Need to learn lessons from stock cycles

The meteoric rise of the stock markets in the GCC, and particularly in the UAE has been the subject of much debate amongst many. The euphoria of stocks is indeed quite widespread and all and sundry talk about it and the current market movements are indeed bringing to the fore a great deal of issues.

The memory of the late 1990s UAE stock market meltdown is still fresh in the older hands at this game, yet there is a new blood of stock market participants who do frighten me with their naivety and approach.

The recent spate of rights issues is indeed one of the main reasons for the stocks to move down lower, and yet it seems not many have understood the role of rights issues on stock market price performance.

The increase of supply, priced lower than current market price always creates a downward movement in the stock prices. Yes indeed the increased capital that the company would have available would, in the long run, allow the company to yield a better performance, but then one has to remember that more capital means a larger base of performance is needed to sustain the returns that shareholders expect.

Apart from Emaar Properties, all the rights issues we are seeing are coming from banks and financial companies, and the strange thing is that the rights issue news has been greeted by brokers by talking the stocks up rather than accepting the reality of the fundamentals having to change.

There is scant attention to fundamentals and even simple measures as price to earning ratios are seen more to justify the upward movements rather than anything else. In a sense this has a lot to do with the novice approach and the mentality for quick returns.

The impact of a rights issue is a case in point. Indeed the increased capital will add good value to the share price performance, provided the underlying business performance holds up under the same conditions.

The reason that banks have gone for rights offerings is to bring in additional capital and to beef up their balance sheets in the light of the new capital adequacy regulations under Basle II accord. This can be seen with the pace with which banks have expanded the asset side of their balance sheets, and backed by good profit performance have continued to build aggressive assets.

Assets come with associated risks and for this capital is needed, thus for the banks the rights offerings are simply an adjustment to the need for more capital in the coming years, as it is not traditional here for banks to shed assets, so the trend is get more capital.

In the case of Emaar, the rights issue is to bring in the capital that it needs to support the bold and profitable expansion plans. Indeed, in the long run I would imagine the rights issue of Emaar makes more sense to translate into better medium term performance than anything else.

However, this does not mean that stock performance will begin to be stellar the next day after the rights issue is announced! Nothing in what I am saying suggests that the underlying performance of the companies is not healthy, my only gripe is that stock market expectations are rather unrealistic in the short term.

It would be wiser for the cooling off before the fundamentals begin to kick into the market place.

The upward movement of both the stock market and the real estate market is not something one sees as common. My guess is that while the higher oil prices has meant more liquidity in the market place, and a better business environment, eventually there will be a trade off between the stock market and the real estate market.

If I was a guessing person my hunch is that the stock market correction will appear first, which will bring real estate values into focus and we will see a spurt towards investors cashing in on stocks and buying real estate as the underlying development of business in the country is attracting more companies and workers, (try to rent an office today and you will know what I mean).

What could hurt this scenario is the leverage that banks are throwing behind the stock market players, and this is not dissimilar from what happened in 1999, where leverage hurt speculators just as much as stock market declines. Here is where the balance has to be created and is the only matter for concern.

For the moment, I would only hope stock market players will see something more than simply price movements as reasons to buy or sell. There is a fundamental story underneath all this, it needs to be seen.

The writer is the UAE-based president of Sher Consulting.