High-flying regional stock markets face a difficult period

With oil prices still at very high levels, and most commentators of the opinion that prices are likely to go higher rather than lower, regional stock market investors have been left aghast at the collapse of share prices which appears to be gaining momentum.

Normally it is true there would need to be a good reason for a stock market to reverse direction. But anyone studying the charts of the Middle East stock exchanges can note the classic bell-shaped curve with an exponential upward line that signals danger. Thus markets that have risen very fast can simply run out of steam and share prices fall back.

IPOs drain liquidity

That appears to be the explanation for the share price slump now in progress across the region. Another reason is the increasing number of initial public offerings which drain liquidity from stock markets as IPO buyers will sell other shares to obtain funds for an IPO.

One more factor pushing shares down is the fact that profits from the local banks in 2005 benefited hugely from the rising stock market. With the stock markets in reverse, banks will not have these profits in 2006 and so therefore their shares move lower in anticipation of a lower headline profit.

Market commentators such as Dr. Henry Azzam, chairman of the Dubai International Financial Exchange warn that this process may not be fully played out until the end of 2006 when the markets will form a new bottom.

However, he expects IPOs will continue to find investors despite the falling market. It remains to be seen how keen investors will be on buying 'new' shares as they watch the prices of 'old' shares falling. Investors may loose confidence in stocks altogether.

Buying on the dips

Whatever happens with IPOs, the usual pattern of a downturn in share prices like this is for a precipitous fall to be followed by a strong rally. This is not usually sustainable and share prices then fall away, so buying on the downward dips could be a very dangerous investment strategy.

On the other hand, regional governments may decide to follow Kuwait and use some of their record oil revenues to support stock prices by letting government agencies buy shares to support prices. Some Asian countries did this successfully in the Asian Financial Crisis of the late 1990s, though it did not prevent many investors sustaining ruinous losses.

It is hard to offer investors advice about what to do at this stage, and those that are still in the market have clearly not been listening to the many commentators' warnings in recent months.

Holding on for a bounce in the longer-term is only a strategy is you are not investing borrowed money, but this is a strategy that has served investors well in previous market crashes. For stock markets always eventually recover, though not all the investors will make it.