Wednesday, March 22, 2006

Lemmings, trilobites and GCC stocks

Okay, I'm in full financial pundit mode.

Yaser Nawar at the catchily-titled 'Equity Investment Ideas has quite a nice graph here. His post lays out the conventional wisdom on the boom and bust. As he points out, share prices were running at pretty large ratios to earnings, while a lack of liquidity meant that investors were clearing their portfolios to free up cash for yet more IPOs. Greed, speculation and naivete are the drivers of the cycle, he implies: the standard 'lemming' theory.

Zimran at Winterspeak also supports the lemming theory.

Evan at The Future Uncertain has an interesting and quite different take on the crash. Bubbles, he argues, are necessary mechanisms in rapidly developing markets. Investors know that changes are afoot, but are unable to tell beforehand which industries, technologies or companies will succeed. So they spread their bets across the lot of them. When the inevitable crash occurs, those that are left standing are the ones that are worthwhile.

It reminds me of the Cambrian Explosion, when evolution threw out a massive number of crazy-looking beasties that roiled and multiplied and evolved and then died off in huge numbers with the extinction event at the end of the Ordovician period. The worse adapted creatures died; the best adapted survived, and, millions of years later, evolved into us. I rather like that story, so I'll dub Evan's argument the Cambrian theory.

There is a problem with the theory, though. As Evan notes: "Egypt, a non-exporter of oil, is admittedly harder to explain using this approach, although the economy is perhaps tremendously dependent on remittances from the Gulf states."

Which suggests that it is too soon to start writing off the role of psychology in investment decisions.

In any case, the investor psychology angle implies one thing quite clearly: the crash will have political ramifications. In Saudi Arabia in particular, the bull run has been linked to the accession of King Abdullah to the throne and the benefits of his economic reform programme. Many are likely to take the crash as an indication that his reforms are ill-conceived.Problem is, it is still far too early for his reforms to have had much effect on the economy: most of them are long-term, structural reforms, not quick fixes. So inferring that the reforms are bad because the stocks have gone bad would be fallacious. Not that that ever stopped anyone.

The Cambrian Bubble theory, on the other hand, suggests that, if the reform initiative survives this downturn, there may be a strong basis for sustainable future growth. Those companies that survive will have proven themselves, and will feast upon the carcasses of those companies that failed - that is to say, they'll buy up their assets and cherry-pick their best ex-employees. Which should, if all goes well, make them stronger.

Edward Chancellor wrote an amusing piece on the subscription-only BreakingViews site last Friday which ended with the line 'Given the Kingdom's anti-boozing laws, foreign residents should be sober enough to resist the temptation [to invest in the stock market].' He's right that opening up the market to them only once the song is over is too little, too late, and doesn't say many nice things about Saudi attitudes to foreigners.

He has also written an interesting piece in the WSJ called 'The Seven Pillars of Folly'.

HIs seven pillars are: liquidity economic diversification stock market boom IPO boom property boom market inefficiency herd mentality

Which is a fair assessment of the situation.

Chancellor then goes on to say that the region's rulers have encouraged the boom, hoping to distract them from religious fundamentalism, and suggests that the day traders of today could be the terrorists of tomorrow.

That may be a little hyperbolic. Arab rulers have taken a great gamble on economic diversification, knowing that only through providing employment and opportunities to their populations can they stem the spreading malaise that feeds revolutionary sentiment. If the stock market crash means that they have lost that gamble, making glib comments about it being their own fault really isn't perhaps the most mature response.

But it is a risk. The crisis of confidence could lead to a retreat from some of the more ambitious reforms - which, circuitously, could lead to increased unrest - though linking it directly to terrorism is a little too tenuous. Which could explain why local governments are falling over themselves to intervene and try to hold off the inevitable. WaPo 15.3.06

Mohammed Ramady, a Finance and Economics professor at King Fahd Uni, points out that some may have compromised their futures by dropping out of education or neglecting their jobs to concentrate on the stock market. Those that stayed the course may well find their gamble paid off; those who abandoned it for easy riches are those most vocal that the government should bail them out.

Souhail Karam and Dayan Candappa or Reuters argue differently. ( Reuters, 21.3.06) "The popular notion that Saudi speculators were exclusively retail investors, leveraged to the teeth, buying stocks at outrageously high prices is misleading", they say: rather, massive hedge funds played the markets, often, they imply, making transactions that would move the market to their advantage. Those funds are now prowling for alternative investments, Europe and Asia may be the most likely targets.

So what next? Are we looking for lemmings or trilobites? Will the crash lead to a massive crisis of confidence, retrenchment and retreat, or will it bolster and strengthen the most viable Gulfi companies? Obviously, we'll see a bit of both. The question is which will outweigh the other.

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