Investors bewildered by GCC stock market crash

Like a general adding up the body bags on a battlefield, the reports from GCC stock markets in mid-week made for grim analysis. Investors are now nursing serious losses from the worst crashes in local stock markets since the late 1990s when the oil price stood at $10-a-barrel.

The Dubai Financial Market is most badly hit, and is now 45% off its all time high of last summer; and Abu Dhabi has followed with a 33% slump in share prices. Doha has taken a similar downward path with shares down a more modest 20%.

But until the past couple of weeks the two biggest GCC stock markets in Saudi Arabia and Kuwait were unaffected. Thus the impact of a 27% fall in the Kingdom and 14% in Kuwait has been all the more unexpected, leading to calls for government intervention to prevent a further downturn, and to correct shares to 'more normal' levels.

Beyond 'fair value'

However, this misses the point. Share prices have been driven upwards way beyond their 'fair value'. The Saudi Arabian bourse has been trading on a market price-to-earnings ratio of 40 compared with a 'fair value' of say 15 for an emerging market with a good economic outlook.

As the Japanese bank Nomura commented last summer this level of valuation is unsustainable in any marketplace, and always leads to a correction. Nomura was a little early in its warning but accurate in its analysis and conclusion.

Will the GCC stock markets therefore continue their decline? Unless somebody steps in to stop this, what is to stop investors panicking and selling out? Clearly the Kuwaiti and Saudi investors who demanded government action have a good case, but governments only usually intervene when markets have blown-off their excesses.

What governments could usefully do now is to stop new initial public offerings which are draining liquidity from the markets. An emergency ban to all IPOs would have some effect. Letting IPOs go ahead will definitely accelerate the decline of share prices - as investors sell in the market to buy the IPOs - and could lead to a market meltdown.

Confidence wiped out

The danger is that market corrections or crashes can wipe out investor confidence for years. The 1998-99 crash kept share prices undervalued for several years as investors had got their fingers badly burned, particularly those investing borrowed money.

It remains to be seen what the wider implications are for the general economy of the GCC, and a slowdown in new projects would seem the most likely impact, although the huge flow of oil revenues will offset any immediate effect on economic growth.

But clearly times will be tougher for anyone involved in supplying goods and services to those retail investors who have lost money in the marketplace, and some of those individuals will face personal ruin as the result of trading with borrowed and lost capital.