Is it too early to jump back into Middle East stocks?

Local investors in the Middle East need to learn that they are not alone in their recent experience. There are countless examples, particularly in emerging markets, of boom and bust cycles in stock markets.

Therefore in order to understand the future outlook, you have only to examine case studies to find a way forward. Of course it may always be different this time but the chances of things turning out very much the same are much higher.

Now when markets go wild for a period, and let us not pretend that the past few years have been anything other than irrational behavior leading to overvaluation of stocks, then a severe correction is perfectly normal. All stock valuations tend to overshoot on the upside and overshoot on the downside.

Bottom picking

So have we really seen the bottom of the Arab markets' bust? It is impossible to tell. Valuations are much lower, but the kind of price-to-earnings ratios we see today are still relatively high, and certainly do not show an over-reaction to the downside. Ergo they could yet move lower over the summer, or in response to a global stock correction in the autumn.

At best stocks are at fair value today, so why should they suddenly leap back upwards to over-valuation. This is just not what happens after a stock market crash on past precedent.

Once investors have lost their nerve they tend to stay away from an asset class until a new generation of investors is in charge and gets carried away again. The conventional wisdom is that once a stock market has crashed you should look to invest elsewhere and maybe in a different geographic location.

Cash is king!

Or may be, not at all; this is a time when the best investment is probably cash. This is not because cash is so attractive - it pays low rates of return and may devalue - but because cash is highly defensive in a downturn for all other asset classes.

Dr. Marc Faber argues that all major asset classes have become significantly overvalued due to a long period of ultra-low interest rates. He expects a huge correction to happen and a big fall in stock and property prices. Those who hold on to cash will be able to buy at cheaper prices later.

Thus even if regional stock markets represent significantly better value now than six months ago, that is not to say that there will not be even better bargains within the next six months. And there simply is no good reason to jump in now rather than wait and see what happens. The downside risk is much higher than the potential upside.