Where next for regional stock markets?

After a stellar performance in 2005, with regional bourses ranked among the best performing in the world, Arab stock markets have crashed to earth in the first quarter of 2006. Now we are seeing something of a minor rally with a few brave investors shopping for bargains.

This is very much the usual pattern in emerging market stock exchanges. Over-enthusiastic retail investors, with little more knowledge of the market than the ability to observe a rising graph, have taken share prices to unsustainable levels. Then after a 30-50% crash bargain hunters emerge.

However, emerging stock markets normally fall by 80-90% before bottoming out, and technical analysts point out that the Arab stock markets appear to have a lot more downside potential. This is not a very difficult analysis to perform: you just look at the share curve's upward path and then project a mirror image for the downside.

Further to go down?

So will markets sustain their rally or drift further downwards over the hot summer months? It is hard to see the kind of madness of crowds that drove the markets so high returning to save them, and if valuation levels were not considered seriously on the way up then why should this be true on the way down? Surely most investors will have packed up and gone away.

Those who remain in the market are either in it for the really long-term, or desperately trying to win back the losses of recent months. Again such desperate souls only show their ignorance about markets, as while they were able to ride up on a rising market it is next to impossible to do so in a falling market, particularly as Arab markets do not allow shorting of stocks.

The brokers and local financial institutions are pretty quiet right now, doubtless hoping like Charles Dickens' Mr. Micawber that 'something will turn up'. There is still a good deal of bold talk about initial public offerings, despite a general admission that IPOs have been one of the reasons for the depth of recent crashes as a drain on liquidity.

Why the IPO talk?

For the IPO gravy train to re-start local stock markets will at the very least have to establish a new base. Otherwise every time an IPO is held the market concerned will be pummeled into the ground as investors sell to fund their IPO applications.

For IPOs are only ever seen in rising and not falling stock markets. Why would you buy a share today if it was likely to fall in value tomorrow?

Optimists will argue that 'it is different this time' but the truth is that stock market history is full of patterns that repeat themselves again and again. And as Warren Buffett once noted the words 'it is different this time' must count as the most expensive in the history of finance.