Rights issues ought to cool the UAE stock market

Last week's $1.36 billion rights issue from the Abu Dhabi listed First Gulf Bank was greeted by a 36% fall in its share price.

This is only logical: if a company doubles the number of shares it has issued then quite obviously the value per share is cut in half. But such simple mathematical truths seem largely lost on the crowds flocking to the UAE trading floors in Dubai and Abu Dhabi these days.

Their concern is far more the spirit of the day, or the hour, in trying to make a fast buck in a rising market. It is precisely this ignorance, or loss of contact with fundamentals, that deeply troubles professional market observers.

To say that market enthusiasm is getting carried away with itself is something of a considerable understatement. UAE stocks have become wildly overvalued on price-to-earnings valuations, and even bad news for the share price is often perceived as good news. For example, the market chose to read the Emaar Properties' rights issue as positive for the share price.

Now there is no doubt that raising additional capital in this way is good for the Emaar balance sheet, and the company does have some amazing projects to finance. But this represents a huge increase in the number of shares in issue, so the share price ought to have gone down and not up on such news, which it did not.

It feels almost churlish to point this out to such an optimistic crowd. It is certainly not what people want to hear. But it also happens to be a simple truth about how a share rights issue works in practice.

This is a symptom of what is happening in the UAE stock market at the moment. The market has become one driven by momentum and neither by fundamentals nor basic stock analysis.

People are buying because they think shares should go up and not because the fundamentals are right, except that in a vague way speculators believe that the economics of the UAE are so good that anything must succeed.

Blind optimism in investment is the most dangerous of human emotions. There are countless examples in history of speculators who have followed a market up, or more typically jumped in very late in the cycle, and found themselves burned. The dot-com crash, or the UAE stock market crash of 1999, should still be in most people's memories.

What compounds speculators' foolishness is the banks willingness to lend them money! And at present UAE banks are queuing up to lend speculators money to put into UAE stocks. This is irresponsible lending on the part of the banks, who should also be considering their own loan book and its future security.

For speculators who put borrowed money into an overvalued stock market will still have to re-pay those loans in the future. So they will either end up very rich or very poor. At the moment speculators still feel they will end up very rich, but that is not what history and past precedent suggests will happen.