beyondbrics

Source: Egyptian Stock Exchange

At last some good news from Egypt’s battered financial markets. Stocks soared on Thursday, with a 7 per cent bounce in the EGX 30 index, after Wednesday’s demonstrations on the first anniversary of the anti-Mubarak uprising passed off peacefully.

That extends this year’s gains to over 22 per cent, making Cairo the world’s second best-performing equity market in $ terms after another recovery story – Hungary (on 24 per cent). But how long can it last,  given the manifest economic and political challenges?

There was no mistaking the investor enthusiasm on Thursday with the authorities having to suspend trading for 30 minutes after the EGX 100 Index rose 5 percent. Orascom Telecom, a bellwether, jumped nearly 10 per cent. EFG-Hermes, the investment bank,  was up 9 per cent.

The day before, hundreds of thousands of Egyptians took to the streets, some to celebrate the anniversary of the turmoil that led to the overthrow of president Hosni Mubarak, and others to protest against the continuing rule of his generals.

Some investors had feared the rallies could trigger more violence. When the demonstrations finished without bloodshed, they decided to buy.

“Yesterday’s protests were peaceful so they calmed fears by some investors leading up to the anniversary,” Tamer Nigm, head of sales and trading at Cairo-based Watheeqa Securities Brokerage, told Bloomberg.

At 4432, the EGX 30 index is 23 per cent up on its late December low. But there is still a lot of ground to cover before the index is anywhere close to the high of 7210 it hit just before Mubarak’s political demise.

By historic standards, this makes Egypt very cheap. As Citigroup said in a report earlier this week:

Prior to Mubarak’s fall the Egyptian equity market (MSCI Egypt) was valued, on trailing Price/Book, at parity with global emerging markets (MSCI EM), and a premium to the rest of MENA (MSCI Arabia). A year on this is no longer the case and Egypt is at significant discounts to both.

The picture is not quite so compelling on a price/earnings basis, with the trailing p/e in line with the EM average of around 11.  But Egyptian companies’ earnings fell by around15 per cent in 2011 due to the political turmoil and are down 46 per cent since 2008. So the scope for a recovery, and a bounce in share prices,  could be much greater than the EM average.

Andrew Howell, a Citi equity strategist and a co-author of the report, told beyondbrics: “One way of thinking about the potential for an earnings rebound in Egypt is the return-on-equity, which is currently 10 per cent. This compares with a 2003-8 average ROE of 25 per cent. If the ROE normalizes upwards to, say,  15 per cent, the PE would fall from 10.3x (trailing) to 5.8x. If it reaches its previous peak, the PE would be 3.8x.

“Over the next 3-5 years these companies have the potential to increase earnings spectacularly if things normalise.”

Citi says in the report that there are still risks ahead since “a real revolution has not occurred”,  core protestors may remain unreconciled, and association with reactionary vested interests and difficult economic times may ultimately hurt the Islamists who have done well at the polls.

The authors add that with support talks with the International Monetary Fund only now getting underway it may “already be too late to avoid full blown fiscal and currency crises”.

As beyondbrics has reported, the threat of a serious short-term economic shock is real, particularly with foreign exchange reserves falling to low levels.  Even an early IMF deal won’t necessarily guarantee stability because the talks are focused on a possible $3.2bn loan, when support of $10bn or more might be needed given that foreign exchange reserves have dropped by half, from $36bn to $18bn, since Mubarak’s overthrow.

Howell accepts that these risks persist, including the currency risks, but argues it’s the right time to buy equities. “We made the call because we saw some  subtle changes in the political backdrop coupled with increasing likelihood of an IMF deal and the fact that Egyptian stocks look cheaper than others in the emerging markets world. We are not looking at any game-changing economic dislocation.”

It’s both tempting and frightening to buy in a crisis. There’s a recommendation attributed to Nathan Mayer Rothschild, the 19th century financier - buy when there’s blood in the streets, even if the blood is your own – and he did not, as things turned out, do badly.

But there are two problems. First, he didn’t actually say it, according to historian Niall Ferguson. Second, the history of revolutionary upheavals suggests that it often takes years before economic confidence and growth return. So today’s investors in Egypt may have to be patient.

Related reading:
Guest post: Egypt must bite IMF bullet, beyondbrics
Egypt-IMF: back on track (at last), beyondbrics
Egypt 2011, FT
The economics of the Arab spring, FT
Egypt in transition, In depth FT