Below is a recap of the performances of GCC stock markets for the first half of 2011:

The Saudi Tadawul index lost 19.6% in value in the two weeks following the unrest in Bahrain; however, it recovered all the losses which were helped also by the increase in oil prices. The index gained 24% from its lowest level on the end of February. The Tadawul is down 0.39% YTD.

Oil prices, which increased 17% since Feb 14^th at the time Bahrain saw some protests, positively affected the petrochemicals sector, increasing its value by 29%.

Below is a YTD chart of both the Tadawul and the petrochemical index; the petrochemical index crossed to the positive zone for the year. However, on a case to case basis not all petrochemical stocks are positive for the year thus this might potentially trigger a catch-up play.

Oil prices have surged over 25% since the onset of the Libyan crisis on February 15th. The geopolitical risks in Middle East region warranted a risk premium to oil prices as protests from Bahrain to Libya increased oil supply uncertainty. Libyan rebels have been marching towards Tripoli with support of the Allied forces. They recently captured the oil port of Ras Lanuf and a resolution of the crisis seems closer.

Also, the risk of unrest spreading to Saudi has been diminished as King Abdullah proposed several economic reforms and Bahrain has stabilized. Couple these factors with a huge surplus of oil in the U.S. and a well-supplied oil market and the logicial conclusion would be an immenint sell-off in oil prices. Thus, I think oil prices will go down to around $90. What do you guys think?

Although Bahrain is a small economy and does not produce much oil, it is lauded for its position as a regional banking and Islamic financial hub and its diversified economy. Given the recent events, a diversified economy isn’t enough anymore as people are shifting their talks from sovereign defaults to political instability. Recent political unrest that has been spreading around the region has reached Bahrain, adding more risk to the economy as the 5-year credit default swaps reached record levels of 304bps, up 64% YTD.

This has placed a burden on all GCC markets, as most markets fell sharply last week sending the S&P GCC Large Cap Index spiraling.

Things doesn’t seem to be improving this week; the Saudi Tadawul has lost 1.6% yesterday and as I’m writing this article the Kuwait SE is down 2.6%, Doha stock market is down 2.3%, and the Dubai (DFM) is down 2.1%.

Kuwait’s Weighted index outperformed the region (given that it significantly underperformed the region in 2009), and Dubai lagged the region (Dubai debt probelms).

The best and worst performers of 2010 on the Kuwait Stock Exchange are:

In closing, we wish you a happy and prosperous New Year, filled with financial joy!

We can see from the graph that Iraq is the highest, i.e the most change in the Dollar amount since 2005, mainly due to the reconstruction of Iraq after the war. The UAE comes second. But what is interesting to see is that in April/May of 2009, developments in the UAE dropped substantially, since many companies cancelled their projects due to liquidity constraints. No other country saw that big of a drop. What made me curious is that Qatar is the most lagging country among the pool, which is hard to believe since we hear a lot about projects in Qatar, especially relating to the Oil and Gas industry.

2009 was a good year for the GCC and the world, but how good? Well, only “relatively good!” The global financial crisis took its toll on the GCC market as it was hurt by the dull impact of the declining oil prices and the overall economic slowdown. As the recession reduced demand for oil, prices dropped to as low as $32.70 a barrel on January 20^th 2009, after touching a record $147.27 a barrel in 2008. In 2009, the weakening dollar bolstered the investment appeal of commodities, and the “Chinese effect” has helped push oil prices back to the 80’s range.

With the expected introduction of the Gulf Cooperation Council (GCC) single currency in 2010, the peg issue is gaining a lot of momentum in the region these days. Should the unified currency be fixed to the U.S. dollar, to a basket of currencies, or simply let the currency float with ongoing exchange market interventions. In 2003, GCC countries pegged their currencies to the U.S. dollar in efforts to facilitate the launch of the Gulf monetary union and single currency. As close allies to the U.S. and oil exporting nations, GCC countries felt it was necessary to peg their currency to the dollar since their primary export, oil is sold in dollars. However, that has resulted occasionally in times of economic destabilization and surging inflation. Over time, GCC exports have become more diversified and a more flexible exchange rate policy such as pegging to a basket of currencies might provide more stability to the region.

As the U.S. dollar plunged to a 15-month low debate has intensified on the choice of type of exchange rate regime.  With the exception of Kuwait, which dropped its peg to the U.S. dollar in 2007 in favor of a basket of currencies, Bahrain, Saudi Arabia and Qatar are still pegged to the dollar. While Kuwait has no plans to return to the dollar peg, both Qatar and Saudi Arabia have repeatedly questioned their dollar currency peg.

Pegging to a basket of currencies has provided Kuwait with a more flexible monetary policy than it used to. With the extraordinary amount of debt the U.S. government has taken, weakening dollar, and record low interest rate- GCC countries should begin to reassess their exchange rate regimes before inflation gets out of control once again. The rising oil prices and anticipated growth in the GCC region could spur inflation once again.

Should they continue in lockstep with the U.S. monetary policy and simply wait for the Fed to raise interest rates, or is time to shift to a basket of currency peg?

I know I misquoted Clinton’s famous election phrase, “It’s the economy, stupid.” For the US in 1992, it was the economy. In Kuwait, people wonder what is our problem. Some say it is political, others say social, and the financially savvy like to point to the economic side as the culprit. The best answer to that question is, “It’s everything, stupid.” Everything: we are dysfunctional from a political, social, and economic perspective.

Political:

The country is daily riding a roller-coaster of politics orchestrated by a  cynical populist parliament and a fragile inefficient government. The political roller-coaster is circulating in a never-ending fashion from impeachment to dissolution. When is it going to end? I don’t want to elaborate on the political side. For more, refer to my previous post titled, “Parliamentary plays derail reform.”

Social:

Why it it that everyone in Kuwait regardless of their wealth live the most lavish lifestyle? The answer is simple: why not? Charge it on a credit card and expect the government to forgive loans. It is sad that a graduating senior from a Kuwaiti high-school’s dream is not to get into Harvard, but to drive a Maserati and upgrade to a Ferrari after college graduation. I remember a time when I was a kid and I used to enjoy going to my family’s weekly gathering to go to the supermarket and buy candy. You know what is a Kuwaiti kid’s dream nowadays? A Blackberry phone and an Abercrombie & Fitch t-shirt. This consumer mentality has to come to an end. More importantly, the parenthood relationship between the government and its citizens has to be abolished. There is severe moral hazard in our nation and its a vicious downward spiral cycle. Our government acts as a free collection agency for businesses. Our parliament sponsors morally hazardous acts such as sending families for tourism in the name of sickness and proposals such as debt forgiveness and “attractive” laid-off employee benefits. Our citizens enlist in unheard of universities in the likes of Zimbabwe and the Philippines to get a high-paying government job doing, well, nothing.

Economic:

We were the first to establish a stock market in the GCC, but today we are the only country without a governing Capital Markets Authority. It hurts, so I don’t want to talk about where we were, coulda, shoulda, and woulda. I wish I could say it in a different way, but what is happening in Kuwait’s stock market is a disaster. The domino effect is unstoppable without government intervention, regulation, and a complete overhaul of the economic system. We desperately need to instill confidence in our stock market. We want to send a message to everyone that what happened during Souq Al-Manakh crisis was a one-time event that isn’t currently in the making.

The government has to take the initiative and push for a new era of economic transparency and development. We need a Capital Markets Authority that acts as a watchdog that punishes all malpractices in the industry. Isn’t it humiliating to see the United States question manipulations by Kuwaiti individuals and companies while no one in Kuwait addresses these issues? Isn’t it ironic that market leaders are currently on the verge of bankruptcy? With added transparency, investors would have enhanced clarity and can potentially make an informed decision as opposed to gamble or leverage on an insider tip. Rest assured that the wounds of burnt foreign investors will take time to heal and it will be challenging to win them back. The establishment of a Capital Markets Authority is pivotal to the critical process of confidence restoration in our financial system. What we lack in Kuwait is priorities. Why don’t we organize and push for passing the Capital Markets Authority in the parliament? Let us prioritize our problems and address them in a one-by-one basis instead of being overwhelmed by their magnitude.

After the Agility controversy last week, people are left wondering what could stop the free-fall of our stock market? As with any solution, there is a short-term and long-term approach that need to be addressed in tandem. Establishing a Capital Markets Authority helps in the long-term, but shorter-term we have to focus on addressing the issue at hand. The reality is that our stock market is made-up of a few Chaebols*. These few Chaebols have numerous companies attached to them. These numerous companies ultimately depend on the success of the few and the few are all in trouble. The biggest four companies by market capitalization in the Kuwait Stock Exchange are Zain, NBK, KFH, and Agility. There used to be Dar and Global, but there are gone.  Zain is operationally challenged and its owners want to bail-out (but seemingly can’t), NBK will be hit hard if Zain owners can’t sell their stake, KFH depends heavily on real-estate and with the wealth destruction in Kuwait there is no hope there, and Agility’s sheer existence is being challenged by a complex fraud case.

I believe government intervention should be through recapitalizing banks. The government should simply buy a 5-10% stake through new share issuance by all banks. This will provide banks with much needed cushion for taking write-downs. Instead of the never-ending provisions drama, let us mark down these assets, take the hit, and move on. The US is a perfect example of such successful approach. Establishing a portfolio that buys into stocks and tries to lift the market is a very limited solution. The government is only addressing a symptom when it does that and should do that simultaneously with other solutions proposed.

*Chaebols: large, conglomerate family-controlled firms of South Korea characterized by strong ties with government agencies.

As Keynesian implied, Qatari banks had their share in the rally which is evidently reflected in their high P/BV multiples. Kuwaiti banks have always traded at a premium, but we got a multiple of 2.47x after omitting Gulf bank’s figure. Boubyan bank is trading at an acquisition premium, hence justifying the high multiple. I believe Burgan Bank is trading at an attractive level. UAE banks seem to be the most attractive, but we have to take a closer look at the quality of their loan books.