Stock Markets and the Role of Market Mechanisms

  • 15 March 2006

Gulf stock markets are presently facing huge crises on a regular basis. These bourses have reportedly lost over $200 billion, or one-third of their market value, in the past few months. Consequently, investor-confidence in the markets has nosedived and future prospects for a recovery are more obscure than ever. It is not surprising that this sharp fall has come after market indices reached record highs, which in many cases exceeded 20 times the real value of registered company shares. The total value of shares offered in these markets had even exceeded the aggregate value of the Gross Domestic Product of all the six countries, which is estimated at $550 billion. At the same time, the investor and speculator base continuously expanded, in total disregard of the simplest economic and investment rules that govern share assessment processes. Thus, markets remained subject to exaggerations in that period, because of inflated assessments by speculators and due to the lack of specialized and independent organizations capable of fixing fair prices for the shares of registered companies.

The present correction in Gulf stock markets is ‘healthy,’ and should continue for two more weeks. Gulf governments should not respond to the increasing calls for intervention and should not influence the course of the markets. Any direct government intervention to influence prices would have an adverse effect in the long run and might prolong the correction period. On the contrary, these governments should seek to open up share markets, promote transparency, phase out speculations and find highly efficient financial brokerages that are capable of innovation, competition. They should also be capable of responding to a variety of variables. Current realities of Gulf stock market calls for the introduction of market mechanisms that function under full transparency.

Such measures could be painful for many investors, especially the small and inexperienced ones. Yet, these investors would have received an important lesson that the temptation of earning big profits in stock markets should not blind them from accepting the possibility of a fall in shares. Some market dealers had considered the period of rising stock market prices as normal. Some of them had argued that the Gulf market situation was exceptional and could not be subject to the factors of conventional and prudent economic logic. However, the same logic is now enforcing the need for a sound mechanism for them. Is it not befitting to give it a chance for all kinds of transactions.