Just what are Arabian stock markets saying about the future?

Such logic is not always found among stock market investors as the current state of local and global markets demonstrates. So why is it that the Arabian bourses have succumbed to what by any measure is a historic crash with markets up to 70 per cent off their highs?

Local stock markets were driven up and up to overvaluation based on over enthusiasm among investors convinced that momentum alone could carry the market ever higher. Once this bubble was pricked the deflation has been every bit as spectacular with poor sentiment undermining confidence again and again.

That is an oversimplification of course. Lax lending by greedy local banks has also fuelled the fire, allowing stock valuations to hit levels that they would not otherwise have been able to achieve. Now another worry on the way down is that local banks may have got themselves into trouble.

Oil price factor

But stock market booms are not erected on thin air. They may be fuelled upwards by not much more, but at the root there has to be a cause. In the Arabian stock markets the root is clearly a rising oil price, the source of local liquidity.

Now the 25 per cent oil correction of this year does explain some of the method in the madness of local stock markets. Liquidity is still large but on a downward path. If nothing else the speed of economic growth is bound to slow which is, and has been, enough to deflate a stock market bubble.

This clearly has a bearing on the profit outlook for local companies. Higher price-to-earnings ratios can only be justified in an atmosphere of rising profits, and if profits begin to fall and move onto a declining trend then stock values can not be maintained.

However, the problem is that stock markets amplify the upside and they also amplify the downside. Thus while a 25 per cent decline in oil prices from record highs is not good news, it is hardly catastrophic unless it continues. But Arabian stock markets extend the trend and so head towards pessimistic valuations.

Crash absorption

With judicious economic management and the record of Arabian central banks is credible, then this stock market crash can be absorbed and its impact limited to certain speculators and a few banks.

What would be more worrying would be if the more pessimistic investors proved correct and the oil price did decline a good deal further, and that led investors to dump property investments as well precipitating a wider local economic crisis. But we are not there yet, and geopolitics could quickly restore the oil price.

As for Western stock markets well perhaps they are the ones due for a crash next and have been driven higher by investor enthusiasm devoid of commonsense in the face of higher oil prices!