Bloomberg/ Kuwait City
Kuwaiti companies will enter the popular emerging-market stocks benchmark compiled by MSCI Inc this month. But you would barely know it looking at the main local equities index, which has failed to stage the customary rally before such an elevation in status.
MSCI is due to unveil its semi-annual index review on Tuesday, disclosing Kuwaiti shares to be added to the MSCI Emerging Markets Index that is widely followed by fund managers. The Gulf State’s inclusion, initially expected in May, was postponed due to operational difficulties associated with the coronavirus outbreak.
Typically, investors rush to buy shares in soon-to-be upgraded markets the moment their pending promotion is announced, for a head start on the flood of money from passive funds – a window that usually lasts about a year. That’s been the case in other countries in the region, such as Qatar.
But coronavirus restrictions, the slump in oil prices as global demand plunged and the blow this dealt to Kuwait’s economy sent a chill through the stock market. The Premier Market index, down 12% for the year, is trading below the level seen before MSCI first announced its intentions to raise the country from its frontier markets group. The gauge climbed 0.5% on Monday, versus a 1.2% advance for MSCI Emerging Markets.
Given the uncertainties around the pace of recovery for the local and global economies from Covid-19, “it would be hard to predict the market direction after the MSCI EM inclusion,” said MR Raghu, executive vice president at Marmore Mena Intelligence. “Profit-booking is commonly observed after an index upgrade, as the market tends to rally into overvalued territory following the euphoria surrounding the index inclusion.”
Adding to the problem is the high valuations on local stocks. The Kuwaiti index trades at more expensive multiples than the emerging-markets group when comparing price to estimated earnings in the next year, making them less appealing to active investors that don’t necessarily follow the benchmarks.
“The far-reaching effects of the Covid-19 pandemic have had a material negative impact on the market’s earnings outlook,” said Salah Shamma, the head of investment for Middle East and North Africa at Franklin Templeton Emerging Markets Equity. “This coincided with elevated valuations as investors positioned themselves for the market’s inclusion into the wider EM index.”
Shamma expects valuations to “significantly” come off the current high as earnings normalise in 2021 and the inclusion trade unwinds. “We continue to be selective in Kuwait and favour resilient businesses that have the balance sheets and the flexibility to adapt to the new world post-Covid-19.”
To be sure, Kuwait shares are trading higher since an earlier upgrade by index compiler FTSE Russell back in 2017, and were the best performers in the six-nation Gulf Co-operation Council last year. Kamco Investment Co forecasts about $2.9bn of flows from passive investors after the full implementation of the promotion, down from an initial projection of $3.1bn.
“Boursa Kuwait is currently trading at early 2019 levels, a period before the confirmation of the MSCI upgrade,” Junaid Ansari, vice-president for investment strategy and research at Kamco, wrote in a note. “This could result in a significant upside for the overall market.”
That said, the Covid-19 pandemic and its impact on the Kuwaiti economy and corporate profitability “are the key risks in the near-term,” he wrote.
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