Jack be nimble, if you want to make money in the Tadawul

Reuters/Hamad I Mohammed

To analyse the valuation range of Saudi Arabia’s stock exchange, you first need to make a forecast for Brent crude oil. Despite higher geopolitical risk, the fundamentals for black gold are bearish on both demand and supply.

So, my forecast range for Brent is $70 to $80 as long as we do not experience a deep global recession.

The latest data from China reinforces my conviction that its property meltdown will send deflation shockwaves across the world.

The Tadawul All Shares Index (Tasi) trades at a price/earnings ratio of 17.6 at a time when its largest sector constituents – banks, oil and gas, materials and petrochemicals – face significant earnings downgrade risk.

In such a macroeconomic milieu, Saudi Arabia’s valuation premium to the emerging market indices cannot be justified. I expect a 12-15 percent correction in the Tasi, since Wall Street is also overvalued.

There are, however, opportunities galore for Tadawul investors who are no longer limited to buying Saudi Aramco or the kingdom’s banks as index proxies.

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Saudi Arabia’s Vision 2030 programme is designed to diversify the kingdom’s economy: reducing the traditional dependence on crude oil exports, boosting the private sector and domestic consumption, creating jobs for millions of young Saudis and attracting foreign direct investment at scale from the West and Asia.

The country’s role as Opec’s swing producer has meant its output has shrunk to 9 million barrels per day, 3 million bpd below its spare capacity level.

The problem is that oil and gas still accounts for 70 percent of government revenues and the fiscal budget breakeven price is far too high at $85 on Brent.

If US interest rates move higher, the Saudi central bank will be forced to tighten monetary policy. A liquidity squeeze at this point in the crude oil/business cycle, with multiple conflicts in the region, could be the catalyst for a stock market correction.

The silver lining in Saudi Arabia is the epic growth in the non-oil sector, strong business confidence and the birth of new industries, subsidised by one of the world’s most future-oriented sovereign wealth funds.

GDP growth could thus rise to 5-6 percent, among the highest in emerging markets. One optimistic metric is the dramatic increase in the female labour force participation rate from 18 percent a decade ago to 30 percent now.

The Tasi gained 14 percent in 2023. Its sharp rise since November reflected the swift fall in US interest rates despite the supply pressures on Brent crude, the deflation big chill in China (the kingdom’s largest oil export market and trade partner) and the escalation in Middle East tensions.

Saudi banks make up 40 percent of the index. So, any disappointment on US rate cuts will hit bank stocks and the broader index in 2024.

A rotation into mid-cap, high-dividend-yield consumer, real estate, construction and healthcare stocks – which benefit from increased foreign ownership limits and a robust listing pipeline – seems an optimal hedge against selling pressure in banking and petrochemicals.

The global macro-outlook in 2024 will be dominated by angst over growth, China’s property meltdown and shadow banking crisis, the wars in Ukraine and the Middle East, the nuances of Fed monetary policy and a US presidential election where Donald Trump is the Republican frontrunner.

This is an environment where volatility metrics in the capital markets can and do rise higher.

In Saudi Arabia, the economic shrinkage imposed by lower Brent crude prices as well as lower output in a rising rate environment also increases volatility in the capital markets.

While China/global macro risk argues against investing in banks and petrochemical stocks, investors can benefit from myriad opportunities in the kingdom’s robust non-oil sector and its diverse domestic growth possibilities.

This suggests investors should increase their exposure to Saudi retail, food and beverage, construction, telecoms, utilities, real estate and healthcare shares.

Nimble sector rotation will be essential to make money in the Tadawul this year.

Matein Khalid is the chief investment officer in the private office of Abdulla Saeed Al Naboodah and the CEO designate of a venture capital firm. He is also an adjunct professor of real estate investing and banking at the American University of Sharjah