Saudi Equities: Oil-Linked Laggards in a Diversifying EM Landscape

Saudi Arabia's equity market has long been a barometer of global oil prices, but its recent performance underscores a more complex narrative. Despite ambitious diversification efforts under Vision 2030, the kingdom's equities remain tethered to hydrocarbon volatility, institutional underweighting, and macroeconomic fragility. As emerging markets (EMs) recalibrate to shifting global dynamics, Saudi equities face a dual challenge: balancing structural reforms with the lingering dominance of oil-linked sectors. This analysis explores why a strategic underweight position in Saudi equities remains prudent amid persistent headwinds.

Oil Price Sensitivity: A Double-Edged Sword

The Saudi stock market's correlation with oil prices has intensified since 2006, with Brent crude emerging as the most influential factor in shaping equity valuations. In 2025, a 17% decline in oil prices has directly curtailed public spending and corporate earnings, exacerbating fiscal pressures. While non-oil GDP growth is projected at 3.4% for 2025, this figure masks the sector's vulnerability to global demand shocks. Analysts note that even as the non-oil economy expands, the market's earnings momentum lags behind regional benchmarks, with the Tadawul All Share Index trading at a 15x expected earnings multiple.

The influence of oil extends beyond domestic production. Global oil market uncertainty, compounded by divergent forecasts from institutions like OPEC and the IEA, has created a policy vacuum. Saudi Arabia's fiscal deficit, now widening due to lower revenues, has forced cuts in investment and subsidies while increasing borrowing. This fiscal recalibration, though necessary, introduces short-term volatility for equity investors.

Macroeconomic Risks and Policy Uncertainty

Structural reforms, including foreign ownership caps in financial markets, are expected to enhance liquidity and attract institutional capital. However, these measures remain gradual, and their impact is yet to materialize. The IMF's 2025 Article IV report highlights the need for sustained non-oil growth and fiscal discipline to address imbalances. Yet, with global trade tensions-particularly the U.S.-China trade war-intensifying, Saudi equities face indirect headwinds. Institutional investors have shifted toward value and industrial sectors, reducing the relative appeal of energy-dependent markets.

Policy uncertainty further complicates the outlook. Citigroup analysts advise underweighting Saudi stocks, citing poor earnings growth and exposure to dollar fluctuations. Meanwhile, BlackRock's Ben Powell acknowledges the kingdom's long-term potential but cautions that low oil prices could delay the transition to a diversified economy. The risk of a "super glut" in oil markets, as warned by some analysts, adds to the near-term pessimism.

Institutional Underweighting and Fund Flows

Institutional fund flows for Saudi equities in Q3 2025 reflect a cautious stance. Foreign ownership in the Tadawul has grown significantly since 2018, but this inflow has not translated into robust equity performance. The MSCI Saudi Arabia IMI's expansion from 70 to 123 constituents since 2019 indicates diversification progress, yet the index remains dominated by energy and financials. Analysts like Junaid Ansari of Kamco Investment Co. highlight potential in bank shares but note that broader structural reforms are still nascent.

The underweight positioning is also driven by geopolitical risks. A potential escalation of the Israel-Iran conflict could disrupt oil flows and business confidence, with cascading effects on the non-oil sector. While a contained conflict might have minimal impact, the specter of regional instability remains a drag on investor sentiment.

Cautious Optimism Amid Long-Term Catalysts

Despite these challenges, Saudi Arabia's non-oil GDP growth is projected to reach 5.1% in 2025, supported by private consumption and investments in retail, hospitality, and construction. Al Jazira Capital's 4.6% GDP growth forecast for FY25 and a 7.1% upside potential for the TASI index suggest cautious optimism. However, these projections hinge on the successful execution of Vision 2030 initiatives and sustained global demand for non-oil exports.

For now, the market's reliance on oil and the absence of immediate catalysts for equity re-rating justify a strategic underweight. Investors should monitor the pace of structural reforms, oil price trends, and regional geopolitical developments. While Saudi Arabia's long-term transformation is inevitable, the path remains fraught with near-term uncertainties.

Conclusion

Saudi equities occupy a precarious position in the EM landscape. Their historical ties to oil prices, coupled with macroeconomic and policy risks, make them a laggard in a diversifying world. Institutional underweighting reflects a pragmatic response to these challenges, even as the kingdom's structural reforms hold promise. For investors, patience and a measured approach are key-until the non-oil economy's potential is fully realized.