In February 1930, Fortune magazine, in its first-ever edition, published the article "Post-panic speculation". The article describes events leading up to the Wall Street Crash of 1929 as a consequence of a business cycle that was allowed to run too fast and too far, creating a feeling of overconfidence that stimulated speculation. The story argued that properly undertaken, speculation performs a useful economic function because speculators assume a risk-bearing function.
However, speculation can be indulged in by the wrong kind of “get rich quick” individuals; and when the wrong individuals attempt to speculate, their activity degenerates into mere gambling.
Fast-forward nearly a century. For most of 2013 issuers and investors leaned back and enjoyed the ride as global equity markets advanced. Internationally, the Dow Jones ended up 26.5 per cent, its highest annual rise since 1995. The Nikkei was up 56.7 per cent, its biggest annual gain since 1972 and the DAX 30 closed 25.5 per cent up, at its highest level since inception in 1988. Market volatility remained notably low thanks to the Federal Reserve’s quantitative easing, which supported stock prices, and inhibited excessive mood swings.
Locally, the Abu Dhabi benchmark gained 63.1 per cent and the Dubai Financial Market General Index ended the year with the second best performance worldwide, up 107.7 per cent. The prospects of global economic growth and the underlying financial performance of listed companies have not quite worn off. But last month, shortly after the addition to the MSCI Emerging Markets Index, investors in UAE markets took money off the table and started showing nerves. The word on the street is that speculation, a slumping share price and margin calls triggered a crisis of investor confidence that profoundly affected sentiment towards the entire market. Is there more to come?
UAE markets have underperformed most of the developed and emerging markets for four years following the financial crisis and are still trading below their highs, so some profit-taking should not really be a concern. However, regional investors are no longer blindly following the herd without questioning the underlying fundamentals. It is a positive sign that investors are starting to assess their risk profile after the bull run. The deeper question creeping into their minds is whether they should decide to be “risk-on” and continue investing in risky assets such as equities, or be “risk-off” and start rotating into safer havens, such as corporate and government bonds or even cash.
In this region during “risk-on” periods asset prices increase in unison (with the strength of the economy), but when market sentiment changes to “risk-off” they tend to recoil with a vengeance. This is partly because hedging instruments, including short-selling, are inaccessible at sensible rates. Currently, the cost of hedging a portfolio position can be in excess of 10 per cent. Clearly, this impacts investor behaviour. Whereas in developed markets these hedging instruments are widely available, regional investors cannot stay “risk-on” in equities by playing the downswings in the market — they are either in or out.
The real danger is that regional investors can get too wrapped up in short-term market movements because they are preoccupied with intraday, real-time stock prices. Some speculators are gambling on steroids. This inevitably leads to major share price fluctuations, as recently witnessed, and more violent swings between risk attraction and risk aversion to equities as an asset class.
To increase the efficiency of regional capital markets, investors in UAE equities should momentarily blind out their short-term investment horizon and focus on the long-term underlying prospects of the UAE economy and the fundamentally strong companies that are listed on the exchange. Equity markets always oscillate and investors can make a quick dirham, but in the long-term share prices tend to move in unison with the health of the overall economy and the underlying performance of listed companies. It is well worth taking a longer-term view on UAE markets.
The Middle East Investor Relations Society urges issuers to upgrade their investor relations practices to help investors understand their company’s fundamentals so that they can make better, more informed and longer term investment decisions.
To this end, the Securities and Commodities Authority this year announced the passage of new regulations that require companies to set up dedicated investor relations functions. Welcomed as a visionary initiative at the time, the most recent events have propelled this regulation to a position of critical importance today. In combination with a joint task force set up by UAE regulatory bodies to ensure the soundness and integrity of trading, the new legislation can now be used to accelerate the process of improving transparency and mitigate the risks emanating from rumours and speculation. This leads to lower estimation and forecast risk as well as less violent risk-on, risk-off cycles.
A nearly century-old quote from Fortune magazine is just as relevant today: "the recent equity markets correction has done a great deal to reduce the number of stock market gamblers, at least for the time being". No doubt investors today will take more care in assessing their risk-bearing function, and be watchful of slipping into gambling mode — that would mean more service to the community and less reason to be nervous.
Oliver Schutzmann is vice chairman of the Middle East Investor Relations Society
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