Gulf markets are set for a fall

The rally in Gulf markets that started in March seems to be losing momentum as optimism shrinks and the reality of the prospects for the next six months sinks in.

There has been a rapid reversal of the sentiment expressed by fund managers at the beginning of this year that buying opportunities are plentiful. Many fund managers and analysts saw the crash in late 2008 as overdone, and started trying to pick out opportunities.

But they now warn of the opposite problem. After markets began to value equities based on the expectation of corporate defaults and a real estate crash, the mood quickly switched to optimism that a recovery was under way. That was wishful thinking, and further bad news from banks and real estate companies is likely before the end of the year. This will weigh on market valuations and many investors who hoped to capitalise on the stock market crash will get burned.

Wary of how quicklay prices have recovered, some fund managers have already been taking profits. By switching back into cash, they hope to protect the value of their funds. This could be a signal that a further stock market crash is approaching. It is worrying that some funds would rather be 30-40 per cent invested in cash than in the markets.

Corporate profits for the second quarter will show whether fund managers have made the right decision. If profits come in below expectations, retail investors are expected to start selling again.

The hope is that by the time third-quarter corporate earnings have been released, investors should have the reassurance that most of the bad news has filtered through the economy.

That should help promote a more sustain-able recovery. But, as the past six months have shown, capitalising on the recovery is not straightforward when no one knows where the bottom is.