Hard to see much upside for UAE stock markets

If you examine the chart of the Dubai Financial Market then a classic pattern indicating a change of direction has formed: a head and shoulders pattern. The Abu Dhabi Securities Market also shows signs of a topping formation.

This looks to be the end of the rally that started at the end of Ramadan last autumn. The rally was the expected bounce back after the crash of 2006. But such rallies are typical of the patterns seen after crashes in emerging markets.

Unfortunately the standard pattern that follows is a fall back to the market bottom that followed the crash, and then a flat-line, usually for two to four years.

But this is not just a matter of technical analysis. There are fundamental reasons not to be confident about the outlook for UAE stocks, despite a healthy local economy. And let us not forget that the Chinese economy boomed in the early 2000s while its stock market flat-lined after a crash.

Profits flatten

One worry is that company profits are growing more slowly now, and that in some cases profits are now trending down slightly. UAE bell weather stock Emaar Properties, which accounts for around a quarter of the value of the combined markets, has said profits for 2008 will be flat.

Given the steep growth in profits from this Dubai real estate giant, to maintain such high profits is an achievement. But for stock markets profit growth is what drives valuations and share prices.

If Emaar is ex-growth then this is negative. And the recent cancellation of the latter's $1.6bn IPO in India is bad news on top of the poor recent performance of John Laing Homes, the second largest US homebuilder bought by Emaar for $1bn just before the sub-prime crisis hit. International profits were supposed to keep Emaar's profits rising as Dubai sales slowed, and this is not happening.

Besides high inflation rates and surging salary levels are beginning to eat into the profits of many companies in the UAE. One recent survey showed that around a third of companies can pass these costs onto their customers but a half can not. Again there is a break on growth in local profits that is stock market negative.

Increased volatility

Recent volatile trading activity in the UAE has also become concentrated into a few stocks. This is usually a top-of-the-market indicator as we saw most recently in the US last autumn.

Also it is notable that the largest stock market of the region, Saudi Arabia has crashed sharply with global markets in January and shows little sign of recovering. Saudi Arabia is a market driven almost entirely by domestic investors who seem worried about the outlook for the oil price, and the downturn has been aggravated by the withdrawal of funds for large IPOs.

Local analysts point to an increasing correlation between movements in global equity markets and regional markets. In the case of the UAE the big influx of foreign buyers since the crash makes this more understandable, although it is actually the local investors who are selling and the foreigners holding on to their stocks.

But with global stock markets seemingly set for a volatile year, the idea that UAE stocks will decouple and outperform looks increasingly unlikely.

See also:
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