Dubai shares 'cheap and unloved' - Merrill Lynch

Dubai was the best market for trade in Gulf equities due to a recent rally in oil prices and improving credit spreads, according to a Banc of America Securities-Merrill Lynch research report released on Sunday.

Dubai was “cheap” and “unloved” following an underperformance of its equities over the past three years because of a slump in its real estate market and a collapse in oil prices from 2008’s highs, it said.

But Saudi Arabia, the world’s second-largest oil producer, remained the best investment prospect in the region, said the report.

Spurred on by a recent surge in the price of oil above $60 per barrel, Gulf equity markets would outperform other emerging markets in the coming months, it said.

“We see the region as a compelling trading buy for investors looking for laggards,” said Michael Hartnett, international investment strategist, in the report.

“Valuations are cheap and foreign ownership once again light.”

The region’s equities had significant room to catch up with Russia, another oil-rich emerging market, where equities had risen 67 percent in 2009. By contrast, Gulf equity markets were up just 1.2 percent in the year to date, with inflows non-existent.

Global emerging markets were up 33 percent this year, with inflows into them remaining strong.

In the past month the region had stopped underperforming emerging market equities, it said.

Key to the bank’s assessment of a strong performance in the oil-producing region, was its forecast that oil prices would continue to rally to reach $75 to $80 in the next few months.

As Gulf markets tended to lag movements in the oil price by three months, the regional markets should outperform in the coming months, it predicted.

The report said emerging market small cap stocks, a group of stocks that like the Gulf were often deemed “risky” and “illiquid”, had started to outperform emerging market large cap stocks in the past month.

Gulf markets were cheaper than emerging markets, with the MSCI GCC, excluding Saudi Arabia, index trading at a 13 percent discount to the MSCI emerging market index on a 12 month trailing basis.

In addition, a period of significant outflows from the Gulf in recent months had come to an end in the past few weeks, it said.

Dubai was the cheapest market in all emerging markets, the report said, with the price to book basis trading at a 56 percent discount to the MSCI emerging market index.

Further compression in Dubai’s credit default swap spreads, which had already narrowed from 700 to 500 basis points in recent months, would provide a catalyst to boost the Dubai financial sector.

The catalyst for Saudi Arabia’s strong performance in the future would be the opening of its equity market to non-GCC investors and its eventual inclusion in the MSCI frontier or emerging markets index.

The kingdom's vast oil reserves was a principle reason why the country represented the best long term investment prospect in the Gulf, the bank said.

With its non-oil sector accounting for 70 percent of Saudi’s growth since 2003, the country’s diversification drive was another factor for its position as the best investment case.

It also held nearly half the of the GCC’s $1 trillion of GDP and two-thirds of its 37 million population.

Saudi Arabia had the region’s second-largest banking sector and was underleveraged, with public debt falling from 100 of GDP in the 1990s to just 13.5 percent in 2008. In addition, its sovereign wealth fund, SAMA, held $456bn of assets.

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