Diversify or die

Stephen Corley hopes the recent crash in regional stock markets will persuade investors to look beyond equities and real estate.

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By  Stephen Corley Published  March 19, 2006

|~||~||~|Stephen Corley hopes the recent crash in regional stock markets will persuade investors to look beyond equities and real estate. It may be useful timing for the GCC investment community to focus its attention on the evolving debacle over the Dubai Ports World acquisition of US container terminals, not to mention the Inchcape Shipping Services link. Notwithstanding America’s idiotic treatment of DPW, the more one concentrates on Dubai’s activities overseas, the less one has to consider the potentially disturbing developments at home and in the GCC at large. In November last year, I wrote in Arabian Business: “Bubbles all have the same design flaw; they burst”. Through any rational analysis, we can say the Dubai Financial Market (DFM) asset bubble has burst. In Western eyes, a crash requires a slump of more than 20% in equity prices, so in conventional terms, the UAE market has crashed and many of the GCC markets are in a potential death spiral. Who knows what horrors await us with the Saudi exchange? However, the sheer scale of cash in the stock markets means that the real economy is no longer immune from their frenetic merry-go-round. What impact will the plunge in prices on the DFM and the ongoing demise of many GCC markets have on consumer spending and economic growth here and further afield? These are no longer inconsequential markets. Perhaps in global terms they barely matter, but a 40% decline in the DFM from its peak represents a loss of indigenous wealth of around US$50 billion. Taken at large, a similar reduction, if it happens, amongst the GCC markets will represent a loss of capital of over US$400 billion. As sure as night follows day, the rose tinted spectacle brigade will tell us that the door slamming shut for equities will be a giant ‘golden hello’ for real estate. With losses of this magnitude and in a period of rising interest rates, I doubt it. Those same asset managers who a few weeks ago were still predicting support for the market from high oil prices and excess liquidity, now maintain that this is a healthy downturn and that some share prices will see a ‘natural’ correction — in some cases by as much as 60%. But what happens when the global liquidity jaws snap shut in 2006 and the US, Europe and Arab central banks begin to tighten credit? Emerging markets are always prone to excess and no more so than here in the Gulf. If the US stock market sold off, emerging markets would decline even more, as has always been the case. And what about company profits and their effect on share prices as local groups enter more competitive markets and experience lower margins? Emaar is looking well beyond its original geographical horizon. When the group reported stellar figures recently, numbers that underlined the astonishing progress it has made in recent years but which fell far short of investor expectations, the announcement triggered panic selling. In due course, its valuation must converge with other global real estate giants and attract a valuation closer to 12 or 13 times earnings. Herein lies the tortured cycle. Many Middle Eastern financial institutions are riding high on record profitability. In some cases this stems partly from increased cost control and better diversification or a broader risk base for lending. All too often it’s a result of increased commissions from brokerage activities and profits resulting from the bank’s proprietary investment in local equities. As margins and profits are squeezed, so are share prices and in turn, the profits of those institutions trading them. They then become overvalued and the price dips again, and so the chain continues. It seems inevitable to me that shareholders will have to face a sustained reduction in earnings growth. The Arab Institute for Investment Security estimates that investment in construction and real estate in the GCC will exceed US$250 billion by the end of this decade. This sector represents 10% of GDP for the Gulf countries, and the financing market for the real estate sector in the GCC was around US$750 billion this year. If real estate sentiment turns negative as well, then the financial sector would be hard hit again, losing returns on loans and from the drop in the collateral value of the underlying asset. Diversify or die would be the advice. Unfortunately it is advice that is likely to be ignored. Oil exporters in the Middle East are still savouring windfall profits of over US$500 billion from energy production in the past two years and local economies have benefited from this through soaring regional markets for real estate and equities. It’s my earnest hope that the recent decline, which is by no means over, will prove a catalyst for change and a timely reminder that the get-rich-quick mentality never wins in the long term. Unfortunately, many brokers are insisting that the current trend is due to investors liquidating holdings to pay for forthcoming IPOs, in which case there is little evidence of sanity creeping back. Stephen Corley is a business consultant with experience in fund and asset management. He can be contacted at corley@emirates.net.ae ||**||

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