Reasons to be cautious about UAE stocks in 2005

Last year the Kuwait Stock Exchange managed to post a gain of more than 30%, defying some worries that its 70% plus rise in 2003 would lead to a market 'correction'.

Now the outlook for the UAE bourse in 2005 looks remarkably similar. The Emnex index soared by 89% in 2004, and has greeted the first days of 2005 with some further heavy trading. So will the UAE bourse now go on to copy Kuwait in 2004, and deliver a very solid, but not exponential performance?

Market watchers certainly hope so. The problem with exponential share price curves is that they are always unsustainable. And if you look a chart for the UAE stock market the upward shooting line is remarkably reminiscent of the NASDAQ in 2000, or any other stock market boom about to go bust.

But the Kuwaiti experience suggests that it is possible for markets to cool a little without collapsing. High oil prices and tremendous local liquidity are capable of supporting even an overvalued market for sometime.

However, there is a very real danger that investors entering the UAE stock market now will get their fingers burned. It happened before in 1998 when the share price charts looked very much the same as they do now.

The real problem is that investor enthusiasm just gets out of control at this phase in the cycle, and that an investment mania grips the market. Everyone thinks that they can not loose, and this very psychology drives the market to levels beyond rational analysis of values to a point where investor sentiment alone is supporting the market.

Then all it takes is one small incident to damage investor confidence and the whole market takes a drastic downturn.

It is a feature of this stage in the cycle of a stock market - and they all follow pretty much the same pattern - that foreign investors enter the market, attracted by past performance. In the UAE in recent days Saudi and Kuwaiti investors have apparently been major investors.

The prudent investor should be asking themselves: What is the upside risk? And what is the downside risk today in the UAE bourse? Cashing out while you are ahead assures success, while staying invested while the market runs ahead carries the risk of being caught in the downturn.

When might that happen? Some sages say after the financial results and dividend declarations this spring, but irrational exuberance by foreign investors could bring that day of reckoning forward.