Resilience in the Middle East: improving economic activity and defensive characteristics

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By Mohieddine (Dino) Kronfol, Chief Investment Officer, Franklin Templeton Global Sukuk and MENA Fixed Income; & Salah Shamma, Chief Investment Officer, MENA Franklin Templeton Emerging Markets Equity

The Middle East and North Africa (MENA) region was resilient despite lingering geopolitical uncertainty and rising inflation, according to Franklin Templeton’s Dino Kronfol and Salah Shamma. While Ukraine and Russia are far from the region and the ties are neither direct nor easy to identify, they give their perspective on how local economies are faring in the face of volatility.

Key points:

  • Improving economic activity thanks to a proactive and robust response to the pandemic and a relatively better position against rising inflation compared to other markets have benefited the MENA region this year.
  • Policymakers continue to push for fiscal and economic reforms as well as environmental, social and governance (ESG) initiatives.
  • Gulf Cooperation Council (GCC) bonds are generally high quality and exhibit defensive characteristics due to lower correlation, lower volatility and lower drawdowns than their emerging market counterparts.
  • MENA equity valuations are trading at a premium to other emerging markets, but have been supported by increased earnings growth.

Proactive pandemic response boosts economic activity

Governments in the MENA region have been proactive in establishing an appropriate framework and guidelines to deal with COVID-19 early on, after launching aggressive vaccine deployments. The United Arab Emirates (UAE) leads with a vaccination rate of over 95% for a two-dose protocol.1 The other GCC countries are expected to roll out their vaccines to 90% of the population by the end of the year. Proactive management of the pandemic has allowed economic activity to resume gradually and on a more sustainable basis. We believe this momentum will continue through 2022 as economies continue to recover.

Strong position on concerns over geopolitics, oil prices and interest rates

The MENA region has benefited from higher oil prices, driven by the Russian-Ukrainian war, concerns over Iranian nuclear talks and a significant drop in oil supply during the pandemic. Russia is likely to remain under sanctions, and companies may continue to impose their own sanctions, whereby they refuse to do business with the country, even if the war ends. Substantial new investments will be needed to offset the decline of existing oilfields in order to meet demand. We therefore expect oil prices to remain high over the medium term.

Likewise, global inflation expectations remain elevated and markets have priced in several interest rate hikes for the rest of the year. Unlike many markets where there is a risk of higher inflation alongside moderate growth, in our view inflation remains well entrenched across the GCC given the currency peg and a strong dollar, while growth continues to increase.

Policy makers committed to reforming curricula

One of the risks of rising oil prices is the possible slowdown in the impressive pace of economic and fiscal reforms in the MENA region. To address the imbalances, policymakers diversified their sources of revenue by introducing taxes and limiting spending and subsidies.

Given the Russian-Ukrainian war and concerns over energy and food security, there is a risk that some of the net zero goals and other long-term initiatives will be cancelled. However, we believe the policies are clear and decisions have already been made to be part of the solution as the world transitions to a low carbon economy. ESG disclosures have improved in the MENA region, with the United Arab Emirates and Egypt making ESG disclosures mandatory. Saudi Arabia’s guidelines in this area are also expected to be published by the end of the year, and its sovereign wealth fund has announced plans to issue green bonds soon.

Defensive Characteristics of GCC Bonds

In our view, GCC bonds are a higher quality component of the emerging markets universe and have strong defensive characteristics. They have historically had a much lower level of correlation with other traditional asset classes and lower volatility compared to other fixed income sectors. Year-to-date performance of the global sukuk market, as measured by the Dow Jones Sukuk Index, and the GCC market, as measured by the FTSE MENA GCC Index, has held up well relative to broad credit indices.2 Note that the GCC represents approximately 70% of the Sukuk index. Over the past three years, GCC bonds have held onto their gains, unlike emerging markets. Drawdowns have also historically been significantly lower for GCC during times of market stress compared to emerging markets.

GCC Bonds YTD 2022

In terms of issuance, as the region moves from a budget deficit to a surplus, GCC bonds could lose market share relative to other emerging markets. However, this year, emerging markets are generally expected to issue slightly less, and GCC bond issuance, while lower than last year, is still expected to account for around 30% of overall emerging market issuance.3 A decrease in issuance could also be slightly supportive for bond prices going forward.

MENA stocks benefit from inflows and earnings growth

The liquidity profile and market share of the MENA equity market as a percentage of the MSCI Emerging Markets Index has increased significantly over the past few years.4 We have seen substantial increases in asset flows entering the region since 2021. These flows increased significantly in March 2022, when many emerging market investors shifted their allocation from Russia to the MENA market. GCC’s initial public offerings (IPOs) also had a bumper year in 2021, and strong post-listing performance should continue to provide the momentum needed to push more IPOs through the pipeline.


With robust liquidity and high oil prices, equity valuations have risen and the region is trading at a premium to emerging markets.5 However, earnings growth has also been above trend since 2021, as MENA economies began to recover from the pandemic. We believe earnings will continue to grow in 2022 and 2023, which should support relatively high current valuations. Within the region, there are different levels of valuation. Saudi Arabia is the largest market and its valuations have risen the most among its GCC peers due to strong local liquidity, growing optimism and increased foreign inflows. However, we continue to see valuation dispersion across GCC markets, which have yet to see similar inflows to Saudi Arabia, despite similar macro fundamentals.

Similarly, large-cap stocks in the MENA region have generally performed well since 2016, with liquidity concentrated in this segment of the market.6 However, we believe that the performance of mid and small cap stocks can improve. It is typically these stocks that have exposure to sectors of the economy other than oil, and local demand continues to be robust.

Within sectors, higher interest rates benefited the banking sector, which is an important component of the GCC market. On the liability side, particularly in Saudi Arabia and the United Arab Emirates, it is mainly composed of current account savings accounts (CASA; unremunerated deposits). Thus, the rise in interest rates should lead to bank profitability and we believe that this characteristic is currently appreciated by the market.

Despite the current geopolitical tensions and interest rate headwinds, we see a number of opportunities for investors in the MENA region’s bond and equity markets. However, not all countries are the same, so we believe it is essential to have a local presence in the region, with insight into local markets and economies.

What are the risks ?

All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as bond prices in an investment portfolio adjust to rising interest rates, the value of the portfolio may decline. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Investments in foreign securities involve special risks, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve increased risks associated with the same factors, in addition to those associated with the small size of these markets, their lesser liquidity and the absence of executives. legal, political, commercial and social established to support securities markets. Since these frameworks are generally even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are amplified in frontier markets. To the extent that a strategy focuses from time to time on particular countries, regions, industries, sectors or types of investments, it may be subject to greater risks of adverse developments in those areas of interest than a strategy that invests in a wider variety of investments. countries, regions, industries, sectors or investments.

Any companies and/or case studies referenced herein are used for illustrative purposes only; any investment may or may not be currently held by a portfolio advised by Franklin Templeton. The information provided does not constitute an individual investment recommendation or advice for any particular security, strategy or investment product and is not an indication of the trading intent of any portfolio managed by Franklin Templeton.

1. Source: Our World in Data, as of April 11, 2022.

2. Source: Bloomberg, as of April 7, 2022.

3. Source: Bloomberg, as of December 31, 2021.

4. Source: MSCI, as of March 31, 2022.

5. Source: Bloomberg, closing March 30, 2022.

6. Source: Bloomberg, as of March 31, 2022.

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

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