|By K Raveendran| There is much hype about the opening up of the Saudi stock market, but any detached view is least supportive of optimism.
The more realistic assessment is based on the fact that the market has already factored in the positivity and moved too far ahead in the expectation of large foreign inflows, making the market expensive for any new entrants.
According to the assessment of Bank of America Merrill Lynch, given the expectation for large foreign inflows, the market has re-rated strongly, with P/E’s expanding 31 percent year to date. This is despite net earnings downgrades of 13 percent and a very weak earnings revision ratio, which has been below 1.0 since May 2014.
This strength has left Saudi market looking relatively expensive to both historical levels and relative to emerging markets on a range of valuation metrics. According to BofA Merrill Lynch, the market is trading on a 12 month forward P/E of 16.4 times, a 16 percent premium to its post 2009 average and a 31 percent premium to the emerging markets.
A serious problem with the Saudi market is that the fundamentals look relatively unsupportive, especially in the near term. BofA ML has based this assessment of the weak earnings momentum and the weakness in oil prices, apart from the high valuations. The premium valuation can be observed across most sectors.
It says the Saudi market suffers from a very weak earnings revision ratio of 0.27, indicating a significant higher number of downgrades than upgrades. Also, given a relatively over supplied market and signs that US supply growth could resume amidst the recent run up in prices, the oil price outlook is negative.
While the Saudi market’s correlation to the oil price has weakened since 2008, a sharp downward correction could raise concerns on the economic outlook for the Kingdom and its ability to meet public spending commitments without drawing against reserves.
These considerations have prompted the bank to go underweight on the Saudi equity market. Consequently, the bank’s investment strategy calls for caution and reliance on stock picking to generate superior returns.