The beginning of 2008 was a great time to be an investor in the Middle East’s equity markets. In the UAE, the most popular country with foreign investment funds, the Dubai Financial Market (DFM) had grown by 44 per cent over the previous year and the Abu Dhabi Securities Exchange (ADX), the best performing index in the GCC, had gained 67 per cent.

Fast forward to October 2008, however, and the line graph representing both stock markets has inverted. By mid-November, the ADX was down 37 per cent, at 2,881 points, and the DFM had tumbled by 65 per cent to 2.053 points, compared with December last year.

The performance of the Egyptian Exchange, which was among the world’s fastest-growing stock markets in 2005 and again in 2007, tells a similar story. By 26 November, the Case 30 Index of Egypt’s largest companies had lost 67 per cent of its value from its 5 May peak.

Every exchange in the region has lost value over the past year. The last major market to fall into negative territory was the Moroccan All Share Index on 15 September, the day that US investment bank Lehman Brothers collapsed. On 25 November, the index was down 14 per cent over the year to date.

Foreign investors are the most popular scapegoat for the erosion of shareholder wealth. According to both local media and many retail investors, unscrupulous foreign investors piled their cash into Middle East-listed companies in 2007 and the first half of 2008 because they hoped to get rich by backing companies operating in markets that were propelled by oil wealth. Those same foreign investors came unstuck in the second half of 2008 because many had bought mortgage debt owned by Americans with no jobs.

The foreigners who had bought Middle East equities in the first half of the year became panic sellers when the mountain of bad mortgage debt caused Lehman Brothers to file for bankruptcy protection.

But this explanation is flawed. Although the statistics showing foreign ownership of regional bourses are incomplete, they reveal that foreigners have only ever owned small stakes in the region’s major stock markets.

According to the ADX statistics, foreigners held just 9 per cent of its equities at the end of 2007.

Yet even after panic selling in September and October, foreigners still hold 5.6 per cent of shares.

The DFM and the Doha Securities Market - the only other Gulf exchange that publishes its level of foreign holdings - have been less willing to check their records, but there is little reason to believe that the ADX is atypical.

Surprisingly, some local investors sound vindicated when they talk about the effect of the crash on local markets.

“This crash is probably the best thing that has ever happened to this market,” says Oliver Schutzmann, head of investor relations at Shuaa Capital, a Dubai-listed bank.

He is not alone. Ali al-Shihabi, founder and chief executive officer of Rasmala, a UAE-based broker and asset manager, and former executive chairman of Saudi Hollandi Bank, welcomes the opportunity to get rid of the excesses of the oil boom.

“I look at the recent downturn as a much-needed time out,” he says. “We have had a bull market and there was a feeling here that all you needed to do to start a company was get the capital, a public relations agency and a brand. Those people never understood what was needed to run a business.”

The oil boom has obscured two major problems that have blighted the Gulf’s capital markets to varying degrees. The first is the real estate sector, and the second is the standard of investor relations.

The whole Gulf, not just Dubai, has suffered from an overheated real estate sector, with real estate developers enduring some of the largest falls of any regional stocks. But the investor relations problem is arguably more important.

Financial results in both Kuwait and Saudi Arabia only have to be published in Arabic, which deters non-Arab investors from working more closely with those companies. Listed companies in the UAE have to inform their regulator, the Emirates Securities & Commodities Authority, when an investor acquires more than 5 per cent of their shares, but the regulator does not publish that information.

The investor relations problem runs so deep that listed companies will not consider merging with one another even if a merger is in the best interests of shareholders. The one successful UAE merger in recent years - of National Bank of Dubai and Emirates Bank - was only achieved when ruler of Dubai Sheikh Mohammad bin Rashid al-Maktoum, the majority shareholder in both companies, forced them to merge.

Many listed companies face a tougher operating environment over the next 12 months. If they use the slowdown to consolidate rather than continue business as usual, regional markets could finish 2009 in their best position for years.

“The region needs six to 12 months to consolidate; for stronger firms to cement their position and for weaker firms to go out of business,” says Al-Shihabi.