4 September 2005

IT IS a tribute to the retail, casino culture of the AGCC stock markets that banks and brokers still hoodwink the public by launching new regional funds at the height of the asset bubble despite persistent overvaluation of the share markets.

It is clear that the level of financial literacy is still embarrassingly low in the region because fund managers raise new money to invest in the markets that already trade at 6 to 8 times book value and 40 to 50 times of their earnings. The valuations of the AGCC stock markets are several standard deviations above their own historic ranges and among the highest ever witnessed anywhere in the history of world finance.

This is irrational exuberance on an epic scale. So it is not surprising that AGCC central bank governors have now joined the chorus of voices warning about the dangers of leveraged stock market speculation in the regional economies. The DIB share manipulation scheme did not surprise me at all. It is really sad that greedy, unscrupulous brokers can violate the laws of the UAE  with such impunity and manipulate share prices to their own advantage. Yet any insider with even a shred of integrity or introspection knows that market manipulation and rigged share prices are only the tip of the iceberg in the litany of abuses  rampant in the local and regional share markets.

Insider trading, front running, rumours, phony orders, illegal expat bidding for IPO's restricted by law for UAE citizens under false names, misleading corporate statements, are only a sample of the abuses and violations in the capital markets. This is a shame because scandals like the DIB manipulation and the subsequent cancellation of all orders in the DIB share really erode the faith of the public in the capital markets.

The macroeconomic fallout of the AGCC share market euphoria has got the central bankers alarmed. SAMA has warned Saudi investors that investing in the bourse is a risky bet, even though the Tadawul All Share index has been one of the best performing markets in the world. The Kuwait Central Bank has mandated lower bank limits for IPO finance to curb speculation, the UAE Central Bank has cracked down on banks that violate its regulatory limits on IPO finance. The central banks know all too well that the AGCC commercial banks have become dangerously dependent on the stock market to sustain their profitability.

It simply defies logic for banks-by their very nature, mature, low growth businesses in one of the most hypercompetitive retail and corporate banking markets on earth-to post 70 to 100 per cent profit growth without some sugar daddy turbo-charging earnings . The stock market, naturally, is the ultimate sugar daddy of AGCC banking since 2004.

However, the easy money has now been made on the AGCC stock markets. There is an increasing tendency for investors to sell en masse on the slightest dip because they know that prices are at exceptionally  inflated levels.

It is alarming that both the UAE and Qatar have exhibited 20 per cent monthly sell offs in a bull trend this year-and that liquidity predictably vanishes when share prices fall, because no specialists or market makers exist as on the NYSE. Since the AGCC share markets are goosed by multi-billion dirham daisy chains of bank leverage, it is not too hard to imagine a scenario where the merest hint of disappointment  with profitability growth trends could  be the catalyst for 30-50 per cent sell offs in the stock market. No wonder the extreme valuations, bank leverage and dangerous capital markets volatility worries the AGCC central banks.

The economies of the Gulf are overheated. Real estate, consumer price indices, commodities prices ,stock markets ,public sector wages, bank credit growth etc all show red signals. Inflation in the AGCC is rising and inflation is the kiss of  death for long term stock market value.

The real interest rates in the AGCC (inflation adjusted) are still extremely low, even though nominal dirham, dinar, riyal rates have all followed the Fed credit tightening cycle higher. This has encouraged the spiral of consumer debt, bank borrowing and speculation in the AGCC stock  market.

The AGCC central banks know that a protracted period of rising inflation can be extremely harmful to small, open  petro-economies without an independent monetary policy since their currencies are de facto pegged to the dollar. Besides, the surge in share prices and real estate has contributed to the wealth effect"  in the AGCC, manifested by higher imports and CPI. So it is inevitable that AGCC central banks will tighten monetary policy, issue CD's to drain liquidity  and dampen excessive bank  borrowing.  A rise in bank reserve requirements and restrictions on lending for stock market speculation is more than a remote possibility.

Such as policy response by the AGCC central banks will deflate the stock market bubble. However, it is critical that responsible banks and brokers educate the hordes of naive investors who fancy themselves stock market geniuses, make them understand risk and return can never be separated.

The classic bubble psychology that persists in the region is the real nemesis of the AGCC central banks. This is the belief that "it is different here" (why?) that "local markets only go up and not down" (you were obviously not long Emaar in 1998) and that 100 per cent  profit growth for banks ad infinitum is logical (about as logical as Santa Claus and the Tooth Fairy).

When stock markets trade at 6-8 times book value and 40-50 times earnings, the only rational response of a prudent investor should be -- Get me out pronto! It is too late to learn the virtues of cash when the knives begin to fall from the skies and Chicken Little squawks headless on his way to the tikka grill.

GULF MONEY BY MATEIN KHALID

© Khaleej Times 2005