published Apr 1, 2018 7:32:53 AM, by Filipe Pacheco
(Bloomberg) —

As Saudi Arabia celebrates its first ever emerging-market classification by a major index compiler, history suggests the market may be headed for a retreat.

The Saudi stock benchmark advanced to the highest since 2015 last week before FTSE Russell said it’s classifying the country as a secondary emerging market, with actual inclusion set to happen in stages starting a year from now. MSCI Inc., which has more investors tracking its emerging-market indexes, may make a similar decision in June.

But two of the kingdom’s neighbors, Qatar and the United Arab Emirates, saw stock rallies fade after MSCI upgrades in May 2014, suggesting that Saudi Arabia could also see a slowdown of the flows that have propelled stocks to their three-year highs.

For Pakistan, the slump was even worse. The country’s main index lost 15 percent last year, even after MSCI enacted an upgrade of the country from frontier to emerging market in June.

“Markets can get ahead of themselves,” said Jason Tuvey, Middle East economist at Capital Economics Ltd. in London. Additionally, domestic concerns persist for Saudi Arabian stocks, including the outlook for oil prices and their impact on fiscal policy, he said. Tuvey estimates crude will drop back from $70 a barrel to $55 by the end of 2019, the year Saudi MSCI inclusion could happen.

“This would weigh on the stock prices of petrochemical companies, which make up around a fifth of the Saudi stock market,“ he said. “And, after policy is loosened this year, we think that austerity is likely to come back on the agenda.”

On the Radar

Still, the country should start to appear on the radar of many investors who don’t currently consider it for their portfolios. Foreigners were net buyers of Saudi stocks every week this year, partially reflecting bets that the FTSE Russell and MSCI decisions would be positive. While the Tadawul All Share Index fell 1.3 percent in the wake of the FTSE Russell announcement, it’s still is up 8 percent this year, compared with a 1.1 percent gain for the MSCI Emerging Markets Index.

“As we have seen in the past, most notably in the cases of Qatar, the U.A.E. and Pakistan, countries being added to the MSCI Emerging Markets Index have tended to outperform strongly in the run-up to index inclusion,” said Daniel Salter, head of equity strategy and research for Eurasia at Renaissance Capital Ltd. in London. “On average, the outperformance has ended shortly after index inclusion.”