Saudi stock market crash a cause for concern

Stock market crashes do not come much more vicious than the collapse that has engulfed the Saudi bourse in the past three months. It has collapsed by 50% after briefly reaching an all-time high of over 20,000 points in February.

The pain for investors is therefore particularly acute as there was little warning and little time to liquidate stocks before share prices disappeared under water. Not surprisingly almost any meeting in Jeddah or Riyadh these days turns into a discussion of the market, and individual tales of ruin are numerous.

Indeed, with some four million plus shareholders almost every family in the Kingdom is touched by the tragedy. And the leverage made available by the banks is widely blamed for the extent of the market's decline.

Market euphoria

It was, for example, not uncommon for an investor swept up in the market euphoria to sell all his assets, including his home, car and to borrow from his wife and friends, and then obtain a loan for the same amount from his bank with the collateral as security. Thus a 50% market decline wiped out these assets entirely once the loan was called in.

Financial ruin is not something investors thought remotely possible with the Kingdom enjoying high oil prices and a budget surplus. Yet such episodes of speculation and collapse are nothing new to investment history, and tend to happen when sudden wealth appears and falls into the hands of the financially ignorant.

As the British playwright George Bernard Shaw once wrote: 'The surest way to ruin a man who doesn't know how to handle money is to give him some'.

Valuation levels

The even worse news is that the Saudi stock market's valuation level is still on the high side. The price-to-earnings ratio has fallen from 45 to 25 but this is still very high. So too is the ratio of GDP to market capitalization at 200% compared with less than 75% for emerging markets as an asset class.

There is also a problem with the earnings side of the p/e ratio as many companies have been booking their stock market profits as annual earnings. Now they will be booking losses, while for the banks in particular the lucrative days of big initial public offerings and brokerage profits look over for the time being.

Stock markets always find their own level but are inclined to over react on the upside and on the downside. Thus it could be a long hot summer for some investors but for non-leveraged investors hanging on is usually a better remedy than panic selling.