As the 2006 closes, the Saudi Stock market Tadawul Index hovered at just about the 8,000 levels. This represents around a 52% fall, compared with as Index of 16,712 at year-end 2005. Two years ago, the Index stood at 8,158, coming back a full circle. What was a more amazing coincidence is that the Saudi Index closed at exactly 8,158.25 for both dates of Dec. 2, 2004 and Dec. 2, 2006, leading to much speculation and conspiracy theories on such an extreme probability ever happening. Conspiracy theories aside, the year 2006 was a turbulent one that will be long remembered as a watershed for the Saudi Stock market, with peaks of 20,966 and lows of 7,500. In between, many thousands made what was seemingly easy money, but many more thousands lost substantial amounts of their lifelong savings, compounded by social ailments, family breakdowns and cases of tragic deaths.
The year 2006 may still be remembered as the one when the Saudi market reached a semblance of long-term stability, a more transparent regulatory oversight, and, above all, the emergence of a more realistic investor outlook. Investment in stock markets combines an element of luck as to timing of entry, but also estimations of returns based on technical stock analysis as well as fundamental market and sector analysis. Behavioral Sciences may play an important role to explain investor behavior in the short run, with individual traders acting the way they do based on emotions and trade, simply because they like to trade. How else can one explain the seemingly irrational behavior of Saudi investors on the way up and on the way down of the market?
Behavioral research analysis, however, suggests that emotional and rational decision-making is complementary, which can be explained in two respects. First, emotion pushes individuals to make decisions, when such emotions are paramount. Second, emotions can assist in making optimal decisions. Studies of the psychological characteristics of professional security traders, while they were “hooked” to live trading, have been conducted and a significant correlation between psychological characteristics and market events was reported. Such studies concluded that emotion was an important determinant of a trader’s ability to survive in financial markets. Does this mean that the overwhelming majority of Saudi investors are emotion and psychologically driven , determined at all cost to survive turbulent financial markets and acting “rationally” in an irrational market?
The answer is obviously not, as some have gained while others have lost. For some who have gained on the market, technical analysis and exist timing has been crucial. Rational investor expectations behavior tells us that current stock market prices are supposed to fully reflect all available market company information, and as such, a stock market price is a “fair market price”. As more information comes onto the market, this is assimilated by adjusting the stock’s price, and over the long run, the price should accurately reflect “fair value”. Pure technical analysis believes that the market is price efficient as all information is reflected in the price.
So much for the theory. In reality, there is often other information that is not readily available to the public that is not fully reflected in the price. This is information held by company insiders, competitors, the company suppliers, contractors or regulators. This seems to have been the case for much of the stock market volatility during 2006, as factual company information became swamped by misinformation, rumors and downright insider dealing and manipulation, causing a massive loss of confidence by small investors.
However, all is not lost, as 2006 may yet turn out to be a watershed year as far regulatory punishment of market manipulators is concerned. For the first time, during December 2006, the Saudi Capital Market Authority (CMA) named, shamed, and fined an alleged market manipulator. This was a long needed transparent and effective signal to the market, than the April 2006 fraudulent cases, whereby the CMA merely suspended two dealers for significant stock manipulation. As this writer and others have urged, the more such fraudulent activities are exposed, and the people concerned named and shamed with stiff penalties, the quicker the small investor’s confidence comes back.
The CMA should also consider the way shares are priced in Initial Public Offerings (IPOs), and move towards a more flexible book building pricing , instead of the current fixed pricing of IPOs. The latter has led to some undervaluation of new IPOs and massive first day gains on fixed pricing, adding to volatility in existing listed shares. Book building ensures that a range of prices is considered after the IPO closes and reflects a better market value for new companies.
Looking ahead, one can only advise patience and taking a long-term outlook for stock investments. In the final analysis, one is hoping to make capital gains based on a company’s general performance and the state of the underlying economy. In both cases, the Saudi fundamentals are still strong, and current market prices are on the low side. Investor education, confidence-building and taking a long-term view on stocks, will be the key element for a more stable 2007 for the Saudi market. Invest and forget is the keyword.
—Dr. Mohamed Ramady is visiting associate professor, Department of Finance and Economics, King Fahd University of Petroleum and Minerals, Dhahran.