Tomorrow's Emerging Markets

By Jane Bryant Quinn
Sunday, April 13, 2008

For the past 25 years, Southeast Asian stocks dominated the dreams -- and the winnings -- of emerging-market investors. Today, those economies are looking more like those of the developed world.

So where should players look for the next ground-floor opportunity? Follow the money, of course. The next quarter-century belongs to the Middle East.

The Persian Gulf states restrict foreign stock ownership. So far, it has been a game primarily for hedge funds and private equity. But the Middle East is opening up to homegrown investors and international capital. In September, T. Rowe Price launched the Africa & Middle East Fund -- the first chance for many U.S. investors to take a shot at markets that they never heard of but that, eventually, will make a splash.

Your targets are the economies of six Arab states -- Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (the UAE consists of seven city-states of which the best known are Abu Dhabi and Dubai). They're gathered into a loose confederation known as the Gulf Cooperation Council (GCC). The GCC just negotiated a free-trade agreement with Singapore, its first with a country outside the Middle East. In December, it announced plans for a GCC common market.

If you think of the gulf states as mostly camels, oil, sand and war, Google "Dubai image" or "Abu Dhabi image" and goggle at what you see. Skyscrapers, stunning hotels and resorts, marinas, golf courses, high-end malls and, yes, bars. Politically, they are poster children for moderate Islam in the Middle East, with religious but cosmopolitan cultures. Jihad looks like yesterday in countries embracing commercial modernity.

The main event is oil and natural gas -- commodities in tight global supply and whose price the GCC can influence. It's "perhaps the most compelling seller's market in the history of capitalism, providing a relatively uninterrupted transfer of wealth to suppliers of oil," said Jay Sellick, managing director of 13D Research, a global research firm in Boca Raton, Fla.

Developed countries will have to import ever more gas and oil from the Middle East, even during economic slowdowns, because they are producing less themselves. Developing countries need more, too, as their standards of living rise. "We believe the GCC equity market could be in the early stages of a huge bull market, not unlike other bull markets that were driven by changing secular dynamics not fully appreciated by investors," Sellick said.

Oil is far from the only story. The GCC is investing hundreds of billions of dollars to diversify its countries' economies, create jobs for their young people and prepare for the day when they run short of oil and their customers develop alternative sources of energy.

They are raising world-class hotels, promoting tourism, creating financial and tax-free trading hubs, relaxing restrictions on businesses and foreign ownership, developing industries such as petrochemicals that need low-cost energy, and backing centers for high technology.

"A year ago, international investors just flew in for a day," said Fahmi Alghussein, executive director at Morgan Stanley in Dubai. "Today, they're setting up shop in the region and putting asset managers on the ground."

Here's just a taste of what's going on:

· Dubai, with few remaining oil and gas reserves, gets more than a quarter of its revenue from the Jebel Ali Free Zone, a main port on the "new silk road," linking India, China and North Africa with Europe, through the Middle East.

· Abu Dhabi, by far the richest of the United Arab Emirates, is turning itself into a cultural destination. It will host branches of the Guggenheim and Louvre museums and is building a center for the performing arts.

· Saudi Arabia hasn't opened its stock market to foreigners, although investors expect that to change. For now, it's courting international capital to help finance six new "economic cities," built around industries such as oil refining, shipping, steel, petrochemicals and information technology. Saudi Arabia's conservative culture doesn't jibe with world tourism (no women in shorts or even pants sauntering in Riyadh's parks!). Instead, it's building Islamic tourism centered on Mecca and Medina.

· Qatar, possessor of vast natural-gas reserves, is building the world's largest gas-to-liquids plant with Royal Dutch Shell's participation. Five major U.S. universities have opened campuses there, including Weill Cornell Medical College and Texas A&M University.

At the moment, the GCC countries aren't included in the emerging-market equity indexes that managers use for their global asset allocation. If that changed, "it would be colossal," said Brad Durham, managing director of EPFR Global in Boston, which tracks fund flows.

In January 2006, MSCI Barra launched separate GCC indexes for the six countries -- a move that will probably generate some U.S.-listed, GCC exchange-traded funds.

The new T. Rowe Price fund holds 60 percent of its assets in the gulf, which is even benefiting from the conflicts in Iraq, Iran and Lebanon. "Money flows to the GCC," said London-based Joseph Rohm, vice president of T. Rowe Price International. "They're the stable economies and safe haven in the region."

Clearly, markets like these aren't for sissies. The GCC stocks bubbled in 2005, crashed in 2006 and haven't climbed back to their former peaks. Hot money rushed in at the close of 2007, when GCC stocks (not counting Saudi Arabia) leaped almost 40 percent. So far this year, they are up 2 percent. Easy money can rush out again.

The current building frenzy is a worry, too, as the countries compete for the financial and tourist trade. They risk creating a glut and a collapse, said Richard Thompson, London-based editor of the Middle East Economic Digest.

It will be a rough ride. But over time, following the money pays.

Jane Bryant Quinn, author of "Smart and Simple Financial Strategies for Busy People," is a Bloomberg News columnist. Alexis Leondis in New York contributed to this column.