Last month’s sell-off in the Gulf equity markets was a timely reminder to the region’s investors that nothing lasts for ever. For the past three years the Gulf markets have enjoyed the best of bull runs. Spurred by record oil prices and high levels of liquidity, investors enjoyed a one-way bet that showed few signs of unwinding.
This year the story is different. In mid-March, many of the region’s markets suffered their worst single-day performance in recent years. The Dubai stock market fell 12% to an 11-month low. In Saudi Arabia, the biggest Arab equity market, with a capitalization of $750 billion, shares fell nearly 5%. The Kuwait index tumbled by 3.67% – its worst performance in three years. Qatar and Bahrain also fell.
What were the reasons for the panic selling? The simple answer is that valuations were getting so high that a correction was inevitable. The Saudi index was trading on an average P/E ratio of 40 before the crash and some speculative stocks were trading at twice that level. In some instances the level of demand for Gulf shares was getting ridiculous. But valuations alone cannot fully explain the story. Many of the region’s markets have been in a downturn for months. UAE stocks, for example, have been performing poorly since the fourth quarter of 2005 and on March 20 were down 17.7% since the beginning of the year. And in some sectors in certain markets, such as banking in Abu Dhabi, plenty of bargains are to be found.
What the downturn reveals is the unsophisticated nature of the Gulf markets. Highly leveraged retail investors with a day trader attitude are still too influential. Most investors in the region believe markets should go up for ever. If they fall, government bail-outs are expected. This is especially the case in Saudi Arabia where the kingdom’s rulers have come under pressure to intervene in the markets. So far they have denied doing so. Intervention is an unsatisfactory short-term solution and flies in the face of market forces.
Far better is the move by the Capital Markets Authority to allow foreign residents in Saudi Arabia to invest directly in the stock market in a bid to improve liquidity, although they will still not be able to invest in IPOs. Previously the 6 million expatriates could only invest via mutual funds.
The Gulf markets have come a long way in a short time but further development is essential. It is imperative that an environment is created in which institutional investors can flourish. Greater transparency is essential. More companies need to make public issues. The development of debt capital markets must be encouraged and promoted. The public must be better educated about investing.
The fundamentals are still very good. The opportunity is there for Gulf leaders to implement long-term reforms. The question is: will they?
