Crash and burn

Stock markets across the Middle East are tumbling, with some down over 40% in the space of just three months. As investors protest on the streets of Kuwait, Massoud A. Derhally asks leading analysts if the bubble has finally burst.

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By  Massoud A. Derhally Published  March 19, 2006

|~|sm1-200.jpg|~|GOING DOWN: Investors look on in shock as stocks in the Gulf fall to record lows.|~|Stock markets across the Middle East are tumbling, with some down over 40% in the space of just three months. As investors protest on the streets of Kuwait, Massoud A. Derhally asks leading analysts if the bubble has finally burst. Finally, it happened. From Dubai to Riyadh, stock markets across the Gulf came tumbling downb. But was it that much of a surprise? It was Michael Douglas in the movie Wall Street that said: “Greed, for lack of a better word, is good! Greed is right! Greed works! Greed clarifies, cuts through, and captures the essence of the evolutionary spirit.” Unfortunately greed is what got the better of people in 1999 when the internet bubble burst and markets tumbled. And now six years on, it may again be greed, and the insatiable appetite of uncanny investors for absorbent returns on their investments, that have contributed to surging stock markets. It was last June when Tarek Fadlallah of Nomura Bank came out with his report the “Great Arabian Bubble”. It said markets were overvalued, and that it was becoming increasingly difficult to rationalise the disproportionate valuations of companies, making it all the more certain that a market correction would take place. One that would be both “both sharp and painful”. But it appears many investors brushed off his warnings. At the time Fadlallah illustrated his point by highlighting the hyper-valuation of Saudi Telecom, whose market capitalisation in June 2005 of US$74 billion was larger than the combined value of British Telecom (US$35 billion), America’s AT&T (US$15 billion), South Korea’s SK Telecom (US$15 billion) and South Africa’s Telekom SA (US$9 billion). “To me it seems rather strange that you have a situation where the oil sector, which is what Saudi Arabia is all about is unlisted and major companies are also largely unlisted—and despite that other companies that are listed still account for 150% of the GDP of Saudi Arabia,” Fadlallah told Arabian Business last June. “If you were to capitalise the value of the oil industry, like the state owned Aramaco and some of the big family companies, you could actually double, triple or quadruple the market cap of Saudi Arabia. You are then telling me that a country that has a GDP of $300 billion has got a market cap which is equivalent to one third or even half of Japan’s market cap and that just doesn’t make sense. You can feel something is wrong there.” Now, nine months, on Fadlallah’s report appears to have been prophetic. So why then have the markets crashed? There is no single answer to the question. “It’s a function of a lot of different things: liquidity crunches, profit taking and underlying valuations. As more and more money is being poured into the stock markets there is greater and greater emphasis being put on the performance of companies. The vast majority of this money was speculative and not valuation driven. The performance was not measuring up to expectations,” explains Rashad Faraj, a Bahrain based investment banker. Markets, especially ones like those of Dubai and Saudi Arabia and to a lesser extent Kuwait, witnessed a meteoric rise that was driven primarily by excess liquidity. Parallel to this lies the economic transformation of the Gulf where companies are emerging from a culture under the umbrella of the 1980s style government management to become more efficient, more professionally managed, more aware of shareholder value and returns. Where things faltered is with investor perceptions of what these companies are actually worth. In Saudi Arabia for instance, the largest and most lucrative market, these budding companies that were undervalued, provided a window of opportunity with potential for growth and return and as such the stock market was a good place to invest. But what happened as a result of this frenzy? People put their money in the markets, which subsequently surged and a herd mentality followed. “There is no doubt that the feeding frenzy did happen and it pushed prices up. A large part of the reason why we are seeing dramatic drops now is that people rather stupidly were allocating 100% of their savings and throwing it in the stock market thinking its going to double tomorrow. But you see the rate of growth plateaus because there are no underlying forces to support that continued sharp rise. The market continues to rise but the rate of growth starts to taper off and as that happens people’s confidence in the market starts to drop off,” explains Faraj. The correction began to take shape when investors realised they were not actually making the returns they expected out of the market and held back on investing further, and as a result a natural sell off takes place. On March 14, or what is now referred to as ‘Black Tuesday” the Dubai Financial Market took a major hit shedding $10 billion or 11.7% of its market capitalisation. The correction converged with adjustments in Saudi Arabia where the market has declined 17%, in Kuwait that is down 15% since its peak in February and in Qatar where the market that has dipped 23%. One UAE based analyst who spoke on condition of anonymity emphasised the market correction in Dubai should be viewed in the context of the last half of 2005 and not as an isolated event. “The decline didn’t start on Black Tuesday. We were flat from June to December 2005 and no one is really paying any attention to this. The market actually broke in January after the fourth quarter results came out. The main reason is because the growth that we are seeing quarter-to-quarter slowed down and then you had Emaar results, which were disappointing, and they confirmed the trend in slowdown so the market broke. This was then intensified because of two IPOs that came at the same time and liquidity was sucked out and this caused the market to drop further and caused a snowball effect,” explains the analyst. “The fundamental reason the market really overshot last year, going up 100% in six months was because a lot of people and institutions were pricing no recurrent market income into their multiples. Going forward, we now have first quarter results, with the market dropping and the earnings quality of a lot of the companies here being bad and really reliant on market income it is going to be negative for the market. However after the first quarter results there is going to be a re-shuffling of allocations and it will become clearer which companies are relying on the UAE market and which ones are not and probably the market will stabilise there,” he adds. Shehab Gargash, managing director of DAMAN Securities is not all that shocked by the turn of events. “It is what we expected. It maybe happened all at once on one day for different reasons in different countries but effectively you need to give back some of the gains across the board. It’s too early to tell whether this is a prolonged end to the four or five year rally that we have seen. It’s too early to predict that at this juncture,” he says. But he adds, “the key will be the flow of liquidity. There is abundance of liquidity unlike other times. Will the flow of liquidity pull back some of those losses in the few days or weeks ahead? That will be the main indicator to look at. The liquidity levels are the big differential between what is happening right now and what would otherwise happen.” Does this mean that the UAE economy will contract? No. Not in the least. The growth expectations of the UAE are very much in line with 2005 and the authorities have managed and continue to keep inflation in check, whilst government spending, oil prices, tourism and construction activity are all still high. For the UAE the decline in its markets means that though operational profits of companies are not going to be impacted this quarter, nonetheless a big portion of their earnings were coming from non-core operations, from market income and that is no longer going to be the case. In Saudi Arabia, where market capitalisation had exceeded US$650 billion, the index had reached 20,000 points, and companies trading at 13-14 times their book value and 34-45 times earnings—investor appetite has not been subdued by the recent market correction. Basil Ghalayini, chief executive of BMG Financial Advisors Group in the Kingdom believes investors have no one but themselves to blame for their “erratic and ignorant” manner when investing despite warnings from the Capital Market Authority points to a recent initial public offering of a the Al Idriss company in the gas sector. “It closed at more than 360 Saudi Riyals whereas the offering price was 185 SR and this shows that the market would be receptive to new IPOs even though it’s at a premium. “The market is not crashing it is correcting itself. The sudden growth that took place in the last few months was abnormal and unjustified and not relevant to the fundamentals of the underlying companies. I think we will see this kind of instability and a sizeable correction. It might stabilise at a certain level once more IPOs are injected into the system.” Still the prospects of stability have not silenced calls from the Shoura Council for the government in Saudi Arabia to intervene or disenchanted investors in Kuwait that took to the streets demanding their government intervene and launch an inquiry into why the market had plunged nearly 4% in one day. “The markets throughout the Gulf have gone unchecked with minor corrections…Kuwait remained resilient and people somehow did not heed the knowledge and the wisdom that markets cannot keep going in one direction forever,” says Randa Azar, chief economist of National Bank of Kuwait. “The bottom line is that you have a lot of unsophisticated investors without much experience in the market and have been buying simply because they see prices going up and they have heard others making a profit. They judge the value of a company based on what its price is. They don’t look at fundamentals.” Rasheed Al Maraj, governor of the Bahrain Monetary Agency (BMA), the central bank of Bahrain believes all that has transpired is long overdue and he echoes the same sentiments of analysts and economists. “For so many months now many experts and central bank governors were voicing concern about the behaviour of the stock market and this euphoria that has taken place. It’s only natural that after a while you will have to have a correction, taking place. You cannot defy laws of gravity forever with P/E multiples skyrocketing. That’s unsustainable,” says Al Maraj. “A correction is always painful but it is the natural progression of any stock market. I’m not too concerned that there is going to be a meltdown. The anxiety that comes with it is obviously difficult but after a while the market will have to settle down at a certain level and start rebuilding based on the performance of the companies.” There are a few lessons for investors in the Middle East and for institutions. Investors should diversify their investments and be in the market with a long-term perspective and they need to do this without losing sight of the tangible elements that fuel companies and economies. It also means not being too overstretched or highly leveraged and institutions, especially, in the absence of credit bureaus need to make a concerted effort when they extend capital that ultimately makes its way to high risk environments like stock markets. This all also means that in free markets, which most markets in the Gulf are, there is no room for government intervention and with growth comes pain. “Governments did not intervene when the markets were going up to prevent this speculative fraught. Why should they now? Analysts always warn about the risks and investors always laugh at them because they are making money,” says Azar of NBK. “If the governments intervene it will actually be detrimental to the development and growth of capital markets in the region. You need that maturity. People don’t learn a lesson unless they pay for it. The lesson is we need more transparency, fundamental research and investing on a sound basis.” What should be of concern to market regulators and investors is whether or not corporations are able to deliver on their growth promises. This of course also stands in stark contrast to the exaggeration of punters taking the market beyond the realm of reality. Are the golden days over? Not just yet. As Gargash of DAMAN Securities says, “the golden days are still here but the exuberance is over.” US Federal Reserve Bank Chairman, Alan Greenspan, would probably agree—but its anyone’s guess what type of a multiplying effect on the economy, a US$365 billion surplus acrosss all GCC countries will have in 2006.||**||

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