Middle East may provide relief from global stock market pain

Investors searching for sanctuary in these brutal global markets might want to take a gander at the Middle East as an area to wait out the turmoil.

Markets in the Gulf Co-operation Council (GCC) countries have outperformed global markets over the past year despite some weakness in July. (The GCC countries are Saudi Arabia, Qatar, Bahrain, Kuwait, Oman and the UAE.) Take Saudi Arabia out of the equation and the remaining markets are close to a record high when weighed against the MSCI World Index, noted Michael Hartnett, global emerging market equity strategist at Merrill Lynch & Co. Inc., in a report this week. Year to date those markets are showing a 1-per-cent increase, while emerging markets as a group are down 16 per cent.

Furthermore, he added, that is the only region in the world where financials are showing positive returns year to date.

The region has a number of pluses going for it - not the least of which are strong economic growth and a positive outlook for earnings, Mr. Hartnett noted. Gross domestic product is expected to grow by 7 or 8 per cent this year and next. Furthermore, valuations are reasonable, apart from the financials, as the region is trading at a 5-per-cent premium to the emerging markets on a trailing price/earnings basis. Inflation however is a significant negative.

Mr. Hartnett, who feels that the overall picture will remain positive even if oil prices slide modestly, says Kuwait offers the best combination of high liquidity and inexpensive valuations, while Qatar stands out as the best macro story, but also is one of the more expensive markets.

The Gulf region is one bright spot in an otherwise generally dismal landscape of global markets. Not only are the developed markets taking a hit this year; so too are the emerging markets that many investors believed could continue to do well even if the big players didn't.

That hasn't happened.

Emerging market stocks are continuing to sell off, and some key ones, Russia and India for example, have hit 52-week lows in the past few weeks. But is now the time for those investors who have taken their lumps in emerging markets to step back in?

Not yet is the answer according to BCA Research, which had recommended on June 13 that investors close their long positions in emerging market stocks. Arthur Budaghyan, managing editor, emerging markets strategy, said in a report this week that his checklist for buying emerging market stocks is inconclusive at this time. "While investors should not get more bearish at this point, we are not advising to rush in and buy yet either," he said.

Mr. Budaghyan listed the conditions that would make him comfortable advising investors to buy the emerging markets. A further decline in oil prices is one such condition; so too are falling bond yields in the G7 and emerging markets. Also, early cyclicals such as technology in general and semiconductors in particular need to provide leadership in the developed markets. And the freefall in U.S. and European financial stocks needs to stop and the banks in emerging markets begin to outperform their local markets.

Since not all those conditions are in place, he feels the sidelines are the best place to be right now, although he is positive on emerging market stocks longer term.

"A more probable scenario for the near term could be that select sectors and countries have seen their lows, but are unable to rally much," he said. "In the interim, other sectors and countries, where fundamentals are bearish, could witness new lows in share prices," he added.

That is just what the Russian market did yesterday. Both the Micex index and the RTS index set 52-week lows. The RTS index is calculated in U.S. dollars. India's Bombay Stock Exchange sensitive index - better known as Sensex - established a low on July 16.