* Some speculative UAE stocks may be overvalued
* Many institutions still reluctant to commit funds
* Aldar-Sorouh merger plan not necessarily good news
* IMF deal important for continued Egypt rally
* Uncertainty over telecommunications stocks
By Nadia Saleem and Patrick Werr
DUBAI/CAIRO, March 14 (Reuters) - After a sharp setback last week, stock markets in the United Arab Emirates have resumed rising in high trading volumes, but some analysts say the rally remains fragile as much of it is speculative and depends on a benign global backdrop.
Dubai's benchmark index, up about 25 percent so far this year, bounced off an eight-year low in mid-January. While many fund managers believe the market is in an overdue recovery from an excessive drop, sharp gains in small-capital stocks with limited fundamental attraction have raised doubts about the sustainability of the uptrend.
Construction company Arabtec is trading at 24 times this year's estimated earnings, compared to historic levels around 10 times, analysts said. The stock is up 89 percent so far this year, far outperforming the benchmark.
Deyaar Development, which swung to a small profit in 2011 after being badly hit by the continuing slump in Dubai's real estate market, is up nearly 100 percent so far in 2012, trading at about 21 times this year's estimated earnings.
"A lot of Dubai names have more than doubled this year -- that's basically just a lot of speculators," said Ibrahim Masood, senior investment officer at Mashreq Bank.
"Investors who are going long on those names are setting themselves up for pain. I don't see fundamental underpinnings for that kind of move."
Added Rami Sidani, Schroders Middle East head of investments: "Small-caps have outperformed the blue chips of the market and some of these companies remain in very bad shape financially.
"Their business models are no longer sustainable given the change in environment in Dubai post- the real estate crisis. The rally has been exaggerated in some names."
One major piece of news for the stock market this week was Abu Dhabi's decision to consider a merger between builders Aldar Properties and Sorouh Real Estate. This was taken positively by investors as a sign that authorities were committed to supporting the real estate sector.
"The current business set-up for Sorouh and Aldar is not viable in the long run," said Ali El Adou, portfolio manager at The National Investor. "So the government is trying to create an entity which will have a stronger (footing)."
The terms of the possible merger have not been announced, however, so it is unclear if shareholders would benefit. And the merger plan can be interpreted as a recognition that the real estate market in Abu Dhabi and the United Arab Emirates as a whole will remain depressed for some time to come.
Abu Dhabi's stock market may be less vulnerable to any reverse than Dubai since its index has rallied at a more staid pace; it is up 9 percent so far this year.
Just as in Dubai, however, trading turnover in Abu Dhabi has risen sharply, by a factor of several times from last year's levels. This suggests there is a lot of short-term money in Abu Dhabi that could be withdrawn quickly if a reverse in global markets spooks investors in the Gulf.
"The markets remain fragile to global sentiment given the lack of institutional money and committed funds to the region. However, fundamentals are improving," Sidani said, mentioning heavyweight Dubai stock Emaar Properties and the banking sector as attractive investment areas.
Emaar is less exposed than many other property firms to weakness in the local real estate sector, since it is benefiting from a recovery in the tourism and hospitality sectors and also has an international real estate portfolio.
In Egypt, investors will be anxious next week for signs that the government is making progress toward securing a $3.2 billion loan from the International Monetary Fund. An IMF team is expected to begin a visit to Cairo early in the week.
Egypt's benchmark stock index soared by almost 50 percent this year, partly on hopes that the loan will help the country avoid fiscal and currency crises. But stocks began falling back at the end of last week on concern that the country's economic and political troubles may not be resolved as quickly as hoped; an IMF loan deal is not inevitable as the Fund may find it hard to reach an understanding on economic policy with Cairo. By Tuesday, the index had sunk to a three-week low.
"An IMF deal may reassure investors about the short-term outlook for the Egyptian pound, reducing the risk of a disorderly devaluation -- this could benefit companies that are net importers," said Simon Kitchen, strategist for EFG-Hermes.
"However, potential foreign investors in T-bills will likely require more than an IMF deal before they become strong buyers." Among companies that could be harmed by a disorderly currency devaluation is vehicle assembler GB Auto, which builds cars in Egypt using imported kits, so it could be among stocks benefiting most from any IMF deal, analysts said.
The IMF has been pressing Egypt's government to narrow its budget deficit; one solution it proposed was to raise the prices which heavy industry pays for its energy. The government last week sent out higher electricity bills to heavy industries, and cement firms are among those that could be hurt, analysts said.
Mike Millar, head of research at Naeem Brokerage, said the market would also be looking to see if there was any progress on the forced, partial nationalisation by the Algerian government of Vimpelcom's Djezzy mobile phone unit. Vimpelcom acquired Djezzy as part of a $6 billion deal to buy the assets of Egypt's Orascom Telecom ; Algeria has said it expects a valuation of Djezzy to be completed by the end of March.
The market will be looking as well to see if Egypt's regulators approve OTMT's sale of most of its stake in Egyptian mobile operator Mobinil to France Telecom .
"We are still waiting for the telcos to have their final resolution," Millar said.
Kitchen said that overall, retail investors were still driving the market. "The market should move higher after the current consolidation, but longer-run concerns about the currency and the political transition are still important."