Markets on summer holidays

The wild gyrations in the UAE stock markets of the past few weeks are worrying and problematic, especially in the context of an overall improvement in global markets. With the rest of the world apparently deciding – even if possibly prematurely – that the worst financial effects of the credit crisis are over, it seems perverse for Gulf markets, especially in Dubai, to suddenly go into reverse. How to explain this apparent illogicality is exercising powerful minds in the Dubai Financial Market and the Abu Dhabi Securities Exchange, but I doubt they will find a simple answer to the conundrum. Equity trading in the region remains a mysterious and enigmatic craft.

Early on in the credit crisis, now one year old, there was much talk that the economies of the Gulf would be insulated from the worst effects of the financial chaos in the United States and Europe. The region had strong growth rates, dynamic expansion plans, and access to serious pools of liquidity in the form of energy revenue. Therefore, it was argued, Gulf markets would be “decoupled” from the general malaise affecting the big stock markets of the west. Each dollar rise in the price of oil reinforced that view.

I never thought it was going to be that easy. In the age of globalisation no economy is an island, and when the biggest economies in the world suffer there was always going to be collateral damage in the emerging markets, even those as strong and apparently resilient as the Gulf. Now that the oil price is falling back – I believe temporarily – some of the logic of decoupling is weakened, but surely not to the extent we have witnessed this summer. The slump on UAE markets appears to be an extreme over-reaction to quite modest concerns about the region.

Take the DFM for example. Despite yesterday’s tentative improvement, the general index is still down 14 per cent on the year, making earlier forecasts of 30-odd per cent growth in 2008 look very ambitious indeed. The index crashed through the psychologically important 5,000-point level, and analysts began talking about the next “floor” of 4,800 or 4,600.

But there is nothing really tangible to explain that decline. Geo-political factors, which tend to spook stock markets in this part of the world, have not change significantly. (It is stretching the imagination to link the UAE stock markets with any fall-out from the short but nasty war in the Caucasus.)

True, the decline in the oil price does in theory weaken the financial fire-power of the Gulf states, but the great sovereign wealth funds of the region have so much capital that a temporary blip in revenues can be easily sustained.

And oil revenue is no longer a significant factor in Dubai, where energy revenues are now in small single digits as a percentage of gross domestic product. You would have thought that international investors, especially, would have learned this lesson by now, but apparently not.

They have been withdrawing funds from DFM stocks at an alarming rate over the summer months.

The real dynamo of the Dubai economy is not oil, but property. The real estate industry is what makes the Dubai machine tick, and there have been fears that the kinds of price increases we have seen in recent years cannot carry on. Last week’s report on UAE real estate from Morgan Stanley, while generally positive, touched a raw nerve when it said the industry might suffer a 10 per cent price fall in the next two years. Investors in the big DFM stocks took fright at this gloomy forecast and used it as the occasion for a more general sell-off of Dubai equity.

Morgan Stanley has every right to its view (see below), but it appears not to have taken into account the possibility of government influence in the real estate. With the big property groups in Dubai linked unbreakably to the government, the authorities have the power to regulate and control the supply of new developments.

This ability should mitigate the possibility of a serious “bubble” effect in Dubai property.

So we are left casting around for solid reasons for the UAE market weakness. Sure, it is the summer season, when even professional investors have to take a break, and with thin volumes any price variations are disproportionately magnified. Couple this with the absence of big institutional investors, and the “herd” mentality of the region’s retail investors – all anxious not to repeat the sufferings of the 2006 collapse when many sustained serious losses – and you have the recipe for languor in Dubai markets.

Maybe it will all come right in the autumn, but I have a suspicion it will require a long-term change of investment culture before the region’s equity markets break out through the cycle of inertia and decline in which they languish.