Saudi Arabian Capital Markets and the Great Airline Transformation

This could be a game-changer or it could be a fizzle: Bloomberg reports that Saudi Arabia is opening its stock markets to foreign investors. The problem is that this market is deeply correlated to the price of oil when volatility is high and underperforms when it isn't. Have a look.

It makes sense. You have a deeply insular society that has been unwilling to open its capital markets until recently, instead depending on home funds for investment. As such, downward volatility in oil portends a drop in future disposable income for the sheikhs, so they all rush for the exits at the same time. As of June, the correlation of the Saudi stock index to oil is very high because of recent events. This makes it perfectly clear why the Saudi authorities need to liberalize their capital markets: it’s the only way to break the index’s mode of dependency on oil prices.

On a price basis (not total return because frankly I am not sure what “shariah compliant” total returns actually are), the index has underperformed for years. It started to catch a bid in 2013 (due to home capital diversification motive) only to see it recouple to oil when the petrochemical prices collapsed last summer. The only way to break the cycle is to change the rule of the game such that money unconnected to oil wealth will become a driver. So they are courting a different kind of capital with enticements.

These intimate moments for a financial liberalization can easily back-fire. Fast money may use the index as a cheap way to get oil exposure long and short, rushing in and rushing out by building huge long and short positions over a very short timeframe.

Keep in mind that capital plays a very different role today than 100 years ago. We live in an age of active management underwritten by central banking and credit money. That's part of why the banks and markets seem so out of control: there is so much cheap funding sloshing around the world, they let almost anybody play with it. This is, overall, a good thing if only because being rich is better than being poor.

But the slosh relegates all that textbook crap about the benefits of opening capital markets to the rubbish bin, and all you learned from your Econ 101 class about capitalism is pretty much obsolete now. The new rules are a work in progress and the global system is still trying to work those out.

What about the “Great Airline Transformation”, you ask? Well, Saudi capital markets will soon act like those Shariah compliant burqa-clad ghost-people who solemnly enter an airplane in Jeddah and in a few hours exit Heathrow as fabulously awesome women, smooth and dusky and turning heads and ready for fun. The transformation is well, wow. You just can’t stop change. And you shouldn’t want to. Far be it from a mere mortal to object to a pretty girl God made (or capital markets his many children make). You just gotta roll with the good stuff that comes out of it.


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