Recent developments in the capital market have shattered old certainties and Middle East equity investors should take careful note of the consequences.
The chief executive of a UK service company listed on the London Stock Exchange was talking at the end of October about the new world emerging for those leading quoted firms and all who invest in them.
His company had a negative book value due to its pension fund liabilities but investors were principally interested in future income trends, not balance sheet ratios. Auditors were only required for signing off the annual statements. His board worked, but rules do not help when directors fall out. For this business, there were few measurable certainties.
If what the chief executive says reflects a general trend, it is going to be even more difficult for analysts trying to identify quoted firms that will deliver above-average returns. Traditionalists sceptical about fundamental analysis will be pleased. They track the charts and prefer to gauge the fickle spirits that govern capital markets rather than study financial statements.
But the stock market herd is being spooked increasingly easily. Computers have replaced people in making decisions about an increasing proportion of stock market transactions, yet human judgement remains critical. Equity traders monitoring hundreds of daily events can trigger waves of buying and selling that can sweep world markets in minutes with long-term consequences.
In mid-September, Northern Rock, a quoted UK housing finance firm, asked the Bank of England for emergency funding. It is now reported that the bank has raised more than $40,000 million in this way. Its share price crashed, its chairman quit, its board is derided and Northern Rock is likely to be acquired. By November 2008, what was considered to be a solid business is likely to disappear forever. And no one saw it coming.
A new equity world is being created that we are still struggling to understand. In early 2004, a second-year undergraduate at Harvard University created an internet network called Facebook, valued at about $15,000 million in October. No equity analyst forecast Facebook’s rise and no one yet dares to suggest it will fall.
All this is raising profound questions for those promoting Middle East share markets. The conventional wisdom is that stock exchanges are vital for the region’s economic development. The experts argued its poor economic trends were partly due to the absence of vibrant markets where companies could raise money and performance could be rewarded or punished.
In the past 20 years, every Middle East country has established or modernised its share markets. But the experience has been mixed. In 2006, the stock exchanges of Qatar, Saudi Arabia and the UAE experienced radical reverses and are yet to recover. The region’s biggest firms prefer to finance growth through internal resources, debt or private equity, not public share offerings. Investing in Middle East shares still feels like gambling.
The lack of maturity in the region’s investment community was blamed. But events in 2007 suggest there is a global phenomenon at work. Unpredictable volatility appears to be systemic. Rational managers wonder why they should be governed by markets that are not. Most Gulf firms are service providers that do not require large amounts of capital. If the owners see no need to liquidate their holdings, why go public at all?
A special factor is at work in Saudi Arabia. The government requires private petrochemicals companies receiving low-cost gas feedstock to go public so the benefits can be spread more widely. But this strategy has costs. By increasing the number of retail investors, the kingdom is encouraging the main cause of the equity market meltdown in 2006.
The UK chief executive sees one unambiguous benefit to being quoted. “The stock market provides a measure of our performance that can then be used through employee share schemes to incentivise my team,” he says. It is telling that Middle East employee share schemes are a rarity.
There is a triple challenge for the Middle East equity industry. For intermediaries, new analytical methods are required that focus on the behaviour of a company’s key customers, the source of future income streams. Investors should do more to ensure their objectives are aligned with employees that manage the relationship with those customers. For regulators, it means coming to terms with the scale and speed of global trading and intervening in the right place at the right time and for the right reasons. One thing is certain. There is no quick fix.
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