Performance of Saudi Stock Market - Research Paper Example

Introduction The Saudi stock market has evolved extensively since it was first inaugurated in 1984. The structural changes and regulatory changes in the market have brought in more investment in the market. The market has grown to the largest stock market in the Middle East contributing about 33% of the total traded volume in the region (Samba Financial Group, 2009). The effectiveness of the Saudi Stock Market can as well be measured by its ability to raise funds. With the Saudi stock market having a market capitalization of $ 313 billion in 2009, it is the largest stock market in the Arab market (Samba Financial Group, 2009). The Saudi capital market is dominated by retail traders who contribute about 87.5% of the total traded volume in 2008 (Samba Financial Group, 2009). Within this research work, the researcher will conduct an extensive review of existing work on the performance of Saudi stock exchange comparing and contrasting its performance to other key stock markets in Europe and America and evaluating the role the stock market plays in the Saudi market. Literature Review: Performance of Saudi Stock Market According to Alshogeathri (2011), the Saudi stock market has experienced six major market collapses since it was formalized in 1984. During these collapses several million worth of investments was lost by the investors and the substantial debts accrued by the investors (Alshogeathri, 2011). This in return has turned major investment funds and mutual funds out of the market due to volatility. This is the main reason why the Saudi stock market continues to be dominated by individual, and mostly retail, investors. In comparison to other developing markets, Saudi Arabia’s stock market is grown in tandem with those economies. In particular with the Gulf Cooperation Countries (GCC), the Saudi market has enjoyed more liberalized trading environment after the restructuring of the bourse in 2005. Most legal restrictions that had been imposed on the bourse were lifted, paving the way for a more integrated market (Marashdeh & Shrestha, 2010). Though Saudi Arabia’s stock market controls approximately 35%-40% of the total traded volumes in the GCC, its market continues to face challenges that require it to have a more integrated approach to its neighbors. Marashdeh and Shrestha (2010) argue that the liberalization of the economies in the GCC markets has contributed to the increasing number of foreign investors in the GCC stock markets. Saudi Arabia’s market has benefited from this new wave. The number of foreign corporate investors in the market is increasing, though still the market is largely dominated by retail traders. The fact that the market is susceptible to huge collapses has kept foreign corporate investors away from the market. This is steadily changing with changes in the governance structure of the market and the investment environment. Seeking further market integration with other GCC economies strengthens the Saudi market. The major downside of the Saudi market is the restriction on investment avenues by foreign investors. Foreign investors can only participate in the market through mutual funds managed by Saudi banks (Marashdeh & Shrestha, 2010). In comparison with other markets in the GCC, a Saudi investment ceiling of 25% foreign investment is a barrier to growth of the market. Other researchers that have done much of work in the area of performance of the Saudi stock market, such as Fama (1991) and Al-Saleh and Al-Ajmi (2012), are in agreement that efficient allocation of ownership of the economy across various sectors is the prime objective of a capital market. This means that the Saudi economy, with all other external factors remaining constant, should grow at the rate of the stock market growth. This is not the case in Saudi Arabia as shown by the many stock market collapses while the economy was growing. In this paper the researcher will review the existing literature on the performance of the Saudi stock market, comparing and contrasting the performance of the market to other stock markets, finally drawing conclusions and recommendations on how to strengthen the market performance. Key factors that are affecting the performance of the market will also be covered in brief. Factors Affecting Performance of Saudi Market Oil Price Shocks The market growth in capitalization, however, has been steady mostly due to the need to invest in the money being made from the oil industry. Oil prices and stock markets have been studied in depth by Rault and Arouri (2009). Rault and Arouri have established a linkage between performance of the stock market and oil price shocks. They cite that proper study of oil price shocks can help investors invest in the GCC countries including Saudi Arabia profitably. The Saudi stock market consists of diverse groups of companies focused on the strong domestic economy rather than the international prices of oil (Jadwa Investment, 2010). Nonetheless, investors are exposed to the oil sector fluctuations through companies which prices are in line with oil prices. Also, companies that operate in areas or sectors that are related to the oil industry will from time to time be exposed to the oil price shocks. Only the petrochemical and industrial investment sectors have a significantly stronger price correlation to oil prices than the Tadawul All Share Index (TASI). Prices of petrochemical products have a close relationship to oil prices. It is clear that oil prices do not have direct impact on the stock market, but through companies that trade with oil companies the stock market is affected indirectly. The price fluctuation especially when oil prices are fluctuating is a clear indication that the two markets are indirectly related. Effect of Financial systems on National Economy Abdmoulah (2010) argues that most Arab countries in the 1990s revitalized their stock markets so that they could develop financial systems that would stimulate growth. The Saudi stock market, with 111 listed companies, represents the largest stock market based on value of shares traded by sectors in the Gulf region. According to Alshogeathri (2011), the Saudi stock market has experienced six major market collapses since it was formalized in 1984. During these collapses, several million worth of investments was lost by the investors and the substantial debts accrued by the investors (Alshogeathri, 2011). This in return has turned major investment funds and mutual funds out of the market due to volatility. This is the main reason why the Saudi stock market continues to be dominated by individual, and mostly retail, investors. Marashdeh and Shrestha (2010) argue that the liberalization of the economies in the GCC markets has contributed to the increasing number of foreign investors in the GCC stock markets. Saudi Arabia’s market has benefited from this new wave. The number of foreign corporate investors in the market is increasing, though still the market is largely dominated by retail traders. The fact that the market is susceptible to huge collapses has kept foreign corporate investors away from the market. This is steadily changing with changes in the governance structure of the market and the investment environment. Seeking further market integration with other GCC economies will strengthen the Saudi market. In conclusion, the Saudi Arabia’s stock market is generally affected by many factors that are not related to the performance of the individual companies listed on the bourse. In particular the regional instability – Spring Uprising – and the Euro debt crises have affected the market, even though the market was not directly linked to these events. The sensitivity of the stock market to information increases the risk of market collapses in Saudi Arabia since it is surrounded by many institutions, sectors or countries that ‘generate’ information. This environment, according to Kim and Shamsuddin (2008), has made the Saudi stock market a risky but profitable avenue for foreign funds to invest in. References Abdmoulah, W. (2010). Testing the evolving efficiency of Arab stock markets. International Review of Financial Analysis, 19, 25-34. Retrieved Novomber 14, 2012, from http://ipac.kacst.edu.sa/edoc/1431/190134_1.pdf. Al-Saleh, N., & Al-Ajmi, J. (2012). Weak-form efficiency in the Saudi stock market. International Research Journal of Finance and Economics, (87), 192-211. Alshogeathri, M. A. (2011). Macroeconomic determinants of the stock market movements: Empirical evidence from the Saudi stock market. Kansas State University. Kansas: Department of Economics, College of Art and Sciences. Retrieved November 14, 2012, from http://krex.k-state.edu/dspace/bitstream/handle/2097/11989/MoflehAlshogeathri2011.pdf?sequence=1. Fama, E. F. (1991, December). Efficient capital markets: II. The Journal of Finance, 46(5), 1575-1617. Retrieved November 14, 2012, from http://www.jstor.org/stable/2328565. Jadwa Investment. (2010). Oil and the Saudi stock market. Riyadh: Jadwa Investment. Kim, J. H., & Shamsuddin, A. (2008). Are Asian stock markets efficient? Evidence from new multiple variance ratio tests. Journal of Empirical Finance, (15), 518-532. Marashdeh, H. A., & Shrestha, M. B. (2010). Stock market integration in the GCC countries. International Research Journal of Finance and Economics, (37), 102-113. Onour, I. A. (2009). Testing efficiency performance of Saudi stock market. JKAU: Economics and Administration, 23(2), 15-27. Rault, C., & Arouri, M. E. (2009). On the influence of oil prices on stock markets: Evidence from panel analysis in GCC countries. THE UNIVERSITY OF MICHIGAN. Michigan: William Davidson Institute. Retrieved November 14, 2012, from http://wdi.umich.edu/files/publications/workingpapers/wp961.pdf. Samba Financial Group. (2009). The Saudi stock market: Structural issues, recent performance and outlook. Riyadh, Saudi Arabi: Samba. Retrieved November 14, 2012, from http://www.samba.com/GblDocs/Saudi_Stock_Market_Eng.pdf. Read More