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Vice Chairman Oliver Schutzmann's article in The National

Thursday, July, 24, 2014
Dubai, United Arab Emirates

In February 1930, Fortune magazine, in its  first-ever edition, published the article “Post-panic speculation”. The article  describes events leading up to the Wall Street Crash of 1929 as a consequence of  a business cycle that was allowed to run too fast and too far, creating a  feeling of overconfidence that stimulated speculation. The story argued that  properly undertaken, speculation performs a useful economic function because  speculators assume a risk-bearing function.

However, speculation can be indulged in by the wrong kind of “get rich  quick” individuals; and when the wrong individuals attempt to speculate, their  activity degenerates into mere gambling.

Fast-forward nearly a century. For most of 2013 issuers and investors leaned  back and enjoyed the ride as global equity markets advanced. Internationally,  the Dow Jones ended up 26.5 per cent, its highest annual rise since 1995. The  Nikkei was up 56.7 per cent, its biggest annual gain since 1972 and the DAX 30  closed 25.5 per cent up, at its highest level since inception in 1988. Market  volatility remained notably low thanks to the Federal Reserve’s quantitative  easing, which supported stock prices, and inhibited excessive mood swings.

Locally, the Abu Dhabi benchmark gained 63.1 per cent and the Dubai Financial  Market General Index ended the year with the second best performance worldwide,  up 107.7 per cent. The prospects of global economic growth and the underlying  financial performance of listed companies have not quite worn off. But last  month, shortly after the addition to the MSCI Emerging Markets Index, investors  in UAE markets took money off the table and started showing nerves. The word on  the street is that speculation, a slumping share price and margin calls  triggered a crisis of investor confidence that profoundly affected sentiment  towards the entire market. Is there more to come?

UAE markets have underperformed most of the developed and emerging markets  for four years following the financial crisis and are still trading below their  highs, so some profit-taking should not really be a concern. However, regional  investors are no longer blindly following the herd without questioning the  underlying fundamentals. It is a positive sign that investors are starting to  assess their risk profile after the bull run. The deeper question creeping into  their minds is whether they should decide to be “risk-on” and continue investing  in risky assets such as equities, or be “risk-off” and start rotating into safer  havens, such as corporate and government bonds or even cash.

In this region during “risk-on” periods asset prices increase in unison (with  the strength of the economy), but when market sentiment changes to “risk-off” they tend to recoil with a vengeance. This is partly because hedging  instruments, including short-selling, are inaccessible at sensible rates.  Currently, the cost of hedging a portfolio position can be in excess of 10 per  cent. Clearly, this impacts investor behaviour. Whereas in developed markets  these hedging instruments are widely available, regional investors cannot stay “risk-on” in equities by playing the downswings in the market — they are either  in or out.

The real danger is that regional investors can get too wrapped up in  short-term market movements because they are preoccupied with intraday,  real-time stock prices. Some speculators are gambling on steroids. This  inevitably leads to major share price fluctuations, as recently witnessed, and  more violent swings between risk attraction and risk aversion to equities as an  asset class.

To increase the efficiency of regional capital markets, investors in UAE  equities should momentarily blind out their short-term investment horizon and  focus on the long-term underlying prospects of the UAE economy and the  fundamentally strong companies that are listed on the exchange. Equity markets  always oscillate and investors can make a quick dirham, but in the long-term  share prices tend to move in unison with the health of the overall economy and  the underlying performance of listed companies. It is well worth taking a  longer-term view on UAE markets.

The Middle East Investor Relations Society urges issuers to upgrade their  investor relations practices to help investors understand their company’s  fundamentals so that they can make better, more informed and longer term  investment decisions.

To this end, the Securities and Commodities Authority this year announced the  passage of new regulations that require companies to set up dedicated investor  relations functions. Welcomed as a visionary initiative at the time, the most  recent events have propelled this regulation to a position of critical  importance today. In combination with a joint task force set up by UAE  regulatory bodies to ensure the soundness and integrity of trading, the new  legislation can now be used to accelerate the process of improving transparency  and mitigate the risks emanating from rumours and speculation. This leads to  lower estimation and forecast risk as well as less violent risk-on, risk-off  cycles.

A nearly century-old quote from Fortune  magazine is just as relevant today: “the recent equity markets correction has  done a great deal to reduce the number of stock market gamblers, at least for  the time being”. No doubt investors today will take more care in assessing their  risk-bearing function, and be watchful of slipping into gambling mode — that  would mean more service to the community and less reason to be nervous.

To read the full article click here