* Kuwait stocks outperforming after 2012 underperformance
* Hopes that economic projects will move forward
* Two major contracts signed since November
* But underlying political tensions haven't gone
* Many institutional investors still cautious
By Nadia Saleem
DUBAI, Jan 30 (Reuters) - After a year of poor performance, Kuwait's stock market is rallying sharply on hopes that the government will finally start spending heavily on economic development. Stocks are vulnerable to a sharp pull-back if the spending does not materialise.
"We are all counting on the unknown: that is, the government seriously pushing the development of the country through its financial package," said Fouad Alhadlaq, deputy general manager at Kuwait's Al Dar Asset Management.
The main Kuwaiti stock index gained just 2.1 percent last year despite high oil prices and positive economic growth. It far underperformed Saudi Arabia, which advanced 6.0 percent, and Dubai, which jumped 19.9 percent.
A major reason was political; persistent tensions between the cabinet and opposition members of parliament, which led to street protests and last month's snap elections, hindered policy-making and made it hard for the government to launch big industrial and infrastructure projects.
Under a four-year plan ending in 2014, the government is supposed to spend 30 billion dinars ($107 billion) on such projects. But analysts say only a small fraction of the projects has been completed and most big-ticket items have stalled.
In the last several weeks, however, hopes that the policy-making gridlock is easing have turned the market around; the index is up 11.1 percent from an eight-year low hit in early November, and it is up 5.2 percent so far this year.
"Everyone is hoping the government will spend $35 billion on projects, which should stimulate earnings for related companies," Alhadlaq said.
Such hopes began to flare in November when the ministry of public works signed a 738 million dinar contract for construction of the Sheikh Jaber Al-Sabah Bridge over Kuwait Bay. The project would take five years to complete.
Then in January, a consortium led by France's GDF-Suez said it had won a contract to build and run a 1,500 megawatt gas-fired power and seawater treatment plant in Kuwait's Az Zour North Independent Water & Power Project.
The project was a confidence-booster not only because of its size - once operational in 2015, it would provide around 12 percent of Kuwait's power generation capacity and a quarter of its desalination capacity - but because a high-profile private investor from abroad had agreed to operate a Kuwaiti project over the long term, not just to build it.
The cabinet appears to have found a way to push some major plans around political obstacles by classifying them as priority projects that are not subject to interference by parliament.
Also, Kuwait's new parliament, which was elected last month after changes to the electoral law and which the opposition says is dominated by pro-government figures, appears to be less confrontational than the old one.
Ibrahim Dabdoub, group chief executive of National Bank of Kuwait (NBK), the country's largest bank, said last week that there was cause for optimism this year as the government accelerated spending on big projects.
"The recent directions from the highest authority and the proposed measures to boost economic activity and spur growth are expected to lift the overall sentiment and create new opportunities in the local economy," he said.
NBK's net profit for the fourth quarter of last year was roughly flat from a year earlier but it beat analysts' forecasts because of lower-than-expected provisions for bad loans and higher-than-anticipated capital gains.
Gulf Bank, the fourth largest bank in the country, more than doubled its fourth-quarter net profit and proposed a distribution of bonus shares.
"The turning point for banks was Q4 - the prices of stocks going up and less provisioning gave room for banks to breath," said Fouad Darwish, head of brokerage at Kuwait's Global Investment House.
He said he believed banks' dividends would add liquidity to the stock market through reinvestment, given a lack of other attractive investment vehicles in Kuwait.
There are doubts about the sustainability of the market's recovery, however. Although parliament has become more quiet, underlying political tensions have not disappeared and opposition figures have said they will hold a series of marches to demand fresh elections.
Small-capital companies such as Gulf Investment House , rather than blue chips, have dominated recent trading of shares - a sign that much of the trade is short-term and speculative.
Many foreign institutional investors pulled out of Kuwait in recent years because of the poor political environment, and there is little evidence that they are returning, even though wealthy Arab individual investors have begun to come back.
"Institutional investors are not willing to touch Kuwait with a stick, especially with the current political situation - the government is not at ease with the opposition," Alhadlaq said.
He suggested that investors should hold on to their stock holdings at present but only buy to expand them if prices dip.
"The whole hype that people are buying on right now is expectations the government will start spending. If it doesn't, we will have a sell-off," said Darwish.