Markets

Duncan Mavin is a former Bloomberg Gadfly columnist.

Saudi Stock Flop
Source: Bloomberg data

For all the meltdown in relations between Iran and Saudi Arabia, the two Middle East countries have got something in common -- at least in terms of markets.

This time last year, Saudi authorities promised to open the country's stock market to an anticipated wave of direct foreign investment. In 2016, it's Iran's turn -- if sanctions are lifted soon, then a tide of foreign money could flood in.

But that's where the similarity ends. The Saudi market's opening has been a short-term flop thanks mostly to the slump in the price of oil. The Tadawul All Share Index slumped 17 percent last year -- a miserable run that coincides with the move to let foreigners put money directly into shares, which took effect in June. 

Previously, overseas investors had to make do with exchange-traded funds and so-called participatory notes. Far from rushing into Saudi stocks, foreigners have pulled funds out of the market each month since they were allowed to invest directly, according to Deutsche Bank. Foreigners now own a smaller proportion of the market than they did a few months ago -- 4.57 percent of Saudi shares at the year-end compared with 5.03 percent at the end of July, according to data from the Saudi Stock Exchange. 

Saudi Arabia Foreign Fund Flows
Outflows have dwarfed inflows in the past year
Source: Deutsche Bank

It's hard to see the downward trend reversing until the price of oil picks up, lifting the country's energy-dependent economy. The government is responding to the decline in oil prices by belt-tightening and shifting more of the economy into the private sector. That could help some industries, such as healthcare as more people are forced to take out health insurance. But the greater concern is that austerity fuels domestic political turmoil in one of the most stable regimes in the region.

Low oil prices hurt Iran too of course. But Iranian oil exports have already been crippled by sanctions, falling steadily over the past several years. That's curbed economic growth: the IMF estimates GDP growth slowed to 0.8 percent last year from 4.3 percent in 2014. Lifting sanctions will boost Iran's exports, cut import costs and give the population access to assets overseas. Real GDP growth could hit 5.5 percent in 2016/17 and 2017/18 before settling into as much as 4 percent annual growth after that, according to an October report by the IMF.

For Iran, the lifting of sanctions is a bigger, broader deal than simply giving overseas investors direct access to stocks, as Saudi Arabia did.

There's room for improvement in Iranian stock valuations too. Charles Robertson, Renaissance Capital's global chief economist, notes that investors rate Iran poorly for ease of doing business and on perceptions of corruption. Still, based on those two measures, Iranian stocks should command a valuation of about 10 times earnings, whereas they're priced at just about 5.5 times now, he notes. Even after their recent decline, Saudi shares trade at about 15 times earnings on average, according to Bloomberg data.

If the sanctions are lifted in the next few weeks, more foreign investment should flow into Iran, and valuations should rise sharply. And while there are plenty of reasons to be skeptical about Iran's market -- not least high inflation and political risk both at home and in the region -- there's also the prospect of a significant boost to the market from the repatriation of Iranian money frozen overseas. One of Iran's senior central bank officials told Bloomberg News last year that as much as $29 billion sitting offshore could make its way home. That cash could help shore up the country's banks or it might be spent on much-needed capital investment. Either option would boost local equities.

Betting on another Middle East market opening up comes with many caveats, in particular the risk that tensions between Sunni-dominated Saudi Arabia and Shiite Iran spiral much further. It's hard to see how sanctions could be lifted if the crisis intensifies. But Iran has enough incentive to cool matters first.  If it does, Iran's stock market may have a better international debut than its Saudi counterpart.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Duncan Mavin in London at dmavin@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net