Credit: Shutterstock photoLast week's concerns about a Dubai debt fallout rattled the financial markets and added yet another facet of uncertainty to investing in today's market. Interestingly, the situation in Dubai is more complex than it appears at first glance. What did really happen and what are the implications for the U.S. market?
A look behind the curtain
To fully understand the implications of last week's news, it helps to pull back the curtain and delve into some facts not commonly discussed in the media. The political structure of Dubai is a complicated one that deserves some attention.
Dubai is a city-state and one of the seven emirates that make up the United Arab Emirates (UAE). Dubai is one of the only two emirates of the UAE to possess veto power over critical national matters, the other one is Abu Dhabi.
Mohammed bin Rashid Al Maktoum is Dubai's current ruler and also the Prime Minister and Vice President of the UAE. The UAE has the world's sixth largest oil reserves, none of which are in Dubai - but the UAE's main revenue is now derived from tourism, property, and financial services.
Dubai and Abu Dhabi are the most powerful of the seven autonomous city-states. While Dubai has been investing aggressively in projects around the world, Abu Dhabi has been more conservative, religiously and financially.
The entity that announced last week that debt payments on $26 billion of loans may need to be postponed is Dubai World. This announcement sent shivers down world markets. Who is Dubai World?
Dubai World is an investment company that manages and supervises a portfolio of business and project for the Dubai government. Investment projects include the palm islands and the world, artificially constructed peninsulas of sand dredged from the bottom of the Persian Gulf, in the shape of a palm and the world.
Dubai World also owns interest in several of the world's biggest ports, the Las Vegas City Center, luxury retailer Barneys of New York and many others. As of 2006, Dubai World had more than 50,000 employees in over 100 cities around the globe. On November 25th, Dubai World unveiled its intent to extend maturities on debt payments until at least May 2010. Dubai World has laid off 10,500 employees and is now working on restructuring its debt of $60 billion. Dubai World's debt of $60 billion accounts for about 75% of the UAE's combined debt.
There are three ETFs with elevated exposure to the United Arab Emirates: Gulf States Index ETF (NYSEArca: MES) - 26.6%, PowerShares MENA Frontiers Country Portfolio (Nasdaq: PMNA) - 17.22%, and WisdomTree Middle East Dividend Fund (NYSEArca: GULF) - 16.35%.
Hoping for relief
Understanding that Dubai World is the government's official investment arm, investors were hoping that its debt would be guaranteed by the state of Dubai. This is not so. Dubai's government declared that is not responsible for Dubai World's debt or financial problems.
According to JP Morgan Chase, the Royal Bank of Scotland was the biggest underwriter of loans to Dubai World, while HSBC has the most risk in the UEA. More defaults for these already ailing banks could send a crippling chain reaction through the market.
Establishing a time-line
Now that we know the bare facts, it will be interesting to tie in events on a time-line and establish a chronological succession of developments. The results will be truly surprising.
Late on Thanksgiving Day, Thursday, (11-26-2009) and early Friday morning (11-27-09), the S&P 500 futures dropped as low as 1,066, a 4.5% drop from the previous day's intraday high. This drop was blamed on Dubai World's announcement. This announcement, however, hit the fan already on Wednesday. It did, however, not affect the market on Wednesday.The major U.S. benchmarks all closed strong.
On Thursday, Wall Street was closed, but equity futures tumbled. The decline in the futures continued and stocks opened soft early Friday morning, but moved up throughout the day.
On Monday, 11-30-09, Dubai released its much anticipate standpoint on the debt. Its declaration NOT to back up Dubai World's debt should have served as a wet blanket for markets. Against all odds though, the markets moved higher, yet again, on Monday.
What's the lesson to be learned
Speculators and conspiracy theorists will certainly have their fun with the events that transpired. Without adding to any speculations, what can be said for certain is this:
1) There is no direct correlation between the announcement and the market's (re) action.
2) The U.S. market saw the biggest decline in months on the very day Wall Street was closed, which might be an indication of what international investors think of U.S. stocks.
3) More toxic assets seem to be coming our way. Someone will have to pay for the debt.
4) We've come to realize that the final outcome for such kind of news tends to be worse than the initial announcement. Remember how AIG, Fannie Mae, and Merrill Lynch initially admitted to only small difficulties?
Before the financial crisis really took hold, the ETF Profit Strategy Newsletter brand-marked the financial sector as a 'down-ward spiral with no stop-loss provision' and recommended short ETFs, such as the UltraShort Financial ProShares (NYSEArca: SKF). Within months of the recommendation, the financial sector (NYSEArca: XLF) had tumbled 75% which resulted in rich, triple digit gains for SKF and other ETFs.
Two years older, but no smarter
Today, the grand majority believes that a major collapse has been averted. In all reality though, the financial problems that caused a near system collapse have been 'fixed' with the same methods that got us into trouble to begin with. This is like healing frost-bite with ice cubes. It's painful and unlikely to work.
Another lesson to be learned from the Dubai episode is how fragile frontier and emerging markets still are. Emerging markets ETFs like the iShares Emerging Markets ETF (NYSEArca: EEM) and Vanguard Emerging Markets ETF (NYSEArca: VWO) have seen record inflows, as investors' appetite for risk experienced a miraculous revival following last year's meltdown.
Contrarian investors view this kind of behavior as a clue to startmoving money into short emerging markets ETFs such as the UltraShortEmerging Markets ProShares (NYSEArca: EEV) or Direxion Daily EmergingMarkets Bear 3x Shares (NYSEArca: EDZ).
The Dubai problems are likely to be forgotten for a few days or weeks, as long as stocks keep moving north. Falling prices, however, will lay bare many previously forgotten financial problems and make them headline material once again. AIG, Fannie Mae, Merrill Lynch, Wachovia, and Citigroup did not come to the brink of a collapse in one day.
It took a string of more negative estimates in succession from company spokesmen before some sort of true damage could be assessed. Odds are Dubai World will be no different.
The Profit Strategy Newsletteris a publication dedicated to forecasting major shifts in the financial world. As such, it has correctly predicted the onset of the financial crisis and the March bottom. Each issue includes a detailed short, mid and long-term analysis of the major asset classes and corresponding ETF profit strategies.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
