Stocks in Saudi Arabia have been rallying, and Jason Tuvey from Capital Economics thinks he knows why.
The Tadawul Index has climbed by almost 6% in March, and now sits at its highest level since August 2015.
It makes the Saudi market one of the few standout performers over the past month — a period in which the US S&P500 has dipped by around 4% amid trade war fears and a selloff in big tech stocks.
Tuvey said oil’s recent climb back above $US70 a barrel would have provided some support for the Tadawul, which is almost a proxy petro-index.
But he cited another catalyst, in connection with recent efforts by Saudi Arabia to become more integrated with the global economy.
“The main driver of the rally appears to be growing expectations that the equity index compiler, FTSE Russell, will upgrade the Kingdom to emerging market status,” Tuvey said.
“The Kingdom has been on FTSE Russell’s watch list for an upgrade since September 2015 – shortly after the Tadawul was opened up to foreign investors.”
Tuvey estimates that the inclusion of Saudi stocks on the FTSE index would lead to an increase in capital flows of around $US5 billion.
And if the Tadawul joins the FTSE, integration onto the larger MSCI index may follow later this year — which could generate further inflows of up to $US38 billion.
Last year, the MSCI announced that stocks on mainland China would be included on its emerging markets index, effective from June 2018.
Benchmarks such as the FTSE and the MSCI open up emerging markets to capital flows from huge global investment funds, who use the indexes as a basis for the composition of their investment portfolio.
However, Tuvey remains cautious about whether the latest developments will lead to a sustained rise in Saudi stock prices.
For one thing, Saudi Arabia’s economy remains heavily tied to the price of oil — despite recent moves by the Kingdom to diversify into other areas.
“We expect Brent oil prices to drop back from $US70 a barrel to $US55 a barrel by the end of 2019,” Tuvey said.
“This would weigh on the stock prices of petrochemical companies, which make up around a fifth of the Saudi stock market.”
In addition, markets can often get over-excited about the prospect of an emerging market joining global stock indexes.
“It’s worth noting that stock markets in the UAE and Qatar fell after they were upgraded to the MSCI EM Index in 2014,” Tuvey said.
So while Saudi stocks have outperformed in March, Tuvey’s conclusion is that the party is unlikely to last.
Capital Economics forecasts that the Tadawual index will fall to around 7,750 by the end of the year — a drop of around 2% from its current level.