bank and Gaza are already listed, with the top five listed firms representing 70 per cent of overall market capitalisation. Most of these struggle to remain profitable. Palestine Telecommunications Group (PalTel), which accounts for 54 per cent of net profit on the Al-Quds Index, has seen its costs rise since its competitor, Wataniya Palestine, launched operations at the end of 2009.

“The competition is intensifying, but with no 3G or even 4G services, the future doesn’t look that bright. They can’t introduce new frequencies because they are controlled by the Israelis,” says Marwan Haddad, a portfolio manager at Dubai-based Rasmala Investment Bank.

Expenses are increasing and revenues decreasing, although PalTel still has a 9.2 dividend yield this year. Wataniya will likely need to float more shares soon as its losses are currently 60 per cent of total equity. If losses reach 80 per cent, a firm is required to recapitalise.

Decreased profits

The investment sector, dominated by Palestine Development & Investment Company (Padico), has not been that lucrative either. Last year, the company’s trading value fell almost 25 per cent, while its profits decreased 34 per cent. Padico is a major shareholder in PalTel and the PEX. However, with some large projects coming up, Padico has the potential to break even in 2013, and could become profitable from the second half, says Haddad.

An exception to the decline of the overall market is the banking sector. Bank of Palestine, the second-largest company on the index with a market capitalisation of $420m, saw its earnings increase 30 per cent last year. With half of Palestine’s economy consisting of small and medium-sized enterprises, it is likely the bank will maintain its business.

“Some smaller cap banks have been posting good returns,” says Haddad. “Palestine Islamic Bank has a 15 per cent year-to-date performance and Golden Wheat Mills almost 33 per cent.”

But, with economic restrictions on the area, growth can only go so far, and until these are lifted it is likely the PEX’s performance will remain volatile.