2008 will probably be remembered as the most eventful year in the modern history of financial services; global markets experienced a once in a generation meltdown. The financial crisis started with falling real estate prices in the US and is continuing without showing any signs of abating. Some of the largest icons in the Western financial services industry have disappeared into thin air, while others are struggling to survive on government backing, which is generating more debt to buy them time. The situation is ironic.
The effects are just beginning to trickle out: major economies are in recession, huge job losses are on the way, consumer spending has stalled, real estate is tumbling, investors have lost faith in the financial system, and most importantly, the image of the US financial system as safe haven has been dented – perhaps beyond repair. We have witnessed in recent years that excessive leverage and speculative activity only creates an illusion of temporary growth and uncertainty in the economy. Debt is not wealth, and borrowed money has to be paid back at a significant mark-up; if we borrow too much we end up working for our creditors rather than ourselves.
This is the fatal problem of "running fast to stand still". Speculative activity is typically a characteristic of market peaks in any economy and if not controlled it can have adverse affects on the long-term prospects of the economy.
Consequently, it has also inflicted the local economy with the problem of inflation, especially with respect to real estate and high operating costs for businesses. It is worth mentioning here that the real estate mania had reached the stage at which people had ceased to think and were simply imitating each other without any regard to the underlying economics leading to an inflated bubble.
The government has quite rightly recognised this and reforms are under way to weed out excessive levels of speculative activity including restriction on sale for a limited time. Short-term transactions fees/taxes could also be an effective way of controlling effects of excessive speculation.
Stock markets need to create diversification to attract investors. As with most young emerging markets, three sectors (banking, financial and investment services, and real estate) account for approximately 72 per cent of total market capitalisation at the Dubai Financial Market (DFM) and 53 per cent at the Abu Dhabi Securities Exchange (ADX). Since these sectors are at the centre of the financial crises, the stock markets have witnessed enormous loss of capitalisation. DFM is down by 72 per cent from its 52-week highs, while ADX has fared slightly better and is down by 48 per cent.
This proves the case for diversification. The stock markets would benefit from inclusion of equities from core sectors such as oil and gas, transportation, logistics and commodity linked equities that will provide diversification to the investors. Introduction of innovative financial products/facilities such as derivatives would also reduce severe volatility giving a sense of direction in the market. We expect the volumes and values to be low in the medium term; however the long-term prospects of the markets remain intact.
At a macroeconomic level, the country has sufficient reserves to tackle any kind of liquidity shock; inflation will also subside with downward pressure on real estate prices. This should bring back economy's business competitiveness, which was fading due to higher operating costs. The impact of change in economic conditions will be reflected in quarterly earnings in Q4. Many financial and insurance companies are expected to post significantly lower earning; banks will be hit by investment losses, slowing credit growth and bad loans. This year could possibly see a spate of merger and acquisition activities, particularly in the financial sector, leading to consolidation and probably better valuations of the merged entities.
Although "V" shape recovery is unlikely, the time is opportune for investments with a long time frame. The stock market looks like an attractive investment at current valuations, however, a successful investment strategy must involve deliberate and wise investment choices. Energy sector remains an attractive sector for long term, while banks (specially the one's backed by government) should receive increased investor attention in medium term. Prospects for the construction sector will be driven by major public infrastructure projects. Obviously, the bull run is over and there is no "quick money" to be made, but the markets still provides opportunities for wise investors with medium to longer term time horizon. In our view, 2009 will be a buyer's market just like 2008 was a time for sellers.
- The author is Chief Executive Officer of Univest brokerage and has previously worked for Daman Securities, ABN Amro, Emirates Bank International and National Bank of Dubai. He is also a member of Young Arab Leaders