Fall Together, Rise Alone!

This is a strange pair of two markets, Saudi Arabia and India. One is a rich oil producer sitting on huge amount of wealth and is 7 times richer than India on a per capita basis. Another is a growing emerging market three times the size of Saudi Arabia.

On the 31^st of January 2005 the TASI index was at a modest 8,231 points while the SENSEX was at its modest 6,555 points. Since that date the TASI index peaked at 20,643 points on 28/02/2006 while the SENSEX peaked to 20,286 points on 31/12/2007. The global credit crisis in 2008 brought them down together (as they did to all the markets in the world) with their bottoms reaching during February 2009 shedding 79% and 56% respectively (from peak) of their values. However since that date SENSEX bounced back to post a return of over 100% while Saudi Arabia totters. This has created a chasm between the two markets in terms of long term returns. During the last 5 years, Sensex produced a negative annualized return of 2% against negative annualized return of 5% for Saudi Arabia. Strangely enough oil prices seem to correlate more to Sensex than to Saudi index TASI (may be spurious correlation!). 

Obviously this bounce back for India has produced some valuation excesses compared to Saudi Arabia. India currently trades at a p/e level of 15 (median is 16.5) while Saudi Arabia trades at 12 (median 14). Due to low valuation, Saudi offers better dividend yield (4.1%) compared to India’s 1.4%.

For the future, the following scenarios emerge:

1. The differential gap narrows with Saudi rising and India staying put or falling

2. The differential gap widens with India keeping up the bull momentum and Saudi straying sideways as has been the trend of late

3. The differential gap stays put with either both markets witnessing upward moment or both markets witnessing side way movement.

We would go with 1 above since valuation for Saudi Arabia borders on reasonable, government spending remaining strong, and oil price continuing to maintain strength. Time for pair trading among uncorrelated markets!

Comparison	KSA	India
GDP Constant USD Bn	657.049	1,946.77
GDP Per Capita PPP (USD)	25,722.00	3,851
Market Cap (USD Bn) (22/Nov/2012)	365	550
Mcap/GDP	56%	28%
Exchange	Tadawul	Bombay Stock Exchange
Index	TASI Al Share Index	Sensex
Performance (CAGR)
5 years	-10%	-2%
3 years	2%	2%
YTD 11/12	1%	20%
Standard Deviation (2007-2012)	37%	45%
Correlation	38%
total number of Stocks Listed IN Exchange	177	11,132
No of stock in the Index	ALL	30
Top 5 companies in index and their weight	SABIC: 20%	ITC 10%
	Al Rajhi Bank: 8%	Reliance 8.75%
	Saudi Telecom: 6%	HDFC Bank 8.05%
	Saudi Electricity 4.1%	HDFC 7.61%
	SAMBA Financial Group 3%	ICIC Bank 7.52
Current Index Level (27/11/12)	6,462	18,537
Historical peak (2005-12)	20,643 (Feb.2006)	20,232 (Dec.2007)
Historical Trough (2005-2012)	4384 (Feb.2009)	8891 (Feb. 2009)
Peak to trough (2005-2012)	-79%	-56%
Trough to current (2005-2012)	47%	108%
current P/E	12	15
Median P/E	14.1	16.4
Max P/E (2005-2012)	18.8	26.3
Min P/E (2005-2012)	7.8	9.0
Div Yield	4.1	1.4

Author:

M.R. Raghu & Humoud Al Sabah

Never Scream Sell in GCC!

We have been regularly monitoring analysts’ recommendations in GCC and notice a weird trend. Most of the calls are either buy or hold. Look at the table below:

Table 1- Recommendations Vs the S&P GCC

Since 2010, analysts scream either a buy or hold nearly 90% of the time. In the 2.5 years of study, only during 2H 2010 the market turned reasonably positive validating the scream. In all the other cases, the market movement was totally in contrast to the scream, especially during 2H 2011 when markets tanked 8.2% while 96% of recommendations were either buy or hold. This applies even at stock specific levels. We produce below some instances where analysts steadfastly screamed buy regardless of sharp drop in share price and side way movement for a long time.


 

Etisalat is a classic example where analysts were screaming buy from Dhs 16 all the way to Dhs 6.5! Thereafter the stock moved sideways since the last 2 years and even then analysts still screamed buy all the way. Another good example would be First Gulf Bank.

 

Analysts screamed buy when the stock was quoting at Dhs 13 and they continue to yell buy till the stock tanked to Dhs 4! After this episode, we notice a string of buy recommendations and some hold recommendations while the stock moved sideways for the last 2 years.

 

While we did not notice buy screams for Industries Qatar at the peak of the market in 2008, we noticed several hold and buy recommendations during the last few years when the stock performance was more or less flat.

So, the aggregate data presented in the tables above as well as stock level calls presented clearly point to one trend: analyst’s pre disposition to scream buy or hold rather than sell. We must say here that it is quite possible that we may have missed out on some recommendations especially those research notes that are proprietary and are not freely available for public viewing. In spite of this failing, we still believe that analysts are more prone to issue a buy/hold rating on a stock in GCC than sell.

It is interesting to understand the psychology behind this phenomenon which we espoused in our earlier blog and we feel they still stand the test. Here is our list of reasoning:

1. Buy recommendations can be acted upon even by new investors (suits the agenda of sell side brokers) while sell recommendations can only be acted by those who hold them (small universe) 

2. Sell recommendations are almost always unpopular with companies and hence will not serve investment banking needs and other favours.

3. Sell recommendations are not acted upon as much as buy recommendations as it means accepting a mistake. (Behavioural finance!). It is difficult to take small loss than a poor but positive return.

4. Analysts are well served by companies they research when they give buy recommendation. They will have more access to information (extremely critical in GCC) next time around since they are in good books of the company.
 

5. In the GCC, absence of derivatives market makes it difficult to action sell recommendations except by portfolio managers. Even where derivatives market enables one to short, since the loss on short position tends to be unlimited, it has limited application (given the risk management pressure).

 

For these reasons, we believe GCC will be a “buyers” market for some time to come.

Author: M.R. Raghu, CFA & Humoud Al-Sabah

Kuwait Top 15 Index

Executive Summary

Kuwait Top 15 Index was introduced to mirror the performance of the market as a whole while making it easier for fund managers to track the index by reducing costs and liquidity concerns. The Kuwait 15 differs from the Kuwait weighted Index and the Price index since it only takes into consideration the top 15 companies according to liquidity and size rather than taking the whole universe which contains hard to invest companies due to minuscule size and low liquidity.

 

International accessibility

Kuwait 15 Index (K15) simplifies investment procedures for fund managers and foreign investors demanding exposure on the Kuwaiti market since the market is top heavy, it makes little sense for index trackers (I.E ETFs) to be fully invested in KSE weighted index and/ or Kuwait Price index in order to mimic the movement of the Index. The K15 index will simplify the process of Index investment; reduce transaction costs and liquidity risks while maintaining low tracking error (since fund managers will only invest in 15 companies rather than 105)


 Non-Oil GDP contribution
One of the main reasons for choosing the KW15 index was “ to be a bellwether indicator of the Kuwait Economy1” we checked this hypothesis by looking at the non-oil GDP contribution of the top 3 contributors2; Financial institutions, Transport storage and Communication and to some extent whole Sale and retail trade. Our findings shows that currently the Kuwait 15 index represents 57% of Non-oil GDP thus it could be used as a “rough” indicator on economic conditions

Limitation
The current structure of K15 gives the optimal exposure on KSE market movement however; missed opportunities from investing in this index might arise including:
1) The index is currently over-exposed to the banking sector; hence it could not accurately gauge performance in other sectors.
2) Although effective in gauging market sentiment, active medium-cap style managers will have larger tracking error since mid-caps are nowhere near the top 15 index.

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