Investing: A Boom in the Desert

Global financial markets from Mexico to Malaysia have magically followed the same rhythms this decade, their fortunes ebbing and flowing in tandem almost on a daily basis. And then there's the Middle East—a world unto itself, largely untouched by global impulses. Equity markets there went through their own boom-bust cycle over the past couple of years, even as stocks elsewhere kept scaling new heights. Now, as equity volatility increases in much of the world, and investors are frantically searching for assets that don't zig and zag with major markets, these bombed-out Middle East markets suddenly seem appealing.

In some ways, they are where mainstream emerging markets like India and Brazil were in the early '90s. Foreign investors are still few. Retail investors dominate trading and institutional participation is scant. Corporate governance is sketchy, and company management far from transparent. Momentum trading, rather than fundamental research, powers stocks.

But the parallels end there. The financial and economic profiles of the core Middle Eastern markets—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates—are remarkably different. For one, these markets, collectively called the Gulf Cooperation Council, or GCC, are liquidity hothouses with surpluses galore. A boom in oil prices has led to a surge in financial savings in the region, with these economies running combined current account surpluses of more than $200 billion a year, or more than 20 percent of GDP. Estimates put the total financial wealth in the region at $3 trillion, compounding at 20 percent a year as oil revenues continue to spill over.

There's been a lot of talk about how this plethora of petrodollars is contributing to the so-called liquidity boom. But unlike the 1970s boom, this oil-related wealth isn't being frittered away. Three decades ago, 70 to 80 percent of the oil windfall went into regional conflicts, higher defense spending and the related kickbacks. Now 70 percent of the oil revenue has either been saved or used to pay down debt. The raw wounds of the previous two decades, when some of the GCC countries stumbled from one financial crisis to another, has led to a policymaking framework that's more conducive to growth. Over the past five years, these economies have more than doubled in size, and at $750 billion, they form a meaningful economic bloc.

All this will ensure that the GCC complex avoids the fate of the '80s, when oil prices plunged and left a massive hole in the region's financial position. Already, the burgeoning financial surpluses helped the economies avoid collateral damage following a collapse in their local stock markets last year. Governments were able to offer financial relief with discounted IPOs of state-funded assets, and kept the investment boom going with huge new infrastructure projects.

This ensured that GCC economies continued to expand at a rate of 5 to 7 percent. Supported by a robust earnings profile and deflating stock prices, the markets have gone from being stratospherically valued a year ago, with price-earnings (P/E) ratios in the range between 40 and 60, to now being reasonably priced, with P/E multiples in the midteens. It's hard to remember when bubbles last burst with such a whimper.

Is the GCC bloc now a credible regional-asset class? The problem is thinking of the GCC markets in strategic terms. These aren't typical emerging-market success stories, driven by accelerating per capita income growth and a large group of domestic consumers. The per capita income of GCC countries is already high at $20,000.

A major structural issue is the concentration of the income pie. While the rulers of the region are indeed under pressure to liberalize, given the demographic challenge posed by population growth averaging 4 percent, they don't want to cede control and wealth. In addition, the quality of the homegrown talent pool is poor. To break away from the oil ball-and-chain, the GCC countries are frantically trying to build their way to prosperity. Dubai's service-sector hub model is being copied from Bahrain to Qatar. But that can't be every country's sustainable competitive advantage.

Still, despite all the long-term shortcomings, it's encouraging to see that even in one of the last outposts of globalization, economic religion is spreading. Relatively high growth should stick for at least a while. Excesses in the market have been weeded out, and listed companies are gaining international exposure. That backdrop presents global investors with more than a few interesting opportunities. Given the heightened interest of foreign investors, the day is then not far when the Saudi market, too, begins to take its daily cue from how the Dow performed overnight, and what the Shanghai index did in the morning.

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