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The surge of activity on the Saudi stock market (Tadawul) indicates that investors are shifting their focus from real estate to the stock market. Is this a bubble?
The surge in the activity on Tadawul is not unique. Most global markets are surging. For example NASDAQ surged by more than 18 percent since the beginning of the year, DAX and Nikkei 225 both gained around 15 percent or more YTD. Also regionally, Dubai market surged by almost 25 percent. Saudi economic outlook is very bright, and that significantly improved the business and consumer sentiments. The financial market is a sensitive parameter for economic outlook and the general sentiments.
Now saying that investors are shifting focus from real estate to the stock market is not pretty accurate. Instead, it can be seen as a diversification across different asset classes. During the past three years, the financial market was fragile and sensitive to any global developments. So, investors focused their attention on the real estate. Now, the financial market is improving, so people are looking to diversify their portfolios again between real estate and equities.
There are limited domestic asset classes for investors to diversify across. Rates on saving accounts are low; there are no derivative securities and the market for debt instruments is thin. Even gold is not an attractive investment at this stage, as investors think that prices are high and unsustainable. Additionally, investors' are reluctant to go outside, to invest either regionally or globally. There are not many benefits from diversification across regions in equities at this time, because equity markets are becoming highly integrated especially in recovery periods. Diversifying across other classes of assets available abroad mostly suits institutional investors because it needs sophisticated analysis. As a simple example, investing in forex through currency trading needs high knowledge in international trade and finance principals and it is highly subject to economic, financial and political risks.
So, in short, it's normal and rational to see investors increasing their holdings of the available financial assets (local equities).
We have to note here that the above conditions are suitable (but not sufficient) for an asset bubble to take place. Economic bubbles in general occur when too much money is chasing too few assets, causing both good assets and bad assets to appreciate excessively beyond their fundamentals or intrinsic values to an unsustainable level. There are many causes for a bubble to occur, but leverage comes as a prime cause. Implementing long and significant expansionary monetary policy (lowering interest rates and/or flushing the financial system with money supply) would eventually result in excessive monetary liquidity in the system. This would end up with easy credit and large disposable liquidity for both individuals and business. At a low interest rates environment, investors tend to avoid putting their capital into savings accounts. Instead, investors tend to leverage their capital by borrowing from banks and invest the leveraged capital in financial assets such as equities and real estate.
However, the economic and Tadawul's indicators show that we are not heading toward a bubble. Although the economy is going through an extended expansionary monetary policy, the leverage ratio does not seem to exceed its historical averages. In 2011, the leverage ratio in the Saudi economy (measured by credit extended to private sector as a percentage of the GDP) was 38 percent declining from more than 50 percent in 2009 and 44 percent in 2010.
Also, Tadawul's indicators assure that TASI is moving according to the developments of the economy and an asset bubble is not in the corner. TASI is approaching 7,900 points; it gained more than 23 percent YTD. But the P/E ratio is still around 12, compared to a historical average of 19. The market capitalization to GDP in 2011 was 58.8 percent. This ratio reached 206 percent in 2005, and reduced to 91 percent in 2006, before it increased back to 135 percent in 2007. The value of shares traded is still low compared to historical averages. The ratio of value traded to GDP in 2011 was around 51 percent. This ratio reached 350 percent in 2005 and 394 percent in 2006. Even with the current daily value of trade of almost SR15 billion a day, the ratio will be less than 200 percent. Additionally, the turnover ratio (value traded/market capitalization) was around 87 percent in 2011. This ratio reached almost 430 percent, on average, in 2006.
What are your views/concerns on the market's direction in 2012?
As shown above, domestic economic indicators and market indicators both look healthy and the market is set to advance in 2012. However, the major concern would be the geopolitical risk, and a probable default of one of larger economies in Europe. Based on the above indicators, the market can easily gain 30 percent during 2012. However, the lack of investment opportunities may be a concern, as we may see that the stock prices for some companies, which are not making profits, are increasing day after day. Investors should learn from their past experiences.
Is the Tadawul index slowly heading toward the magical figure of 22,000?
Such assumption follows a well-known assumption in behavioral finance called Extrapolation. Extrapolation means projecting historical data into the future on the same basis; if prices have risen at a certain level in the past, they will continue to reach those historical peaks. The idea is that investors tend to extrapolate past extraordinary returns on certain stocks into the future, causing them to overbid those stocks in an attempt to capture the previous higher rate. This is something maybe known in technical analysis, but not based on any fundamentals.
However, I see it different now. The behavioral factors that pushed the index to 22,000 in 2005 and 2006 do not exist any longer. It is true that more than 90 percent of the investors are individuals. But in 2006, most of participants have no experience concerning market crashes. Actually, the market was moving according to the herd behavior and the so-called greater fool theory. As investors tend to buy or sell in the direction of the market trend, and there were many perpetual optimistic market participants who bought overvalued assets in anticipation of selling it to other speculators at a higher price. But now, investors had two major experiences of market fall, although the herd behavior may continue to appear, but hopefully not to follow the same great fool theory again.
Also, the banks do not seem to be keen to extend loans for equity trading. Banks generally improved their risk management practices after 2008.
The stock market may soon open doors for foreign investment. In which way/s will this impact the market performance?
After allowing foreign investors to invest in Tadawul through mutual funds, entering into swap agreements with authorized persons in Saudi Arabia (investment banks) and through exchange traded funds, the Capital Market Authority (CMA), is in a plan to allow foreign firms that have securities listed on other exchanges to apply for a dual-listing on Tadawul under the condition that the other exchange should have "equivalent rules" to Saudi Arabia. This seems to be the first step of a two-phase process, where Saudi-based investors will be able to trade stocks listed by foreign issuers, and at a later stage, foreign investors will be permitted to trade both external and Saudi Securities.
This step by itself is not expected to have a significant impact, because the qualified stocks are those who already listed elsewhere. Currently most of the regional bourses are performing well, this may discourage regional companies to consider dual listing in the medium term. Dual listing would be more attractive in the cases where the local market is strongly outperforming other markets in the region, which will attempt regional companies to access the ample pool of capital.
Maybe the biggest advantage for Tadawul to get through opening directly to foreign investors is to be part of the MSCI Emerging Markets Indices, a target that some GCC countries have been looking for during the last few years. The Saudi Market is the largest in the Arab World, and it represents attractive investment opportunity for foreign investors. However, not being part of the MSCI Indices prevented Tadawul from accessing institutional investor liquidity. Tadawul has been opened to GCC citizens since 2007 and to foreigners via share-swap transactions and exchange-traded funds, but the participation of foreigners (GCC nationals, Arab expatriate, foreign expatriate and share swap) is still less than 4 percent (in buying and selling). As February data show, buying of non-residents foreigners through share-swap was only 1.2 percent, while selling is 0.5 percent. Such percentages can be improved significantly if Tadawul become part of the MSCI indices. Improving the participation of institutional investors (domestic and foreigners) will increase the liquidity of the market, and may lead individual investors to participate through more advanced investment vehicles.
