This article was published in the 3
December 2009 edition of the Financial Times.

Copyright - The Financial Times Limited 2009.

But the structural and fundamental underpinnings of these markets paint a different and attractive picture for the long-term investor. The outlook for Dubai's hydrocarbon-rich neighbours such as Saudi Arabia, Kuwait, Qatar and Abu Dhabi is rosier. Despite having only 40m people, these countries have two-thirds of the world's oil and 45 per cent of its gas reserves. Debt levels are minimal and recent high hydrocarbon prices have led to huge reserve accumulation of over $1,000bn.

Gulf countries plan at least $2,000bn of spending on infrastructure projects in the coming years in order to diversify their economies away from oil.

Unlike the debt-fuelled stimulus programmes in developed countries, this fiscal spending comes primarily from current revenues and remains viable even with oil prices at $40. Above this level, surpluses continue to accumulate, with Saudi Arabia increasing its reserves by over $350m a day at current oil prices.

Regional corporations, including many of the listed companies in Dubai, have reorganised this year and positioned themselves to participate fully in the ongoing infrastructure boom. Companies also benefit from major structural advantages such as low or no taxation, cheap feedstocks such as natural gas for petrochemical companies and free land for real estate developers. These factors should allow the return on equity to go back to historic levels of around 25 per cent next year, compared with the 10-15 per cent of other emerging markets.

The financial sector makes up half of the Gulf's investable market and has weathered the credit crisis impressively. Banks have made sizeable provisions and reined in lending as non-performing loans peak in the coming quarters. Their understandable caution has led to pent-up demand for credit in addition to new lending required to support infrastructure projects. The market revival will be helped by low interest rates and accommodative monetary policy as Gulf currencies remain pegged to the dollar. Money supply is growing at a double-digit rate and once velocity increases and banks start lending, local asset prices should rise.

As these markets enter the main emerging indices in the next few years, a key structural shift will be a move from current foreign ownership levels of less than 3 per cent to the 40-60 per cent typical of other emerging markets. After halving last year and not participating in the recent rally as they remain off-benchmark, valuations are low, at nine times 2010 earnings, compared to over 14 times for Asian markets. Gulf markets have historically traded at above 20 times earnings as profitability and earnings growth have been structurally high. Local governments consistently reinvest their surpluses into local markets with this flow augmented by leveraged retail investors who make up the bulk of regional volume and who will chase upwards market movements.

As with any market, there are risks. If oil drops significantly below $40, proposed projects may be rescheduled or restructured. The region also remains susceptible to an increase in geopolitical risk, although this might be partially balanced by an accompanying spike in oil prices.

Opaque family groups have a large presence in these markets, particularly in Kuwait where the main families have significant corporate cross-holdings in a manner similar to the Korean chaebols. These groups have traditionally been conservative, but as seen with the recent troubles of the Saad and Algosaibi groups in Saudi Arabia, some may have over-extended themselves.

Many Gulf companies are run by western expatriates and corporate access is surprisingly good with transparency improving, but large numbers of companies (and governments) are still not accustomed to the requirements of investors.

While Gulf markets may remain under pressure in the short-term as the fallout from Dubai eases, the outlook for 2010 and beyond is strong, with significant and sustainable earnings growth as government spending accelerates.

Indeed, we have already seen sharp recoveries in the Qatari and Egyptian markets, which sold off dramatically when they reopened earlier this week. As global stimulus programmes taper off and the durability of the global consumer is put to the test, foreign inflows should increase and become increasingly sticky as these markets gradually move into the mainstream.