EFG-Hermes sees MSCI adding Saudi Arabia to watch list

It’s time to buy Saudi Arabian shares because the kingdom this week will likely begin the formal process for earning an emerging-market tag for its equities, according to EFG-Hermes Holding SAE.The kingdom’s stock market won an upgrade to overweight from underweight from the Cairo-based broker-dealer’s research division before MSCI on Tuesday says whether it will add the country to a watch list. That would allow for its potential classification as an emerging market next year.

Mohamad Al Hajj, equities strategist at EFG-Hermes in Dubai, comments below on what supported the change in recommendation, including the country’s changes to its market rules.
What makes you believe that Saudi Arabia will be added to the watch list?

We believe that the changes to the qualified foreign investment rules done in the second half of 2016, and the implementation of T+2 in April this year should guarantee a place for Saudi Arabia on MSCI’s watch list this Tuesday. Moreover, Tadawul data show swaps holdings as a percentage of total foreign ownership are down from 100 percent to around 50 percent, which means there are more QFIs engaging with Saudi Arabia.
What will be the market reaction should it be added to the watch list?
We believe the reaction will be positive, which is why we turned overweight on the Saudi market last week. Local investors in particular seem unprepared for a watch list decision.
Assuming Saudi Arabia is added to the list, do you see a rally under way?

The market is about 15 percent away from long-term peak forward multiples of 16 times 12-month forward earnings; we believe the market will move towards that level if Saudi Arabia is put on the watch list.
How meaningful could this be to the country’s stock market? And could it impact other markets in the region?
This will be the largest index inclusion since at least 2001, and would put Saudi Arabia in the Top 10 emerging markets even excluding Aramco. Passive inflows alone would be equivalent to 2.5-3 times current active holdings in the Saudi market. We think it would finally place Middle East, North Africa on the map as an important subset of emerging market and EMEA.
What if the kingdom isn’t added to the list: do you foresee a selloff?
A no-go from MSCI this week would be taken very negatively by Gulf Cooperation Council and foreign investors, who are positioned for an addition to the watch list. A GCC and foreigner-led selloff wouldn’t do any favors to the weak local-investor sentiment. As such, we would see this as a very negative event for the Saudi market, but think no watch list is highly unlikely.

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