For the best analysis of the stages of the emerging market business cycle Dr. Marc Faber’s epic ‘Tomorrow’s Gold’ is the best place to turn. He provides events and symptoms, as well as clues on timing, by which to identify what phase a city or nation has reached in the business cycle.
His cycle moves in seven phases from zero to six, with stage three as the exuberant boom which Dubai enjoyed in 2005-6 up to and including the stock market crash; then came the rebound and an extension of the real estate boom up to September 2008.
Since then we have been in stage five with a 50 per cent plunge in house prices, and two of the biggest real estate players have just gone into technical default – we have empty offices and unfinished construction sites all over the city. That was stage five, now we enter stage six.
Capitulation and bottom
Stage six is ‘the capitulation and the bottom’ according to the great master. Here investors give up on stocks, with volumes down 90 per cent. Capital spending falls sharply. Interest rates fall to a low point. Foreign investors continue to sell out and the currency is weakening.
Symptoms of stage six in an emerging economy are: a very negative press; foreign brokers leave town; mutual funds suffer outflows; airline and hotels under financial pressure; underemployment for professionals; and universal complaints about how much individuals have lost in real estate or stocks.
Anybody living in Dubai can spot the symptoms: the negative press about the Dubai debt crisis; the governor of the Dubai International Financial Centre being dismissed; airlines with expanding capacity and falling revenues; hotel revenues falling due to heavy discounts; bankers with little work on their desks; and the stack of legal cases against real estate companies and whines about money lost in the stock market.
Marc Faber is pretty spot on with his timing: ‘Phase four will occur 6-18 months after the (stock) market’s high, while phase six usually occurs much later, 4-6 years after the market high’. It is indeed four years ago that the Dubai Financial Market crashed.
How much pain?
How long does phase six last? That is partly a matter of proactive government. The heads-in-the-sand approach prolongs the pain until market forces correct price levels. A dynamic response will clear the debt burden and liquidate insolvent companies earlier, and quicken the recovery after the initially greater pain.
The announcement of the $26 billion debt suspension at Nakheel and Limitless would appear to be the start of this process in Dubai. That is actually the good news and not the bad. The bad news is that obviously not all the problems of the Dubai real estate crash and its debts are concentrated in these two companies.
They are undoubtedly the biggest problem, but there are many other smaller companies whose business models have failed so badly that realistically they will never be able to repay their debts which are presently just rolling up bigger and bigger, day after day.
That is why 2010 might well be characterized as a year of ‘capitulation and market bottom’. This will be the real shake-out from the boom: 2009 was actually relatively shielded by the $15 billion in bond issues taken up by Abu Dhabi based institutions.
The Nakheel and Limitless debacle has marked the opening of a new stage in the Dubai business cycle with credit now going to be much tighter and more focused, even when it originates from the UAE capital Abu Dhabi. There will be more business failures and bad debts for the banks.
For investors looking for bargains to buy in the UAE then 2010 will actually be a great year to go prospecting and buy things, although there might be no need to rush as in 2011 will still see local stock markets and real estate at a pretty low ebb.
Stock market bottom
Equities do generally move ahead of real estate, however, and a true bottom ought to appear sometime later next year, when all the bad news is written into share prices. That might also include a temporary dip in the oil price as global speculators get burnt by a double-dip recession in major economies.
But the Gulf region is still a buy. There is the huge cash flow from hydrocarbons with the lowest global extraction costs, and the anticipation of much higher prices as the world economy grows and new supplies are limited and expensive to exploit.
This is the cheap feedstock for local industries like petrochemicals which are receiving massive investment right now in the region. Then there is the low or no taxation status to lure multinationals, in a world of rising taxation levels, and free land for real estate development.
Historic returns on equity in the region have been around 25 per cent, far above anything obtainable in the so-called advanced economies, and higher than the 10-15 per cent average for emerging markets.
Dubai is the commercial, trading, transportation and financial hub of the Gulf region so it is bound to be a leveraged play on the success of the region. It exaggerates the ups and as we have seen over the past year or so also the downs.
Other regional cities might have pretensions to copy Dubai but they lag a decade or more behind in infrastructure, and perhaps a hundred years in business thinking. So for those with a strong stomach for real capitalism Dubai will be the place to invest for the future.
The problem is that this will not be true for the next year to 18 months, except where special situations emerge.
There was a really nice article in Gulf News today calling for privatization of key Dubai assets like the airline, airport and utility companies to pay off the emirate’s debt. But the author clearly knows little about the impact of dumping stock on an already depressed local stock market.
That might be a great way to stimulate a stock market after stage six. But selling off the family silver at fire-sale prices would raise little money and flood the bourse with equities. No the Nakheel and Limitless debt crisis is actually the best way forward but it will not make for an enjoyable or profitable 2010.
Disclosure: Author is a Dubai property owner