Middle East equity markets are expected to grow in 2011 as investors start trading again and high oil prices boost confidence.

The positive outlook will be a relief for regional markets, many of which lost billions of dollars in value during 2010. Although a tentative recovery began late in the year as oil prices rose, Gulf markets are still significantly behind the valuations they reached at the end of 2007.

By the end of 2010, the total market value of the Gulf stock exchanges was $770bn, compared to $1.1 trillion at the end of 2007, according the Arab Monetary Fund. The Dubai Financial Market (DFM) shrank by around $4bn, while the Abu Dhabi Securities Exchange (ADX) fell by about $2bn.

“The Dubai World debt problems are behind us now, along with most of the negative news, so confidence is improving,” says Ahmad Shahin, analyst at UAE-based Shuaa Capital.

“Interest from international institutional investors in the region has increased significantly,” says Yazan Abdeen, equities fund manager at ING Investment Management. “Mostly important for the regional markets will be the cleansing of the banks’ balance sheets, which will put in place the liquidity necessary for them to perform very highly,” he adds.

Many regional investors are in a more difficult situation, having only just started to recover from the stock market crash of 2006. “Local investors have gone through two massive corrections in the past four years,” says Abdeen.

That has left many cautious, and led them to consider investing through funds rather directly.

Analysts predict that Saudi Arabia, Qatar and Egypt will be the best performers over the next 12 months.

Qatar will be buoyed by continued optimism about the impact of its successful bid to host the 2022 World Cup, although some analysts warn that equity markets may be in danger of overestimating the effect this will have on corporate earnings.

Saudi Arabia will be boosted by higher oil prices, government spending on infrastructure, and the potential opening of the market to international investors. Oil ended 2010 at more than $90 a barrel.

“Saudi Arabia has been gradually liberalising ownership rules for equities over the past 13 years. The only step remaining is to allow foreign investors to own shares directly,” says Fahd Iqbal, head of strategy at EFG Hermes. “As the largest and most liquid market in Mena, this change could potentially be transformative for liquidity, although it would depend on how restrictive ownership rights are.”

Qatar and the UAE could also benefit from being upgraded to emerging market status by US-based index provider MSCI. That could enable international investors to pour an additional $4bn into the two markets in the 12 months following an upgrade. Iqbal says, “For the first time in two years, we see a greater than 50 per cent probability of the UAE and Qatar qualifying for a MSCI emerging market status upgrade.”

Egypt is already classified as an emerging market by MSCI, which means it should receive a boost from international investment funds, which will be making allocations throughout the beginning of 2011.

Markets in Bahrain and Kuwait could be the region’s underperformers. In 2010, the two shrank by 2 per cent and 0.7 per cent. Political uncertainty in Kuwait and the lack of progress on the financing bill for the country’s investment programme will make investors wary.

Last year’s worst performer, the DFM, may see some recovery in 2011 as the government continues to work on resolving the debt problems at its state-owned companies. Most analysts say there are selective opportunities in Dubai, but problems remain.

“Companies like Arabtec have a good track record, but don’t have the liquidity to participate in new projects,” says Abdeen. “That issue will have to be resolved if they are to benefit from infrastructure spending.”