Bursting bubbles in the gulf

The recent fall in some of the Arab stock markets was predictable and governments should not attempt to prop markets up

We have mentioned over the last six months, that the Gulf markets, and in particular the Saudi stock market had gotten ahead of itself. The metrics we used were always simple to understand: the market capitalization had surpassed the national productive economy by a measurable distance. In fact, at its peak in February of this year, the market capitalization of Saudi Arabia at its peak had reached nearly four times the value of the GDP. To put this speculative fervor in perspective, at its manic NASDAQ-driven peak, the US market capitalization had hit 1.75 times the GDP. We use the Saudi market for analysis since it is the largest of Gulf markets, and actually has become one of the largest emerging markets in the world.

The flood of IPOs in a fairly arcane and unregulated market led to an unhealthy, almost parabolic trajectory. This, coupled with excess small public participation as well as an over zealous margin trading (day trading on borrowed money) has led to the inevitable and dramatic fall. So far, at the time of writing, the Saudi market has lost 30% of its value from the top, or nearly $200 billion, yes billion.

Though we did point to the high risks embedded in the Gulf markets in two articles, the devastation is truly awesome. Even the most pessimistic of analysts did not except the decline to come so swiftly, and what is more eye-popping, is that rather than allowing the market to adjust to more reasonable valuations, the authorities, asleep at the wheel when it came to reigning in speculation and lending, suddenly, panicked and stepped in to attempt to cushion the fall.

As we all know, perhaps the most damaging type of government intervention is when political leaders try to swing markets. There are many historical examples of failed attempts, the most spectacular that come to mind are the US attempts to stop the crash of 1929, and the twelve years the Japanese spent trying to stop the Nikkei’s collapse from 39,000 to nearly 8,000. Needless to say, I truly believe that not only is government intervention futile, but it can actually accelerate the fall, creating a larger frenzy on the downside. The purist in me might ask why would any government even want to prop up speculation? It seems absurd, but many governments do it.


Recent attempts at reversing markets were characterized by jawboning, i.e. talking up the market, much like the internet analysts did in 2000 prior, during and after the meltdown. The talking heads go on television claiming that the fall is “exaggerated” and the economy is fine. It may very well be, in fact the Saudi economy is more than just fine, it is growing faster than most emerging markets and government and capital spending is up sharply, but even the strong growth does not legitimize the outlandish market valuations with less than stellar companies going public.

As the authorities showed, accentuated laxness in allowing shady companies to list and an amateur public to speculate they, in effect, fanned the flames of the inevitable boom-bust cycle. In most Gulf markets, authorities are also attempting to make what they deem as “structural” moves to stop the falls. For instance, Saudi is allowing non-Saudi residents to invest as of the end of March. But at this stage, who wants to catch the proverbial falling knife? A 30% fall is not simply a garden variety “pull back” or healthy correction as some pundits like to call it, it’s a calamity, and it indicates some serious technical damage. Once this process begins, and especially at such a high level of excess valuation, little can and should be attempted to stop it. It is simply a market adjustment phenomenon tied closely to human behavior, which is summed up in two extreme modes of conduct: greed and fear. Once the greed is replaced by fear, the process is a long one, and in some cases, Exhibit A Japan, may take decades.

Foreign participation

Propping up the market not only doesn’t make sense and is not a clear mandate for governments; it also means that governments, in any attempt to buy the market is wasting precious cash, which will be unavailable for other ventures. My guess is, a broader participation of foreign players from the get go, would have perhaps provided the market with a healthier backdrop.

Here are some numbers for Gulf markets. The Abu Dhabi Securities Market has so far lost 23.4% on the end-2005 close of 5,202.95 points and 37.7% on its all-time high. The Kuwait Stock Market dropped 1.1% to close below the 10,000-point mark at 9,939.30 points, 13.2% below its 2005 close of 11,445.10 points. The Doha Securities Market dropped below the 9,000-points mark to close down 4.4% at 8,873.08 points. It is 19.7% below last year’s close of 11,053.24 points.

In this context, one wonders, can the Beirut bourse withstand any gravitational pull? So far the answer is no. Since the fall in the Gulf markets, Solidere and the main “money center” banks are off by nearly 20%. Many will have you believe that the reason for the Beirut fall is the political situation, but while the shenanigans of the decaying political system may not be helping, the true culprit for the most part is the fall in the Gulf markets. First, the mood of Arab investors and therefore their appetite for risk declines as they get hit. Secondly, as they get margin calls and they need to cut risk in their portfolios they will liquidate their assets abroad, once they have made some decent gains. Of course, had the political situation been better, the fall in Beirut may have been smaller, but there still would have been a sizeable pullback. As oil and stocks have fallen in tandem, the rationale for risking some cash in illiquid markets such as Beirut fades.

It is certain that the attempts at stopping the market fall in the Gulf will ultimately fail, as every single government intervention historically has, but in the interim, there will be sharp upswings. And while it is true that the Lebanese market does not suffer from the same overvaluation as the Gulf, at their peak, banks in Lebanon were trading at multiples associated with global banking powerhouses, an unreasonable state of affairs, despite their strong results and the astute banking culture of Lebanon. In sum, as long as the Gulf markets are hit by selling, it is tough to envisage a very rosey outcome for Beirut stocks, and even the most perfect political denouement may not be enough, as stocks in Lebanon are already up massively from their lows anticipating better times ahead. Some foreign funds may be tempted to jump in should the political situation improve, for a tactical play, but too many fiscal and economic bumps are straight ahead to look for anything more than speculative spasms.

In the long term, I do believe that there is room for improvement in Beirut equities, and for the bourse to attract foreigners and Arabs. For now, the main focus has been on debt securities (bonds) as the government has had to borrow excessively to finance reconstruction, but eventually, as more family businesses are incentivized to list, and a proper equity culture develops, Beirut can place itself on the regional market map. This is a tall order, though, as this will require a better environment, both political and economic and frankly, more credible leadership and clearer policy. Ideally, most emerging markets must undergo genuine reform in order to attract the larger players, i.e. the US and European funds.