Stock market crashes and real economic growth

Investors in the UAE and Qatar stock markets are no longer happy people: Doha Securities Market is 29% off its peak of late last year; the Dubai Financial Market is 35% down and the Abu Dhabi Securities Market 28% down on the day this article was written.

By contrast Saudi Arabia has just passed another record high and Kuwait has been moving sideways around an all-time high. In terms of price-to-earnings ratios Saudi Arabia trades on around 40, the UAE under 20 and Kuwait in the mid-teens.

Markets ahead of profits

Shuaa Capital's presentation to a RAKbank seminar last week highlighted a gap between the index of GCC company profit growth in the past few years at 305% while the stock market index is up by 450%.

This suggests that whatever the outlook for oil prices - and a record $150 billion surplus is in prospect for 2006 according to Shuaa Capital's forecast - GCC share prices have risen too far ahead of profits. Thus a correction from share price levels that are 50% above profit growth is to be expected, and this is what is happening in the UAE and Qatar; and Saudi Arabia may not be far behind.

In short, investor confidence has gotten ahead of valuations, which need now to retreat to a more reasonable level. Shuaa Capital thinks this may already have occurred in the UAE, but its fund managers are not yet confident enough to go back into this market.

So will the disappointing stock market performance begin to impact on the real economic outlook for Qatar and the UAE? The answer is probably not, provided that the authorities do nothing to accelerate the decline in share prices further.

IPOs acclerate decline

That should mean a halt to all new initial public offerings. IPOs drain liquidity from a stock market as traders tend to sell their existing shares to buy the new ones. This is fine in a rising market, but in a falling market this process will accelerate the selling of shares and risks causing a market panic.

On the other hand, if handled carefully a stock market decline at a time of surging economic growth can be absorbed with a negligible impact on the real economy.

Clearly some losers on share prices will be unable to buy the new car that they intended to, but others will simply decide to invest elsewhere, for example in property, and investment will shift to another asset class and support that area of the economy.

So there is no need for alarm in the business community if a stock market that has flown too high comes back to more sensible valuation levels, though this will be little compensation to those who have lost money.