Reason to believe in Saudi stocks

The Saudi market correction this year has affected Saudi banks, whose net income has fallen sharply from share-trading brokerage services.

Technically, the banks should have been barred from acting as share brokers under the new Capital Market Law that was introduced three years ago, but this part of the regulation was not fully implemented due to the lack of alternative brokers to banks.

With the licensing of many new brokerage houses over the past two years, Saudi banks should have withdrawn from this activity or set up separate subsidiaries, but the net effect was that, just like market participants, the lenders thought that the boom in share trading would go on forever. Current trading daily volumes are a pale imitation of previous peaks, and undoubtedly this reduction has made banks refocus on their core business once again.

A lot has happened since February 2006 when the Saudi market peaked. The market seemed to be out of sync with the rest of the world and often with other Gulf markets, with no apparent correlation.

If this had occurred once, we could put it down to temporary phenomena, and explain it away in terms of a flight to safety in local markets. Some have argued that the non-correlation of the Saudi market was because it was not cross-listed with other stock markets. If it were, then it is also argued that sharp falls in one market would be corrected in another, based on technical and fundamental analysis of under-valued stocks.

Until that happens, and the Saudi market opens up to international investors with stocks cross-listed, one has to fall back and try to analyse the behaviour of Saudi investors. Analysing trends over the past 12-14 months, one can describe the events of the Saudi market as having gone through cycles of euphoria, rationality and amnesia in unequal doses.

Mass psychosis

Due to perceived lack of transparency and stock trading training that is based on technical and fundamental principles, the Saudi market had seemed to be gripped by a mass psychosis. This typifies the period of financial euphoria when the Tadawul reached a peak of 20,900 in February 2006. In this period, the general paper profit-making becomes, temporarily, a self-fulfilling prophecy that leads to a self-sustaining and self-congratulatory behav-iour. This sucks in both the "irrational" unsophisticated investors as well as the "rational" analytic inclined investors.

In economics terms, this leads to all investors having a "vested interest in error". As members of a crowd, all are willing to suspend disbelief on what is happening. The herd mentality sets in. But people learn the hard way, and for some Saudi investors, especially the smaller ones, it has been a bloodbath. The current market performance is steadier and investors are being cautious with more modest gain expectations.

It is said that the market is 90 per cent retail, so speculation is still rampant.

The market regulators - the Capital Market Authority (CMA) - have introduced tougher sentences on insider dealers, jailed and "shamed" some, suspended listed companies, and have insisted on more transparent listed company reporting requirements. This seemed to have brought a certain degree of public confidence. The Tadawul index now reflects a more cautious, but rational behaviour, with investors swayed by CMA actions and announcements, as well as a closer analysis of company fin-ancial results and professional stock market company evaluations.

Trading ranges have remained within narrow bands, and gone, it seems, are the daily 8-10 per cent price fluctuations. The CMA has not been standing still, though, and on October 20 it launched its new operating trading system which contained a variety of enhancements to improve both the operation of the Saudi exchange and its transparency.

Among the technical enhancements of the new system based on the Nordic OMX exchange, is its ability to boost the capacity of processing trades to two million transactions per day from current levels of under one million. Different types of orders will also be processed by the new system: market, limit and hidden orders. The last are large enough that, if transacted, they could distort the market. Now such mega-orders will be executed in tranches. The effect of the introduction of the new system was to raise the market by nearly four per cent over a week. Smaller investors have plucked enough courage to re-enter the market.

- The author is Visiting Associate Professor at King Fahd University of Petroleum and Minerals, Saudi Arabia.