The Arab world’s largest bourse has endured a difficult 2010, buffeted by global problems that jar with the robust economic fundamentals in Saudi Arabia.

Anxieties over international financial events from Dubai to Greece have triggered sporadic bouts of panic selling among Saudi investors.

In a sign of the market’s sensitivity to external events, the mid-May sell-off of global equities found a strong echo in the kingdom, with a 14 per cent decline in the Tadawul All-Share Index (Tasi) that month.

Foreign investors clearly recognise the fundamental strength of the Saudi economy

James Reeve, Samba Financial Group

The Tasi was up 13 per cent in the first four months of the year, but the Greek/eurozone debt crisis fears in May undermined the market’s performance. By the end of July, the bourse was almost flat on the start of the year, closing at 6,187 – a rise of just 2.37 per cent.

Pre-financial crisis performance

The Tasi has fallen from the heights of the pre-financial crisis years. In 2008, the Tadawul was second only to London for new equity issuance, but like other Middle East and North Africa (Mena) markets, initial public offerings (IPO) ground to a halt in 2009.

By 9 March, the Tasi hit its lowest level since November 2003 at 4,130, as oil prices fell to $40 a barrel, about one-third of their 2008 peak.  

Even compared with developed and emerging markets, the Tasi has underperformed. Its 62 per cent rise between March 2009 and March 2010 compares unfavourably to the 107 per cent increase for the MSCI emerging markets (EM) index over the same period, despite Saudi stock valuations bearing comparison with other emerging markets.

P/E ratio of selected bourses
Abu Dhabi 9.9
Bahrain 11.1
Brazil 17.6
China 17
Dubai 9.8
Kuwait 13.7
India 20.5
Oman 11.8
Qatar 14.5
Russia 13.5
Saudi Arabia 18.2
Turkey 11.6
UK 12.2
US (S&P 500) 17.1
P/E=Price earnings ratio. Source: Jadwa

Until recently, the Tadawul had fared well relative to other emerging markets. However, the Tasi’s fall in reaction to the eurozone fiscal crisis in May was actually more precipitous than that of the MSCI EM index, with the former slumping 14 per cent in the month, compared with 10 per cent for the MSCI EM.

“This demonstrates that despite the kingdom’s sound economic fundamentals, the Tasi is still closely correlated to global currents,” says James Reeve, senior economist at local lender Samba Financial Group.

“In addition, second-quarter corporate results in the kingdom were a little mixed, and were below expectations.” 

“This is in contrast to global markets where results have definitely been better than expected. Consequently, the relative performances of the Tasi and the MSCI EM have narrowed quite sharply in recent months,” he adds.

The Tasi is still performing better than its Gulf counterparts. By the end of July, the Dubai Financial Market was down 19 per cent on the start of the year and Abu Dhabi was down by about 9 per cent. Qatar was flat on the start of the year, while Kuwait, Bahrain and Oman showed declines of between 3-8 per cent. By these standards, the Tasi’s performance does not look so bad.

Tadawul all-share index performance
(Second quarter 2010)
Open 6,801
Close 6,929
High 5,760
Low 6,094
Change (%) -10.4
Companies traded 142
Trades 6,314,825
Volume 11,379
Value (SRm) 265,678.00
Source: TASI

The pre-May period saw the Tasi hit its strongest stride, peaking at 6,929 on 26 April. But the May eurozone crisis has left its imprint on the Saudi bourse and the market is struggling to recover. Volumes remain low and caution is the watchword for investors. The clearest sign of a recovery of investor confidence would be the Tasi continuing to rise amid consistently higher trading volumes.

Strong fundamentals

Economic news from Saudi Arabia – taken in isolation – should not give cause for negative investor sentiment. Compared with countries where consumer spending has been eroded by massive job cuts and reduced incomes in the wake of the global financial crisis, Saudi Arabia has got off relatively lightly. Unlike Europe, the kingdom is continuing to invest in the productive areas of the economy and government spending will continue to underpin growth.

Unlike advanced economies such as the US, where the pre-2008 boom was linked to high levels of leverage and personal debt, the Saudi economic boom from 2002-08 was due to the steady rise in oil prices over that period. Saudi investors had not borrowed to play the stock market.

What, then, explains the poor performance of Saudi equities this year? One problem is the Saudi private sector has yet to fully shrug off the gloomy sentiment that has pervaded since May 2009, when the two large – though unlisted – Saudi family conglomerates, the Saad and AH Al-gosaibi groups, defaulted on more than $15bn of loans. The investor fright that descended reflected concerns that the groups’ debt problems were shared across the entire Saudi corporate sector.

The banking sector was heavily exposed to the two firms’ bad debts. A partial settlement of the debts in September 2009 lifted investor sentiment. But other bad news afflicted the market’s performance for the remainder of the year, notably the Dubai World debt standstill request announced at the end of November.

The Tasi traded in a fairly tight range and stayed stable for the early months of 2010. Analysts felt it suggested an improvement in investor sentiment. As local Jadwa Investment noted in a March report, the early year gains came on the back of rising oil prices and renewed vigour in global markets that supported a consistent rise throughout March when the Tasi surpassed its 2009 peak.

Fragile confidence

Though benchmark sectors have suffered this year, such as petrochemicals and banking, retail and construction sectors – those more domestically focused stocks – are performing better.  

However, the gains came amid low trading volumes, a clear indication that investor confidence remains fragile. The total volume of transactions over the three months to the end of February was on par with the monthly average for the first eight months of 2008.

The average daily number of transactions in January was the lowest for five years, at little more than 73,000. Indicators such as mutual fund ownership and the reduction of the proportion of trading accounted for by retail investors also pointed to less local investor interest in the market.

The weaker investor appetite may not all be the result of residual concerns about Saudi corporate debts.

“Saad/Al-Gosaibi was a bigger issue for foreign investors than domestic ones,” says Reeve. “For foreign investors, it seemed symptomatic of broader issues of disclosure and corporate governance that have tended to make them shy away from Gulf markets. Once domestic investors worked out that the Saad/Al-Gosaibi crisis did not present a systemic threat to the country’s corporate and financial sectors, they regained their appetite fairly quickly.”

Yet the Tasi has still proved sluggish in recent months. Volumes have stubbornly refused to grow, dropping to about 70,000 transactions a day in July, low by historical standards. The Tasi underperformed many global markets during the month, wiping out most of the earlier gains. Corporate earnings were largely unimpressive for the second quarter, rising 11 per cent on the previous quarter. 

There are structural factors that are affecting the Tasi’s performance. Like most Mena markets, the Saudi bourse has a relatively small number of institutional investors – the investor class that has been most active in the developed world in driving a market recovery in the post-Lehman period of October 2008.

In the US, institutional investors were quick to buy up stocks that had seen their values bottom out at the end of 2008. For retail-dominated markets such as Saudi Arabia, where individuals account for 90 per cent of investment, there is a greater reticence to make timely plays. 

Capital market reforms in Saudi Arabia

Change may come as capital market reforms start to make headway. In March, the Tadawul allowed non-Gulf nationals for the first time to invest in exchange-traded funds (ETFs) – index funds traded on an exchange in the same way as a stock – granting foreign investors an opportunity to gain exposure to Saudi equities.

“Foreign investors clearly recognise the fundamental strength of the Saudi economy, and I think ETFs are the logical vehicles for exposure given the restrictions on outright ownership of Saudi shares,” says Reeve.

However, Reeve adds that foreign investors are mindful of the Tasi’s intrinsic volatility given the dominance of retail investors in the market, so exposure to the market, even through an ETF, is unlikely to be taken lightly.

There are other positive indicators. Saudi Arabia is leading IPO activity in the Gulf, with seven of the eight issues in first half of 2010 launched in the kingdom. If investors can block out the gloomy global economic news, the Saudi market may be on course for a stronger growth phase. But the turbulent events of the past three years hardly give confidence that the worst is behind it.