Is it now time to exit GCC stock markets?

It is an iron law of stock markets that what goes up must come down! The fear and greed of investors is what drives stock markets, and such human emotions are prone to over exaggerate the ups and deepen the downs.

For 2005 has been such a remarkable year for GCC stock markets, with near 100% gains that the very good performances of 2003 and 2004 have been left in the shade. But it is important to note that this stock market party has been running for sometime, and that news of high oil prices is not exactly new in the Middle East.

It is not so long ago that the trading floors of the region's stock exchanges were among the quietest places in town. Now the floors are like crowded nightclubs with no room to sit, and full of euphoric souls anxious for a good time.

Astronomic valuations

However, the signs are on the wall that the good times may be coming to an end. Valuations of key stocks have been spirited to astronomic levels and trailing market price/earnings ratios in the mid-40s are worrying by global standards.

Nomura Securities recently pointed out that Saudi Telecom was valued at more than all the European telecommunications giants together. Now business may be good in the Kingdom but is the outlook really that good? Will Saudi Telecom's profits soon dwarf those of its European counterparts?

It is quite clear that Gulf stock market valuations - i.e. share prices - have lost track of reality. Investors have become quite oblivious to little things like profits which are the only sound long-term way to value companies.

Third quarter profits have also looked stretched to the limit with bank profits inflated by IPO fees and lending and other non-interest income that may not be repeated. It is surely not a sound thing when rising profits are coming from the stock market boom itself.

The madness of local investors was seen in the rush to buy shares in the Dana Gas IPO which was 148 times oversubscribed, giving each individual investor a miserable $479 share allocation. Even granted the instant profits on listing, it is unlikely that this would be enough to pay borrowing costs and the cost of traveling to Dubai for the 56% of non-UAE participants.

Local liquidity

Some analysts argue that liquidity is so strong in the GCC at the moment - basically there is a lot of oil money sloshing around - that share prices can not crash. But it is wrong to assume that shares will stay up just because an economy is expanding.

Look at the Chinese experience of the past five years. In China shares peaked in 2000 and have being falling ever since, despite a phenomenal expansion of GDP in this period. On the other hand, it is true that ample GCC liquidity should prevent the kind of 80-90% share price collapses typical of emerging market bourses.

However, GCC stock market investors should be weighing the upside against the potential downside in local markets and deciding that now is the time to quietly head for the exit door. There is little more money to be made, and a lot to be lost.

The danger is that this quiet exit becomes a noisy stampede to get out of shares. This is what normally happens, particularly in emerging markets, and this is not a pretty sight for anyone involved.

People who have foolishly placed all their capital in one asset class discover the virtue of diversification, and those who have borrowed to invest, thinking that they can not lose, have a real problem.