INTERNATIONAL. Tensions over Iran, unrest in Syria and concern about refinancing of upcoming Dubai debt are making international investors wary of Gulf and other Middle Eastern markets this year, just as developed markets enjoy fresh gains.
Storming oil prices and healthy balance sheets among energy-producing Gulf economies kept these markets on a relatively even keel last year, as international investors saw the region as an alternative to the debt-laden euro zone and United States.
But liquidity injections by the European Central Bank in the form of its long-term refinancing operation and quantitative easing by the U.S. Federal Reserve have boosted developed markets, partly draining the Gulf of its "alternative" appeal.
Iran's threat to block the Straits of Hormuz and increasing unrest in Syria have reined in market enthusiasm.
"It's well-known that tensions have risen, whether you are looking at Iran, Israel, Iraq, Afghanistan," Andrew Brudenell, fund manager at HSBC Global Asset Management, told Reuters.
"All these things have been so much in the news, you can understand there is some concern."
Several Middle Eastern stock markets have risen this year but their gains have been modest compared with a stomping 15% rally in broader emerging markets .MSCIEF.
Qatar .QSI, one of the few markets to rise last year, with a 1% gain, has dipped 1% this year.
The cost of insuring Qatar and Saudi Arabia's debt against default hit its highest in 2-1/2 years in early January after Iran threatened to close the vital Straits of Hormuz Gulf oil export route, in response to tougher sanctions from the West.
Tensions over Tehran's nuclear program have helped push up Brent crude prices by about US$8 a barrel in the past six weeks.
While higher oil prices usually help the markets of the Gulf's energy-producing economies, this time it is different.
Five of the six Gulf Cooperation Council members - Saudi Arabia, Bahrain, the United Arab Emirates (UAE), Qatar and Kuwait - rely on the world's most important energy shipping lane being open to export most of their oil or gas.
"If Iran blocks the Straits of Hormuz, these countries will not be able to deliver their exports," said Dina Ahmad, emerging markets strategist at BNP Paribas. "There is still somewhat of a risk premium priced in CDS in relation to geopolitical risk, in particular the sanctions in Iran."
The involvement of the Arab League in calling for Iranian ally Syrian President Bashar al-Assad to yield power and start a political transition is also adding to the concerns over risk.
Another worry for investors is the ability of Dubai entities to refinance their debt, following Dubai World's DBWLD.UL debt standstill in November 2009 which sent shockwaves through global financial markets.
While an initial test has passed, after Dubai Holding said it was repaying a US$500 million bond maturing last week, the focus has now switched to further flashpoints this year.
Investors say Dubai and Abu Dhabi are likely to come to the aid of struggling entities, as they have done in the past, but uncertainty remains.
Investors say the region's markets did well last year given the Arab Spring unrest, and that it may only be a matter of time before they bounce back.
"Frontier markets do perform with a bit of a lag during periods with a significant change in sentiment," said Brudenell.
"You had a surprising outperformance in Middle East and North Africa (MENA) markets in 2011. Given what happened last year, that's pretty amazing."
One bright spot is Saudi Arabia, where the stock market .TASI hit multi-month peaks this week, buoyed by expectations the country will press ahead this year with plans to open the Saudi exchange, the region's largest, to foreign investors.
Gulf regional investors are likely to continue to provide support for the region's markets, and are less likely to be scared off by geopolitics. But, with stock exchange volumes remaining low in the aftermath of the 2008/09 global crisis, the markets need a bigger push.
"Significant international flows are one factor that would cause these markets to pick up, but headline risk has them mostly on hold," said Florence Eid, Chief Executive of research and advisory firm Arabia Monitor.
There was also disappointment after UAE and Qatar failed to be upgraded to emerging market status from frontier market in MSCI's flagship stock indices at the end of last year.
Although many investors had not expected an upgrade so soon, and still hope for it within the next two years, the move would probably have drawn broader emerging market funds to the region