Middle East fund managers have on balance become bearish on the region's biggest stock market, Saudi Arabia, after oil's rally ran out of steam and the kingdom confirmed strict rules on foreign investment, a monthly Reuters survey shows.

The survey of 15 leading investment firms, conducted over the past 10 days, shows none expects to raise its equity allocation to the Middle East in the next three months - the first time this has been recorded since the survey was launched in September 2013.

Last month, 33 per cent of respondents said they planned to increase their equity allocations. The proportion intending to cut equity allocations has risen to 20 per cent from 7 per cent.

Oil prices, which are a major driver of economic performance in the region, are headed for a monthly loss after rebounding in April, and their longer-term outlook remains uncertain.

Also, falling trading volumes and thin corporate news flow indicate that markets are already slipping into a summer lull. Ramadan, which will start around June 18 this year, usually sees activity decline even further.

Fund managers are particularly negative on Saudi Arabia, with 27 per cent planning to cut their allocations in the next three months and just seven per cent planning to increase them.

This compares with 13 per cent planning to increase allocations and the rest seeing them stable in April.

Saudi Arabia's stock market is particularly sensitive to oil price movements as petrochemical companies account for almost a quarter of market capitalisation.

Another important factor is the opening of the kingdom's market to direct foreign investment next month. Some investors had hoped that Saudi Arabia's Capital Market Authority would relax initially proposed rules that placed strict ceilings on individual and total foreign holdings in local stocks.

But in early May, Saudi regulators announced a final version of the rules that preserved those ceilings, making it clear they don't want any sudden deluge of international money.
 
Foreigners can directly own no more than 10 per cent of the market by value - in many other big bourses, they own 20 per cent or more - while a single foreign investor can hold no more than five per cent of any listed Saudi firm, and total foreign ownership of a firm is limited to 20 per cent.

For now, another major deterrent to investment in Saudi Arabia is valuations, fund managers said.

"Because of Saudi Arabia's equity rally to date, valuations currently fully reflect market fundamentals and the positive sentiment accrued from the announcement," Invest AD said.

"Broad market valuations are high relative to history and to some other comparable markets, especially when seen against expected earnings growth during a period of relatively low oil prices.

"We will look to increase our weight in Saudi Arabia as soon as valuations return to attractive territory, particularly with our favorite stocks and/or if we see a higher-than-forecast positive change in earnings growth."
    
Fund managers are neutral or marginally positive on other Gulf markets which in terms of year-to-date performance are far behind Saudi Arabia's 17 per cent gain and are therefore valued more attractively.
    
Twenty-seven per cent plan to increase their equity allocations to the UAE and 20 per cent expect to cut them, compared to ratios of 27 per cent and seven per cent in the previous survey.

"Although oil prices remain under pressure, equity markets continued to show strong resilience and managed to overcome the ongoing geopolitical issues," said Tariq Qaqish, managing director of asset management at Al Mal Capital.

"We believe companies in general will deliver strong results in 2015 and governments will continue to support the economy by higher spending, especially in the Gulf region."

In Qatar, 20 per cent plan to increase allocations and 13 per cent see them lower, the opposite of April's ratios.

Meanwhile, Egypt once again became investors' favourite in the survey after the Cairo government put on hold for two years the planned introduction of an unpopular 10 per cent tax on capital gains from stock market operations.
    
The move sparked a rally that lifted the market as much as 11 per cent from its five-month low in just a few days.
   
Twenty-seven per cent of respondents plan to increase their Egyptian equity allocations and none plan to cut them. Last month, twenty per cent of respondents said they planned to increase allocations and seven per cent saw them lower.-Reuters