Asset market distress begins to spread, tough times ahead!

When you put this sort of a backdrop together it tends to make the optimism seen in global equity markets right now look a bit sick. How can stocks remain a good investment in a world of rising interest rates and inflation, and a deteriorating real economy?

The Middle East was a harbinger for a change from the bullish years of the mid-2000s towards a more sobering outlook for the rest of the decade. Stock markets in Saudi Arabia and the UAE have lost more than two thirds of their value since peaking in late 2005, and are still falling with the oil price.

There appears to have been a switch from stocks to real estate in local markets, but the normal time-lag between a peak in emerging market shares and a peak in real estate is 12 to 18 months. Real estate pundits like EFG Hermes mark 2007 as a transition year for UAE property with a decline in prices from 2008.

Realty time-lag

Indeed, the recent experience of the US housing market's plunge into crisis is a reminder of how quickly optimism about the sector can turn into gloom; some commentators are already calling a US real estate recovery but a 'dead cat bounce' or false rally is almost certain as corrections in real estate are never that short.

The same is also true for the oil market on which the economic welfare of the Middle East depends. A bear market, or a bull market correction - call it what you will - is not going to take six months. Eleven months is the shortest oil bear market on record and the lowest plunge was 56 per cent which would mean $44 oil.

That is the optimistic view. An average bear market correction would see prices dip as low as $14 a barrel, and certainly a correction below the long term average price of $24 a barrel can not be ruled out.

Oil leads the fall

It has taken the 15 per cent drop in oil prices since the New Year to bring this bear market into focus. Until then it looked more like a modest correction.

Where will the bearish forces now at work in asset markets strike next? Will UK housing join the US in a correction? UK house prices did fall in December, according to the Halifax. Will the major equity markets suddenly decide that falling oil prices mean that economic growth is weakening and that the outlook for profits is deteriorating?

Certainly last May the first signs of energy price weakness gave global stocks a swift correction. Expect more of the same this time, and we also saw some hedge funds getting into trouble due to energy price movements, so history could be quickly repeated there. Cash is king in a recession, and anyone who forgets that is history!