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Investors must be feeling they have been on one long bungee jump during the last week. However what goes up must surely come down — but when does a market correction become a market crash? We are pretty close.
In the last week the DFM index has recoiled a significant 8 per cent even after today’s respite. This appears to be partially a result of a capital flight to other investment opportunities and merely reflects the fickle nature of investors. More worryingly is the extent to which brokers have allowed investors to trade on margin. In the UAE these are often informal unregulated arrangements between broker and investor. All is very well when the market is moving in the investors favour.
A different matter when it is not as markets tend to move excessively in either direction before finding a trading range. In the event an investor cannot meet a ‘margin call’ the broker should automatically sell down the position. In theory this should protect the broker from any losses. In the event the investor has not provided any margin then the broker stomachs the loss.
It is difficult to gauge the extent to which margin trading is widespread though it is probable that some brokers are currently facing settlement problems. Regulators should also ensure that there is adequate supervision in this area before it threatens the stability of the overall market.
There are some portents from the crisis in Japan some years ago where an overvalued real estate market led banks and brokers to offer margin trading to local investors that resulted in a stock market bubble. The subsequent crisis resulted in a downward spiral in asset prices where the fallout is still being felt today. However, there are some fundamental differences in the UAE market particularly in terms of liquidity, inflation and the economic cycle.
The other concern is the disproportionate influence that one or two stocks have on the overall index because of their relative weighting.
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