Summer of discontent for Gulf markets

The myth that Gulf markets were immune to fluctuations in Western economies has been shattered.

Traders gather around a terminal at the Dubai Financial Market.

At the end of June, Udo Schaeberle, a fund manager at BHF Bank in Abu Dhabi, was managing US$650 million (Dh2.4 billion) and looking forward to a long vacation. Just over two months later, his fund is now $150m smaller, either wiped out by falling share prices or withdrawn by worried investors. Given the situation, he is surprisingly sanguine. "Even people who call themselves long-term investors have gone," he says. "This shows that even our institutional investors were taking their money out. International bankers you talk to say their clients seem to be short term, because long-term investors are wary about a lack of regulation and risk." Rather than joining the exodus, Mr Schaeberle has converted part of his fund into cash - and moved his shareholding into low-risk stocks. His return has been 4.3 per cent this year, not spectacular until you compare it with the MSCI Index's tracker of GCC exchanges, which is down 23 per cent. In addition, the MSCI GCC Index lost 3.32 per cent last month, while Mr Schaeberle lost 2.78 per cent. The real "disaster", as Mr Schaeberle describes it, was in July, when the GCC index dropped 4.6 per cent and he lost 4.3 per cent. But losses continued. On the first day of this month alone, the GCC was down five per cent, while on Saturday the Tadawul, Saudi Arabia's biggest index, ended down four per cent at 7,802.25, its lowest close in a year. Mr Schaeberle is not alone in wondering where it all went wrong this summer. Why did the investors leave so suddenly - and how can they be tempted back? Before the summer, it all looked so promising. Investors had begun to buy into a "decoupling" theory - that the fate of rich emerging regions such as the Gulf were no longer linked to the fluctuations and vagaries of the Western economies; if the US sneezed, the GCC would not necessarily catch a cold. The boom started in September last year, just as the West started to experience the full force of the credit crunch, and was boosted by the emergence of foreign investors who had entered the market believing the GCC was destined to soon revalue its currencies. They follow a fixed exchange rate with the US dollar, and at the time the dollar was weak - the expectation was that the GCC states would remove the dollar peg and return to free-floating currencies, which would then strengthen. So investors moved large amounts into local currencies, because if a de-pegging occurred these would suddenly be worth many times more. The market rocketed - the Dubai Financial Market nearly doubled in size in less than six months, from 3,968 on Aug 22 last year to 6,291 on Jan 15, and the Tadawul climbed from 7,538 on Aug 1 last year to its peak of 11,895 on Jan 12. After January, the GCC markets dropped from their peak but were steady, and still well above their pre-boom levels. It was in June and July that the markets began to go belly up, and now the index has fallen to nearly the level it was a year ago, just before the boom. The key factor was the strengthening of the dollar, while simultaneously the oil price fell - with a rising dollar, the pegged currencies would enjoy cheaper imports and lower inflation, something which had started to become a real problem in the Middle East. As it became more obvious that the dollar was going in one direction, investors, particularly hedge funds, started to unwind their positions and, as quickly as they could, pulled their money out of equities. This triggered a downwards spiral as it became clear the benefits of currency revaluations were disappearing. Mohammed Ali Yasin, the chief executive of the brokerage company Shuaa Securities, said that over the summer investors have had to "make sure their balance sheets look balanced". However, Mr Yasin denounced the effect that a rash of negative analysts' reports had on the market once stocks began to fall, believing many were self-interested - for example banks offering short-selling services. One must not forget the role of retail investors, however; while they may not be the most experienced, they appear to have taken the markets downwards after seeing which direction it was going. Hashim Omran, the vice president of asset management at EFG Hermes, said there was "panic" among retail investors in the past two months, which set in train a wave of selling. In addition, a Morgan Stanley report last month claiming Dubai property prices were set to fall 10 per cent badly damaged the belief that the market would rise indefinitely. Soaring house prices have started to become a real problem, which has fed into a general inflation dilemma, as it has the world over; this is linked to what many claim has been a prime factor in the market falls, but which often makes no sense to people - "lack of liquidity". This appears to have been caused by central banks tightening money supply in order to bring down price rises. Mujib Mousa, the head of local and GCC investments at Markaz, a Kuwaiti investment house, said: "Central banks reduced lending ratios and ordered banks to limit aggressive lending into the region. They were determined to keep lending ratios low." As a result, interest rates offered on bank accounts have been attractive. What now for the GCC? Third quarter results, due out next month, are on everyone's lips as the catalyst that could spark the markets back into life - they are widely estimated to be healthy. But as Mr Schaeberle says, the problem is that the market is factoring in high earnings - the question is what will happen if they are worse than expected, because suddenly the stock prices will no longer appear so cheap. One suggestion has been that Sheikh Mohammed bin Rashid, Vice President of the UAE and Ruler of Dubai, may thrust a pipeline of initial public offerings (IPOs) of state-owned companies such as Emirates airline, Dubai Duty Free or Dubal onto the markets, to provide a shot in the arm. The idea was received cautiously by Mr Yasin: "I don't think the market conditions would help an IPO. People would be raising their eyebrows at that, as we need better conditions than this. I don't think it would be the best time." Some companies are planning to take matters into their own hands. On Saturday, Emaar Properties, the largest publicly traded property developer in the Middle East, said it would start buying back up to 10 per cent of its shares next month. "At Emaar, we firmly believe that there is no better investment we can make than in our own future," said Mohammed Ali Alabbar, the chairman of Emaar Properties. The market was not convinced: shares closed down three per cent yesterday reaching a three-year low. One of the most radical ideas would be to redeploy the vast capital reserves of the region's sovereign wealth funds away from investments in foreign companies and towards their domestic markets. Simon Derrick, the head of FX strategy at the Bank of New York Mellon, said the argument was logical: "If you have problems with the local economy draining out of foreign investment, it makes sense to replace or counterbalance that with your domestic funds." In Russia, where stocks have already fallen 40 per cent this year, the government has vowed to prop up the local markets with money from the two wealth funds, which together total $175bn. Initial market reaction has been mixed, but that is unlikely to deter Dmitri Medvedev, the Russian president. Will the UAE follow suit? [e-mail]