Inclusion in MSCI EM Index Fuelling Bullish Sentiments for the Saudi Stock Exchange

Published on 13 Jul, 2017

On the 20th of June, 2017, the Morgan Stanley Capital International (MSCI) announced that it would include the MSCI Saudi Arabia Index in its 2018 edition of the Annual Market Classification Review, potentially in the MSCI Emerging Markets (EM) Index.

Qatar and the UAE are the only two nations among the GCC countries that are part of the MSCI EM Index right now.

Inclusion in the MSCI EM Index is a gradual process. After an announcement in 2012 of a likely inclusion in the Index, over two years of scrutiny passed before Qatar and the UAE were made part of the MSCI EM index. This inclusion process for the MSCI EM Index had been divided into 3 phases as follows:

• Phase 1 — In its 2012 annual market classification review, the MSCI had announced that MSCI Qatar and MSCI UAE indices would remain under review for a potential reclassification to Emerging Markets as part of the next Annual Market Classification Review in June 2013. 
(Source: MSCI Press release dated 20-June-2012)

• Phase 2 — After a year had passed,  the MSCI had announced in 2013 that it would reclassify the MSCI Qatar and MSCI UAE indices to Emerging Markets as part of the May 2014 Semi‐Annual Index Review. 
(Source: MSCI Press release dated 11-June-2013)

• Phase 3 — The May 2014 Semi‐Annual Index Review concluded on the 29th of  May, 2014.

Qatar and UAE Indices Rally, Led by an Inclusion in MSCI EM Index and Various Other Country-specific Factors

The Qatar and UAE indices have performed exceptionally well over these phases outperforming its GCC peers by a wide margin, as evident in the following chart: 

Qatar has risen over 65% from Phase 1 to Phase 3. The Qatari market reflected the Qatari financial market’s progress at various technical, regulatory, and operational levels, with the inclusion of Qatar’s markets in MSCI EM Index, higher than expected corporate profits, better investor confidence, a sound banking sector, and continued domestic economic growth to name a few.

Similarly, the UAE’s markets rose sharply over Phase 1 to Phase 3 as well. The rally was fueled by real estate stocks amid bullish investor sentiments about the future, encouraged by economic prosperity in the oil-rich country as well as the complete recovery by the real estate sector from the crisis that engulfed it in 2008. The UAE’s inclusion in the MSCI EM Index further boosted investor sentiments, leading to a huge inflow of foreign funds that provided further impetus to the markets.

TASI is Expected to Surge 57% Over the Next Two Years in a Base Case

We have worked out the expansion in valuation ratios for Qatar and the UAE over a span of 2 years from the beginning of Phase 1 (20-June-2012) until the end of Phase 3 (29-May-2014). The valuation multiples used for the calculations are 1-year forward Price to Earnings (P/E) ratio, trailing twelve months (TTM) price to book (PBV) ratio and lastly trailing twelve months (TTM) price to sales (P/S) ratio.

The expected expansion of the valuation ratios has been applied to the KSA's multiples, which then leaves us with a base case TASI 2-year target price of 11,665.

We have then adjusted the target multiple for three probable scenarios — bear, base, and bull. 
This expected expansion also factors in several country-specific factors besides inclusion in the MSCI EM Index for Qatar and UAE. In order to adopt a more rational approach, while also factoring the fact that Saudi Arabia is a significantly larger economy than Qatar and the UAE were at the time of inclusion in the MSCI EM Index, we have used an adjustment factor to arrive at a more conservative target multiple. Qatar has risen 65% over the three phases, while Abu Dhabi and Dubai rose 111% and 245% respectively. Hence, we believe that a 57% surge in TASI over the next two years is reasonably achievable, even on a conservative note.

Under a bear case scenario, the target comes to 10,212, implying a 38% upside from the latest close, whereas in a bull case, the index should surge to 13,117, implying a 77% upside from current levels. 

For calculating the expected expansion for two years, a weighted average of the growth from Phase 1 to Phase 3 of the valuation multiples has been considered and assigned country-specific weights as follows:


Expansion in Valuation Multiple for GCC Countries from Phase 1 to Phase 3

The PE ratio for Qatar had widened 49% over the mentioned period, while the Dubai index saw the highest spurt, rising 153%. Our calculations point to an overall weighted average PE expansion growth of 81%. 

The PS ratio for Qatar had widened 58% over the mentioned period. The Dubai index again saw the highest spurt, rising 180%, while Abu Dhabi almost doubled as well. We estimate an overall weighted average PS expansion growth of 101% based on our calculations. 

The PB ratio for Qatar had widened 48% over the mentioned period, and the Dubai index again saw the highest spurt, rising more than 200%. Overall, we have estimated a weighted average PB expansion growth of 98% based on our calculations. 

As evident from the weekly charts, the index has broken out from the triangle formation, which suggests a positive trend. Furthermore, the index also formed a double-bottom pattern (first bottom on January 2016 at 5,348.61 and the second on October 2016 at 5,327.49). It confirmed the pattern on June 21, 2017, at 7,334.87, indicating bullish sentiment among traders and the possibility of a continued uptrend. The RSI on the weekly charts is hovering in the bullish territory, indicating strength in the current uptrend. The index is also showing signs of convergence between price and volume (price rise with increased volume), suggesting increased demand at higher levels. The positive slope of the 20-week EMA implies the uptrend could sustain for a long term (at least for 2–3 years). A Fibonacci projection, the best tool to predict the length of the current uptrend, indicates that the index could test 11,100 to 12,000 over the next 2-3 years.

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