Month after month, the Tadawul All Shares Index scales new heights. But the current good times won't last forever
Jeddah - Michael Milken did it. So did Ivan Boesky, as did Martha Stewart. And, apparently, at least 44 Saudi nationals also engaged in insider trading - or at least some form of illegal stock trading on their country's nascent bourse. But there's a vast difference between those infamous traders in the West and their counterparts in the kingdom - and it's not just the scale of their crimes.
The scandals involving Milken, Boesky and, to a much lesser degree, Stewart, shook investors' faith in the ability of the markets to regulate themselves. The charges recently brought against the Saudi executives, on the other hand, have persuaded many that the Capital Markets Authority (CMA), the body responsible for regulating the Saudi stock market, has finally got some teeth. Indeed, the very minor scandal in the kingdom has reinforced the perception that the CMA is capable of reforming one of the world's messiest markets. And that could not have come at a better time.
Place two graphs on your desk, one charting the price of oil over the last eight years and the other tracking fluctuations on the Tadawul All Shares Index (TASI) for the same period. Notice any similarities? When oil prices fell to record lows in 1998, at under $10 per barrel, the Saudi market was also touching bottom, declining by more than 28 percent to barely 1,400. Then, as oil prices began their long, steady ascent, so did the TASI. Today, with oil selling at well over $60 a barrel, the TASI is likewise soaring. The market gained 346 percent in value in 2003, 197 percent in 2004 and is up nearly 75 percent for the year through August.
"If oil prices fell to $50, $40 or $30 a barrel, then we would see the TASI fall accordingly," says Said Al Sheikh, chief economist at the Jeddah-based National Commercial Bank (NCB). "The impact of oil prices on the TASI is twofold. First, there's an impact on sentiment: when oil prices are high, Saudis believe, quite rightly, that the government will increase expenditure, that there will be more projects, more money in the banking sector, that demand for goods and services will increase, that the profitability of Saudi companies will grow, and that the market will rise accordingly. Second, oil prices do have a very real impact on the economy and, therefore, the market. I just don't see how the two can be delinked. And this remains the fundamental weakness of the Saudi market."
The fact that the market's rate of growth has slowed over the past three years, then, is hardly cause for concern. Just like the recent insider trading scandal in the country, the gradual rationalizing of growth is a sign of maturity, or at least adolescence. The TASI has gotten so big, so fast, that many analysts hope that it will cool off - and sooner rather than later. Saudis themselves are investing so much of their wealth in the market, which is closed to foreigners, that any serious correction would shatter the lives of millions of small investors. For the moment, just about everyone is getting rich. But the question stands: How much longer will the good times last?
Between June 19th and July 18th, the TASI nosedived by 2,436 points, from 13,997 to 11,561. Although the market climbed back up above 14,000 points within another month, then rose to nearly 15,000 by the end of August, that quick drop took many small investors by surprise, and taught them a painful lesson. What goes up, they learned at their cost, must come down. Even if oil prices somehow prove to be the exception to that rule in the coming decade, it will still hold true for the Tadawul Index. The June-July slump won't be the last in Saudi history.
"The rate of growth we have seen in the last two years probably can't be sustained," says David Butter, an analyst specializing in Saudi Arabia at the Economist Intelligence Unit (EIU). "There's bound to be a correction, or at least some flattening out, though I don't see a collapse of the market anytime soon, simply because of the strength of the principal stocks. There is some uninformed trading going on right now, however. There's a lot of speculative trading, and a lot of the current valuations simply don't justify the level of trading."
"With the exception of a few companies, the market is overvalued right now," agrees Said Al Sheikh. "True, the fundamentals of the Saudi economy are strong, but some stocks remain overvalued, especially those companies involved in agriculture and services. The amount of speculation, often based on little more than rumor, means that a correction, at least in some places, is bound to happen. Any bad news in the region - whether it's related to oil or political developments - would put great downward pressure on the market. That could cause a very sharp correction. At its current level, the market is becoming extremely sensitive to any bad news."
Far too many small traders in the kingdom are poorly informed about the vagaries of the market. They see their brother, uncle and cousin buying brand-new Cadillacs with their earnings on the bourse, and figure they can do the same. Consider that half the country's population applied for shares in a new Islamic bank, Bank Al Bilad, when its shares were floated in late April. On the first day of trading, more than 1.9 million shares changed hands. Extremely heavy trading lasted for two months, while share values rapidly rose and fell. By summer's end, however, Al Bilad shares were right back where they started, at about 750 riyals ($200).
In its short public life so far, Al Bilad is the exception to the rule: it's one of the few companies that hasn't gained value on the Saudi bourse. (A few firms, including the National Agricultural Development Company, the Saudia Dairy and Foodstuff Company and the Savola Group have all lost value in the last year, though those losses were fairly slight.) Indeed, there have been plenty of big winners among the 77 listed companies, led by Saudi Basic Industries Corp., the kingdom's petrochemical giant that accounts for about 25 percent of the value of the TASI.
In 2004, only one Arab company made it onto Fortune magazine's list of the world's 500 largest corporations. With $18.3 billion in profits for the year, up 47 percent from 2003, SABIC has grown into a truly global player.
When I asked the EIU's Butter if he would rather have a million dollars in SABIC or Google shares, he didn't hesitate. "I'd take SABIC," he told me. "Yes, it will have its ups and downs, just like any other company, but there are grounds for believing in its steady long-term growth. If I could diversify a bit, I would also love to be able to invest in some of the major banks, and would put some money in Savola and the telecom sector, whether it were Saudi Telecom or Etihad Etisalat."
The EIU's Butter might love to get a piece of the action in Saudi Arabia - but that's not going to happen anytime soon. And that's almost surely a good thing. At the moment, the entry of foreign investors would simply add to the current demand, which is already overwhelming. Increasing demand while supply remains limited to less than 80 stocks - the majority of them state-owned firms, and the bulk of those shares owned by the government - would turn the current exuberance into something approaching a feeding frenzy. Valuations would rise out of all proportion - something that some analysts say has already taken place, particularly among the smaller listed companies - and speculators would quickly start betting the boom would go bust. The market would be overwhelmed, then collapse.
The market is currently on a trend towards opening up but, like so many things in Saudi Arabia, this is likely to happen very gradually. This is where the Capital Markets Authority returns to the picture. In July, the CMA issued new laws pertaining to the establishment of independent financial brokerage firms in the country, ending the monopoly held by Saudi banks on share trading. "This is going to increase the efficiency of the market," said Nahed Taher, another economist at National Commercial Bank. "It will make the market more controlled and transparent."
"The priority now is to get all the capital market reforms in place," agrees the EIU's Butter. "That means moving the operational side of the market away from banks to dedicated intermediaries. When we have brokerages, fund managers, asset managers and portfolio managers, and the proper advisory services and infrastructure, then we could see the entry of foreign investors directly into the market.
"At the moment," Butter continues, "the Capital Markets Authority doesn't have enough power to penalize poor trading practices. It has prohibited a number of board members of companies from trading in their own shares - because they possessed privileged financial information - but that's just a first step. Still, it is a sign that the authorities are aware of the market's weaknesses and are trying to address them."
According to NCB's Al Sheikh, "The CMA is now moving in the right direction, but very slowly. The CMA's credibility is improving, especially when they have taken action against insider trading and unofficial portfolio management. This has had a very good impact on the market. But the CMA needs to pick up the pace and take real action against those who break the rules."
As the Capital Markets Authority moves forward with reforms, there is every chance that the market will begin to cool off. But while making trading less of a free-for-all may dampen some of the enthusiasm among small investors, it will also help rationalize much of the current action on the TASI. But will the CMA actually make good on its promises? If history is any guide, the regulatory body won't take much action as long as the price of oil remains sky-high.
In Saudi Arabia, there has historically been an inverse relationship between rises in the price of oil and the speed of reforms. According to the EIU, "At times of high oil prices, the kingdom's economic performance improves substantially, although, perversely, its longer-term prospects worsen. High oil earnings ease the pressure on the government to push through badly needed fiscal and structural reforms that would reduce the economy's dependence on the state and encourage the private sector to become the main engine of growth."
The private sector is indeed the linchpin of Saudi Arabia's long-term economic growth. And the dearth of private-sector listings is perhaps the market's single greatest weakness, even more important than the lack of appropriate regulatory mechanisms. Talk to the CEO of just about any of Saudi Arabia's big family businesses, and they'll tell you that this is exactly right. Then ask them why they don't do something about this and actually go public. That's when the backpeddling starts.
"Part of the reluctance to go public is cultural, but it's also generational," says Al Sheikh. "Within many families you see a gap between the older generation and the sons; the older generation doesn't want to give authority to the sons, and they certainly don't want them to take the company public. But by not doing this, they may be jeopardizing the sustainability of their company. These companies need encouragement from the authorities to see that they there are real benefits to going public. A dispute between family members can lead to the collapse of a company; going public can help them avoid that fate."
True, some of the large family businesses have gone for partial listings, but too many of them refuse to even consider going public. They don't need the money, they'll tell you, and they certainly don't need the headache involved in preparation for any listing. Most of all, they don't want to open their books to public scrutiny. This isn't the case because these family businesses are corrupt or have something to hide; rather, it's simply not the way they do business, nor the way their fathers and grandfathers did business before them.
A generation ago in Saudi Arabia, getting rich on the stock market was unheard of. A generation before that, bulls and bears were thought of only as animals that lived in zoos. Times have changed, however. As the kingdom increasingly integrates into the global economy, the old ways of doing business will have to be put by the wayside. For private businessmen, and, yes, businesswomen, as well as Saudi investors, a new age is dawning. Not so long ago, the recent insider trading scandal would have rocked the kingdom. Today, it's no big deal. As a matter of fact, it might well prove to be exactly what Saudi Arabia needs.
By Farid Al-Ittihad
© Arabies Trends 2005
