* Bond yields well below Gulf blue chip dividend yields
* This combining with valuations to boost stocks
* Off-benchmark allocations to Mideast stocks surge
* Trend may continue for some time
* Hopes that ex-dividend pull-back won’t repeat
By Nadia Saleem
DUBAI, Feb 21 (Reuters) - Most Gulf stock markets have already risen sharply this year but for the bulls, the rally is just beginning. Many base their optimism on a trend which they say could last months longer: a flow of money out of bonds into equities.
Globally, inflows into emerging market equity funds have exceeded inflows into bond funds every week but one since early December, according to EPFR, the funds data company. Last week, emerging market equity funds took in additional money for the 22nd straight week.
That shift is being felt in the Gulf, where Dubai’s main stock index is up by 19 percent year-to-date, Abu Dhabi’s benchmark is up 14 percent and Qatar is 5 percent higher.
“Investors are seeking higher returns as opportunities in the fixed income space are becoming scarce. Equities is one alternative,” said Ali Adou, Abu Dhabi-based portfolio manager at investment firm The National Investor.
Bond yields in the Gulf fell sharply throughout last year without triggering any big shift of money into equities. The yield on Dubai’s $750 million, 7.75 percent bond maturing in 2020 tumbled more than 3 percentage points over 2012 to 3.83 percent.
But a key point for the markets came at the end of the year when bond yields dropped substantially below the dividend yields offered by major blue chip companies, dramatically worsening the risk/reward ratio of holding bonds for many investors.
Rami Sidani, Middle East head of investment at Schroders in Dubai, said Gulf blue chips with growth prospects were currently offering dividend yields of around 5 to 7 percent.
Such yields are now combining with several other positive factors to support stocks, analysts said. One factor is the rally in global equity markets; another is relatively cheap valuations in the Gulf, where markets are trading at around 11.5 times corporate earnings, below levels close to 15 times for some southeast Asian markets.
Historically, the Gulf has traded at lower valuations than many other emerging markets because geopolitical and economic risks are perceived to be higher. But with bond yields at rock-bottom levels, cheap valuations started to attract investors.
“Valuations are very cheap because we came off a low base and there’s a gap to global equities,” said Fadi Al Said, head of investments at ING Investment Management in Dubai.
Regional investment bank EFG-Hermes estimated that off-benchmark allocations of money to Middle Eastern equities markets had reached their highest level since 2009. Off-benchmark investments are those by funds which are not aiming to mimick market indexes.
Any big change in the relationship between bond and dividend yields could quickly undermine the stock markets. But Sidani said the cash flows and business environments of companies in the Gulf suggested their dividend outlooks would remain stable for the next two or three years, which would help to protect confidence in stock markets.
On the bond side, the Dubai yield has rebounded to 3.91 percent from a low of 3.51 percent hit in mid-January. But its current level is still well below the 5-7 percent range for blue chip dividends.
In past years, stock markets in the United Arab Emirates and Qatar have sometimes rallied in the first few weeks of the year as investors bought shares in anticipation of receiving their dividends, and then pulled back sharply when the shares have gone ex-dividend.
This year, investors are hoping that inflows of funds are so strong that major market pull-backs will not occur.
“The rally in local equities is driven by multiple sources - local, regional and international inflows - because of macroeconomic improvement in the UAE,” said Al Said. “People are looking at the future and expecting positive developments.” (Editing by Andrew Torchia)