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Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, as well as two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays).
Welcome to the Confluence Investment Management Bi-Weekly Geopolitical Report. I'm Phil Adler. You might be surprised when you learn which foreign stock markets are growing the fastest. Growth is not necessarily a reason to invest in these markets, but they might deserve a a second look, and Confluence associate market strategist Daniel Ortwerth joins us today to provide just that. First, Daniel, it's clear that Confluence does not favor foreign markets right now.
Phil Adler:So would you call this week's study an attempt at getting out in front of what may be opportunities down the road?
Daniel Ortwerth:Hi, Phil. I think the idea here is to make sure we are not missing an important development in an area that might not seem center stage for the rest of us. As analysts, we do need to devote most of our attention to the largest, most prominent markets and the main issues that are driving the discussion. However, it's a big world out there. The US economy is only about a quarter of the total global economy, and The US stock market, even after its impressive run these last few years, is less than half of the world total in terms of market value.
Daniel Ortwerth:That means foreign markets and economies are large and possess tremendous potential. If we don't regularly devote some of our time to reviewing and understanding the whole picture, we run the risk of entirely missing either an opportunity or a threat until it might be too late.
Phil Adler:Well, I was surprised when I read your report at just how many stock exchanges exist around the world, over 100. For the purposes of your study, you divided them into geographical regions and then compared the exchanges in those regions by market cap. Why is market cap a more useful way to measure these foreign stock exchanges than, say, trading volume.
Daniel Ortwerth:Each of the different statistics for measuring a market have their value. Things such as trading volume and number of listed shares certainly do matter. However, in our view, market cap is the simplest and best way to gauge the broad community of investors' perception of the investment potential of a company, a market, or even a country. It shows the level and the trend of how much money is flowing into a company or a market or even an entire region of the world. It also provides a quick way to compare investment destinations to see how the different choices are faring against each other in the competition for global capital.
Phil Adler:As you compared these different regions by growth in stock market cap, you found that Middle Eastern markets in the past ten years grew the fastest, and and it's not really close. I was surprised considering the political volatility in the region. What do you think is the reason?
Daniel Ortwerth:Well, Phil, we should probably mention that ten years ago, the Middle Eastern market cap was only the sixth largest of the regions that we measured, and that's out of nine, barely more than 2% of the total for the whole world. When you're that small, it's relatively easy to post an impressive percentage growth number. Still, the growth rate of 15%, almost double the second fastest growth rate, was impressive, and it vaulted The Middle East to fourth on the list of regions. The bigger surprise in our analysis is that we did not find any one single factor or set of factors that applied across the region causing some sort of rising tide to lift all boats. Rather, we found that individual country specific factors caused dramatic market cap growth in three countries, so much so that they outweighed other markets in the region that barely treaded water or even in some cases collapsed.
Daniel Ortwerth:Different factors in different countries fueled the rise.
Phil Adler:Let's look then, Daniel, at the Middle Eastern markets that grew the most. What was most surprising to you?
Daniel Ortwerth:Clearly, it was the leading performance of the Iranian stock market. The last ten years have subjected Iran to exactly the kind of negative factors that normally we would expect to weigh heavily on stocks. The economy has suffered sharp downturns. Unemployment and inflation have both been high, and inflation in particular has been volatile. Weak.
Daniel Ortwerth:Western economic sanctions have taken a heavy toll, especially on oil export revenues, which have declined as much as 80% during this period. To top it all, Iran has been involved in military conflicts that haven't exactly
Phil Adler:boosted Iran's performance?
Daniel Ortwerth:Three factors combined to fuel the rise. First, since the sanctions largely shut the country of 90,000,000 people off from the global economy, domestic companies found themselves with a large captive market and little to no outside competition. This proved a sales bonanza. Second, in the high inflation environment, Iranian citizens turned to stocks as a store of value, a way to conserve their cash in assets that they assumed would rise along with inflation. And third, a class of speculative international investors seeing this trend as a possible opportunity for a quick gain piled additional money onto the flow from domestic investors.
Daniel Ortwerth:Taken together, these three things caused a boom. Although the Iranian stock market has recently given up some of those gains, most of them remain today.
Phil Adler:Now among the top performers, exchanges in Saudi Arabia and The United Arab Emirates also showed strong growth in market cap. Of those two, Daniel, which seems more stable in terms of economic fundamentals?
Daniel Ortwerth:They've both shown some pretty encouraging things, but between the two, we think it is The United Arab Emirates. UAE leadership has spent the entire twenty first century pursuing an agenda to develop itself into the premier financial hub of The Middle East. Along with an expansive construction program of supporting infrastructure, it has established tax codes and a regulatory structure that have encouraged participation from throughout the international investment community. These efforts have not focused on The Middle East's typical source of wealth, the petroleum industry. Rather, they have sought to maximize diversification across industries.
Daniel Ortwerth:As one of the clearest signs of the country's success, UAE exchanges have become known for their high volume of initial public offerings, new money coming to the table. The UAE continues to attract new market participants, and we expect this trend of growth to continue.
Phil Adler:Why does the Israeli market's performance lag many of the others in the Middle East region in terms of cap growth despite Israel's developed economy?
Daniel Ortwerth:Phil, I'm not sure it's fair to say that it lagged. Let's look inside the numbers just a little bit here. From 02/2014 to 02/2024, the world total market cap, that's the entire globe's stock markets put together, grew at an average annual rate of 5%. For perspective, the New York Stock Exchange market cap grew 4% annually during that time. Well, from 02/2014 to 02/2022 when the conflict in Gaza began, the Israeli stock market grew at an average annual rate of 5%, the global average.
Daniel Ortwerth:This actually makes sense since Israel is, as you mentioned, the only country in The Middle East that is considered to have a developed economy. The Israeli stock market suffered a drop after the Gaza conflict began, but it has recovered since then, and its average growth rate over the entire ten year period is about 3%. On the bottom line, though, the Israeli market did fine, but it didn't stand out in either a positive or negative way across the whole ten year period.
Phil Adler:Are there concerns that investors eyeing these markets for the future should be especially cautious about?
Daniel Ortwerth:Yes, Phil. There are. And I'd like to emphasize too. Historically, oil has played a dominant role in Middle Eastern economies, and disruptions or threats to the flow of oil have caused economic and financial havoc. Last year was a period of surprising stability in the price of oil despite numerous destabilizing geopolitical events.
Daniel Ortwerth:Only time will tell how long this trend of relative stability will last. However, oil remains the dominant driver of Middle Eastern prosperity, and the recent period of price stability may have contributed to the rise of Middle Eastern market caps. If volatility returns to the oil market, stock prices throughout the region, regardless of economic sector, could suffer. Also, as we have often emphasized, global fracturing and block formation along the lines of the global geopolitical competition between The US and China is a theme we expect to play a dominant role in The Middle East. Each country will likely face a choice at some point to more closely align itself with one block or the other.
Daniel Ortwerth:One potential consequence of this could be the relative opening or closing of the capital markets of any given country to Western investors. Just because a country's stock market rises does not necessarily mean it will be a welcome market for all investors as the block formation proceeds. A country such as Turkey or The UAE may well succeed in, as we say, straddling the fence between the two powers, but another country such as maybe Saudi Arabia might choose to tailor its policies to favor one or the other with consequences for investors.
Phil Adler:Daniel, how do these markets compare to The US in terms of regulations that enforce accounting standards?
Daniel Ortwerth:Well, it varies widely, and investors should exercise caution. We think of Israel as being similar to The US, and we recognize the strides certain other countries such as The UAE and Saudi Arabia have made to establish credible, compatible standards. Generally, however, we view this region as a place where diligence needs to be applied on a case by case basis.
Phil Adler:One takeaway for me, at least, as as I read your report was how stock market performance relates to inflation. High inflation within a country is not necessarily a negative for stock investments there. In fact, it might be a positive. Now, am I correct?
Daniel Ortwerth:Well, Phil, it can be, but only under what I would consider extreme circumstances. Under normal circumstances, investors usually choose the stock market when seeking growth in the value of their investments. Meanwhile, they usually go other places such as treasuries or high quality bonds, for example, when seeking capital preservation or protection from inflation. However, in some emerging markets, when inflation gets bad enough, meaning high enough, and investors lose confidence that other traditionally safe assets are going to hold their value relative to inflation, we've seen investors resort to the stock market not as a source of growth, but as a store of value. In other words, as an inflation hedge.
Daniel Ortwerth:Along with Iran, we have seen this in Turkey.
Phil Adler:Is this relationship between stock market cap growth and inflation also a useful prism for investors in The US market?
Daniel Ortwerth:Well, Phil, I sure hope not. And we do not expect that to be the case, but it could happen. As much as we expect higher inflation in The US in future years than we have seen since the end of the Cold War in 1991, we do not expect it to reach the levels we have seen in Iran or Turkey. Further, we recognize that The US market provides an unparalleled array of choices for investors across the range of goals, including inflation protection. Still, we cannot entirely rule it out.
Daniel Ortwerth:Regulatory and technological changes in recent decades have made stock in The US easier than ever, which means that if US Investors decide that stocks are the best way to fight inflation, and if inflation indeed stays higher for longer and gets more volatile, it could in fact be good for stocks.
Phil Adler:Thank you, Daniel. This week's report is titled Middle Eastern Stock Markets, an overview, and you can find a link to the written report on the Confluence web page, confluenceinvestment.com. The report does include a look at some of the markets, including Turkey, that we did not focus on today. Today's discussion is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice.
Phil Adler:This information does not constitute a solicitation or an offer to buy or sell any security. Our audio engineer is Dane Stole. I'm Phil Adler.