To analyze the current turmoil in markets and with sovereign debt it may be best to turn to the famed entrepreneur and guru Willy Wonka (the Gene Wilder 1971 version).
"There's no earthly way of knowing which direction we are going. The danger must be growing for the rowers keep on rowing, And they're certainly not showing any signs of slowing!"
The latest example of this market confusion is the return to the front pages of concerns over Dubai. According to the report from Zawya Dow Jones, creditors to Dubai World may get just sixty cents on the dollar as part of the deal to reschedule $22 billion in debt. Once again, Middle Eastern markets took fright, credit default swaps surged and the financial market "experts" feigned indignation and surprise.
To be fair, it would have been tough to predict such potentially punitive terms for Dubai World creditors. But given events since November, when DW first announced its standstill on debts, should we really be surprised at what appears to be a tough opening gambit from the company?
Given what continues to be such awful underlying fundamentals and a severe supply and demand imbalance in the key underlying assets of Dubai World and its property developer arm Nakeel, should we really be shocked at such a haircut for investors?
World's Tallest Building Doesn't Ease Oversupply
Global markets may have been distracted with problems in Greece and the euro zone, but nothing has fundamentally changed in Dubai in the last four months. Yes, Abu Dhabi grudgingly stepped in at the last minute to avert default on a bond linked to Nakeel last year. But the supply and demand imbalance in the underlying property assets worsened since November.
For example, what's the one event you can think of off the top of your head that has happened in Dubai since November? That's right. They opened an even bigger office and residential block, the Burj Khalifa, which at 2,717 feet is the tallest building in the world.
If you are trying to shore up property demand, increase rents, reduce vacancies and stimulate activity, I'm not convinced you do that by flooding the market with more commercial property.
And here lies the problem. International lenders want a full and timely payment from Dubai World but, despite the bravado from the company and the Emirate, it appears the underlying property assets of the company are still tumbling in value.
Saud Masud, senior real estate analyst at UBS, said he believes that, if the Dow Jones story is correct, then the real return for investors will be even more punitive than the headline 60 percent of debt repayment and is way below recovery expectations:
“We believe creditors are expecting 60 to 70 cents recovery or at par recovery 2 to3 years out," Masud said. "Alternative 1 implies 25 cents present value recovery (assuming 15 percent discount rate), hence a wide disconnect with investor view.”
Other analysts share the concerns.
Credit Suisse strategists said the Zawya Dow Jones reported terms "won't be far away from" the first official debt restructuring proposal which is expected in March or April, adding that the news is "marginally more negative than anticipated."
The Big Real Estate Problem
But is the economic picture for Dubai improving?
This generates fierce debate. Yes, key assets such as the magnificent Jebel Ali port will be a major beneficiary of an upturn in world trade as the globe struggles out of recession. But it's Dubai real estate that is the great concern still.
Masud has been forecasting 80 percent peak-to-trough declines in the Emirate's real estate for more than a year now. He told me Monday that, in his estimation, prices are now off 50 percent and that another 30 percent to 40 percent decline was still on the cards with vacancies set to peak at a staggering 50 percent.
For its part, Credit Suisse predicts that the current concerns are more of an "aftershock" from November's announcement but fears a "real double dip" in case more Dubai government holding company's make overtures to restructure debt.
Whether we are seeing the beginning of the end to Dubai’s problems or a lull before another downside leg remains to be seen. But from an investment perspective concerns over debt repayment and underlying asset values remain the predominant fears for the medium term.