The Saudi go-go stock market is at it again, spurred on by cheerleaders to break above the 10,000 level, and they did. It would seem that the events of “Black February 2006” are now a distant memory, when the Tadawul Index plunged from nearly 22,000 to 7,900 closing levels in December 2006. And it is not only in Saudi Arabia that stocks seemed to have rebounded, as both the UAE and Qatar have seen more than 20 percent gains since late summer alone. However, these two markets are more liberal than Saudi Arabia in allowing foreign investors, and both European and US institutional investors have been active. Saudi Arabia has not followed suit on the premise that domestic liquidity is more than sufficient in the local market, but also that such foreign investment could as easily evaporate and leave — the so-called “hot money” in times of uncertainty.
What seems to be driving the local markets in the Gulf? Oil prices, a main engine of government revenue and liquidity injection, seems to be at record highs, the regional financial markets also seem, on the surface, to be weathering the international credit and subprime crises, and real estate has boomed. Institutional reforms are gathering pace and the Saudi market was lifted by the introduction of new regulatory and operating mechanisms by the Capital Market Authority, which opened the door for more transparency and accountability. Still all this does not justify around a 12 percent increase in the Tadawul index in almost two weeks. Daily movements of 1.5-2.0 percent gains seem once again to be the norm, rather than the exception, leading to fears that an asset price bubble is in the making.
Not all listed companies are overpriced, based on technical and fundamental stock picking analysis. The 2006 market crash led to some company and sectoral lower valuations than those of other attractive emerging markets such as India and China. According to some latest estimates, P/E ratios are hovering at the 12-14 levels, giving dividend yields of over 6 percent, much more competitive than commercial deposit rates. Price to book ratios for some companies is at under the 3 level compared with 12-15 levels in February 2006.
What seems to be the problem then, given this rosy picture? The issue here is that despite some new listings on the Saudi market, the number of listed companies is still too few, currently at 106 companies. The Tadawul index is also not sectorally diversified enough to reflect the true base of the Saudi economy. As such, a few companies tend to dominate market price movements, and sometimes these do not reflect the economic fundamentals of economy.
The Saudi capital market will be in a much healthier trading stage once the number of traded companies is over the 200 level and these corporates reflect a wider economic base. Over the past few weeks, stocks such as Jabal Omar, Emaar and Kayan have tended to push up the overall index, while investors have tended to ignore other blue chip companies. And so, the Tadawul has been on a roll in 2007 — opening at 7,900 , falling to a low of 6,800 in June 2006, and now breaking through the 10,000 psychological index.
Not all analysts are comfortable with this upward march of the index again, and a few are warning that profit-taking waves within narrow ranges will take place, and that some speculative stocks were moving without any investment basis relating to their core profitability. However, there are those who are cheer leading the markets on, reminiscent of the 2006 share trading euphoria, but the same cheerleaders strangely silent when the markets crashed.
With year-end results due, there could be a wave of profit-taking sales to keep the markets from overheating again, but psychology, rather than fundamentals, seems to be the main driver of the Saudi market all over again. So far economists have analyzed stock and commodity market bubbles after the fact. If the price plummets in the absence of any popularly recognized exogenous shocks, thereby forming a classic “bubble”, the traditional reaction of economists is that investors should have known better than to extrapolate price trends, rather than rationally contemplating the fundamentals determining the long-run value of the asset.
As during the heyday of 2006, general paper profit-making, becomes a self-fulfilling prophecy that leads to a self-sustaining and self-congratulatory behavior among investors. This sucks in both the “irrational” unsophisticated investors, as well as the “rational” informed investors. They both end up having a “vested interest in error” — members of a crowd with a one way herd mentality that defies logic, with few that stands in its way. Once again, Saudi investors are not looking at long-term investment strategies, but short term speculative gains, and have forgotten earlier financial history.
The result is that the same mistakes are repeated — much too early, given normal “financial amnesia” cycles — and almost under similar circumstances.
Let us hope and pray that trading remains within narrow bands, with modest gains and that the investing public accepts this. The alternative is for another bout of profit-taking, quickly developing into a rout as doubts and unease creep in. All it takes is for one or more internal or external event for the rumor circuits to take over and all rationality suspended.
(Dr. Mohamed Ramady is visiting associate professor, Finance and Economics at King Fahd University of Petroleum and Minerals)