Background
Introduction
The performance of the stock market is considered one of the most important indicators of the economic development of any country. Stock markets aid economic development and growth through efficient channeling of savings into investment. Almost every country in the world has its stock market, though there are great differences in their degree of development. Nowadays stock markets are integrated and affected by common factors, which can be local, regional, factors and international factors.
The Statement of the Problem
This research tries to investigate the major factors affecting the performance of Saudi Stock market and US stock market and detect whether the two markets are affected by the same factors and to the same extent.
The Importance of the Problem
The importance of the problem stems from the importance of securities markets to the economy and the role they played in its development and growth.
The Objectives of the Study
The objectives of this study are to:
- Identify the factors that affect the performance of stock markets in Saudi Arabia and US
- Determine whether these factors are controllable or not.
- Investigate the impact of these factors on the two markets
Organization of the Paper
This paper is organized in four chapters. Chapter one is an introductory chapter and includes the statement of the problem, the importance of this problem and the objectives of this study. Chapter two is a theoretical background which includes the importance of the stock market, factors affecting the performance of stock market, and historical background about Saudi stock market and US stock market. Chapter three is the core of the study and it presents the analysis of the factors and how they affect both the Saudi stock market and US stock market. Chapter four is a brief summary of the research with its results and conclusions.
Stock Market History
Historical background about stock market
Historical background about US stock market
The earliest record of organization dealing with security trading was in New York where brokers directly dealt with each other and this trading can be traced back to Buttonwood Agreement. The security exchanges in the earlier times were led by auctioneers acting as intermediates. Auctions of wheat and tobacco were also conducted by these exchanges. In order to set a floor commission rate 24 traders came together for signing the Buttonwood agreement. Amongst the earliest securities that were traded in the market were bonds of the revolutionary war and the stocks of the first bank of the United Sates; bank of New York. It was in 1817 that the stock brokers in the New York who were operating under the Buttonwood agreement called on new reforms and reorganized. These traders adopted restrictions on manipulative trading and forms of governance.
After they had reformed and were named as York Stock and Exchange Board, they started renting the spaces of their buildings for the purpose of security trading. The activity of security trading was previously taking place at Tontine Coffee House. Consolidation of the market was achieved by the invention of electric telegraphs. The exchange then moved to its location at the Wall Street. It was the location of the exchange that eventually led to the dominance of the exchange over others. The exchange was located at the heart of all business and trade activities that were coming to United States and going from United States to other countries. It was also the base for most of the large corporations and banks in the country. The organization set requirements for listing fees for companies listed in the exchange. This led to the fact that the exchange soon became a wealthy institution. Unlike NYSE there is no physical space that is occupied by NASDAQ and trading is executed electronically by the exchange through a network of computers.
Historical background about Saudi stock market
The history of joint stock companies the Saudi Arabia can be traced back to 1930’s. It was during this period that the first joint stock company which was named as the Arab Automobile company was established. Arabian Cement Company went public in the year 1954 and was followed by the three electric companies that went private subsequently. According to the economic needs in that period more joint stock companies were subsequently formed. By the mid of 1970, as the number of joint stock companies increased considerably, the need for stock market in the country began to emerge. Subsequently the electricity companies were merged and foreign banks in the country were nationalized and their shares were offered to the public. All these developments led to an increase in the number of shares available for trading should be regulated. However owing to the lack of regulations in trading at that point of time in the country, trading in stock was highly limited. In the early years of 1980’s there was a considerable increase in oil prices which led to increase in share trading volumes and market capitalization. It was in 1985 that all stock trading activities in the country was placed under the supervision and control of Saudi Arabian Monetary Agency (Gulf base, 2015). It was in this period that broker based stock trading system was discontinued in the country. In order to protect the market against the adverse effects of speculation and help it to develop and mature the banks of the country were entrusted to act as brokers. This is expected to enhance the participation by the private sector in the stock market, and ultimately to the development of the country.
In a database that is supervised by the International Financial Corporation the Saudi Stock market was listed. This listing is an evidence of the development of the Saudi Stock market. Now Saudi Stock market is amongst the leading stock markets in the region in terms of number of indicators.
Importance of stock market
Importance of Saudi stock market
The Saudi stock market is the largest stock market in the Middle East. It is also bigger than the combination of stock markets of all other gulf countries (Hankir and Baltaji, 2015). As a stock market there are great opportunities that are offered by the Saudi Stock market. However, until recently only citizens of Saudi Arabia and other gulf countries are allowed to trade in the stock market of the country. Citizens of GCC countries are allowed to trade in the Saudi stock market subject to the restrictions imposed by the respective GCC country and through the closed investment funds only. Till recently the stock market of Saudi Arabia is one of the world’s most restricted stock market. However, the country is now opening the stock market to foreigners in order to attract foreign investment and reduce over reliance on income from oil. The country is the wealthiest and most powerful amongst Arab nations. The country has oil reserves that are greater than that is present in the United States and Russia. Income from oil currently accounts for 90% of the revenue for the government of the country. However, the government wants to open alternate sources of revenue and that is why the stock market of the country is being opened to attract foreign investments. However, as of now only foreign institutional investors are allowed to participate in the market.
Importance of US stock market
NYSE is considered as the largest and the most powerful stock exchange in the world. The rising power of the stock exchange was in line with the rise of the economic power of the United States. There are two major stock exchanges in the United States; NYSE and NASDAQ. Though NASDAQ is the largest in terms of number of companies listed, by means of market capitalization NYSE is larger than the combination of the NASDAQ, Tokyo and London. The merger of NYSE and Euronext has increased the appeal of the stock exchange on a global scale. The stock market in the United States is the most developed and influenced in the world and has the capability to affect all the stock markets across the world. The dominance of the stock market of the United States is in sync with the dominance of the economic power of America. Although all major stock exchanges around the world have influence on each other it is the stock market of the United States that has the largest influence on all other stock markets. Thus a slum in share prices or trading activity of the US stock market leads to global depression.
Theoretical back ground and Factors affecting the performance of stock markets
In this part of the research we are looking to discuss theoretically the stock market definition, major players, & the effect of the stock market on an economy.
What is a stock?
A stock is a share in the ownership of a company, it represent a claim on the company’s assets & profits by getting dividends. A stock can be called a share or equity too. (investopedia stock basics)
What is a stock market?
A stock market is a market that has the shares of publically traded companies which are issued than traded through exchanges or over the counter. (stock market )
Major players in the stock market
Major players in the stock market are; households, governments, companies, pension funds, insurance companies, mutual funds, index funds, exchange traded funds, investor groups, banks, & other financial institutions.
Why is a stock market important for an economy?
A stock market plays a great role in creating a free market economy. Companies can get access to capital funding in exchange to providing the investors an ownership part in the company. Also small investors tend to grow small amount of money into larger sums by investing in the stock market, & becoming wealthy without taking the time, effort & risk to start a business, or make sacrifices related to having a high paying career. (stock market ). The stock market also provides investors with liquidity, as investors can at any time in a normal market condition to liquidate by selling the stocks in comparison to investments in property. Stock market
Stock market is an important part of the dynamics of the economic activity of a country, as the stock market indicated the social mood of the economy & the consumers’ confidence in the economy. When an economy is performing well & short term expectation is a positive uptrend that reflects also on the stock exchange of the economy as stock prices tend to be increasing. Therefore stock market is considered to be an important sign of a strong well developed economy. The smooth functioning of all activities related to a stock market affects the economic growth of a country by lowering cost & risk companied take in order to produce goods & services in the economy. Furthermore, as a result of this efficient market the increase in production in the economy will improve employment as well.
Stock market also plays a role in moving the funds from units of excess funds as saving accounts to units that are short of funds as stocks. This movement of funds within one economy enhances the use of financial resources in an economy, which will improve the economy’s growth. (wiki stock market)
Stock market as well provides information on major blue chip companies in the country, & the performance related. Which gives an indicator of the development in the different sectors of the country, the size, depth & liquidity in the market indicated the size of investment & liquidity in the market as well the investors’ confidence in the economy.
There is a saying in the market & I quote” stock market has predicted 10 out of the last 3 recessions’ (Pettinger, 2015). So if an investor monitors the stock market of any country that will give him an indication of where the country’s economy is heading. For e.g. China now they are trying so hard to keep up their economy, this hassle in holding up the economy has reflected on the Chinese stock market which was the spot light of interest for investors’ globally. Another example in 1929 the U.S. stock market crashed & was the main factor for the great depression in the 30s.
Stock markets’ fall affects the wealth of investors, which will result in a drop in spending from consumers & sales in the economy affecting as well the performance of companies which lower overall GDP of the economy. (Pettinger, 2015).
Factors affecting the performance of stock markets:
Oil
Is a commodity that is naturally occurring formed in the earth, which is extracted & refined to be used in different products, & as an energy substance. Major oil types traded in the market are Crude oil & Brent oil. The prices of oil are traded in future contracts in the market.
The relation between oil prices & the economy
Oil prices has an effect on inflation in an economy, as when prices of oil drop to very low level it tends to push the economy towards deflation & lowers the CPI of that economy. As we can see in the below picture the lower oil prices lowered the CPI towards deflation.
The oil prices affect consumers spending, as although inflation gets lower but it pushes consumer purchase lower too. As seen below (how does oil impact the economy).
The effect of oil prices on an economy is different between oil producing countries & oil importing countries. For sure oil prices do lower inflation globally & lower global growth. Oil prices if they sustain the lower trend they affect consumer behavior in oil importing countries, more than a mere short term drop. Also the reason for this drop has a great part as a drop because of increased supply has a different affect than a drop because of a drop in demand & slowness in global economy.
Importing countries react to a drop in oil prices positively. As this drop will lower cost of energy on companies & increase production, consumers increase their purchases, which increase profit of these companies, increase recruitment & improve the GDP of that country. In contrast net exporters of oil, gets affected negatively by a drop in oil prices, as their GDP drops, & revenues gets lower especially that usually they are oil depended countries in their production. (2015).
When analyzing the historical effect of oil prices & stock market in importing countries of oil, we note that the correlation is very low, as their economies get affected by more factors than just oil prices as interest rate for e.g.
The only sector in the stock market of oil importing countries that gets affected positively usually is the transportation sector as their cost drops due to lower energy costs. (ross)
Stock market in oil exporting countries has shown that the effect of a drop in oil in the short term has a more significant impact on the stock market than an increase in oil prices. The correlation between oil prices & the stock market gets higher in a drop in oil prices. In both cases the real effect on stock market comes from the government spending & the change in public projects. When the government starts major new projects & increases its spending than the stock market reacts by getting higher when oil prices increase. (Low oil prices affect private sector activity and corporate profitability, 2015) (capital, 2014).
Inflation via deflation definition
Inflation is the purchasing power of a consumer; it is the level of prices of goods & services paid by a consumer at a certain time. When its increasing that means inflation & when dropping that’s deflation. (inflation investopedia)
Inflation /deflation relation to the stock market
Inflation/deflation has a different effect on stock market than unexpected inflation/deflation. The unexpected always seem to have a stronger effect on the stock market. Too high inflation doesn’t mean increase in stock market as that high inflation takes away part of the profits of the companies by the extra cost they are bearing. On the other hand low deflation is a sign of recession & usually the stock market investor behavior will be sellers in the market. (Geetha, 2011) (macmahon, 2012)
Inflation
The stock market of any country of any country is influenced by various factors that determine its economic development. Inflation is a commonly known factor that has such influence on the equity market. Many studies have revealed that the stock market is a key indicator of the economic development of a country. It is defined as a consistent rise in the price rates within a specific industry or in the entire economy of the state (Makiinen 344). The increase in the interest rates is justifiably considered one of the factors that affect the state economy in the most negative manner. As a result, the Federal Reserve, investors, and businesses conduct constant evaluations of the equity market to monitor the inflation patterns.
When it comes to defining the effects of inflation on the Saudi stock market, one must mention that the latter shrinks significantly as the inflation rates increase. In October 2015, the rate of inflation in the Saudi stock market stood at 2.4 percent (see figure 1 below). The graph in figure 1 below also reveals that the inflation rate in Saudi remained at an average value of about 2.8% since 2000. On the other hand, the current inflation rate in the United States stock market is -0.09%. Odekon reveals that the US consumer prices increased by about 0.2% in the month of October. This value was seemingly high (15). The US average inflation rate was 3.3% as compared to Saudi’s 2.8% in the month of October.
Similarly, inflation has a range of negative effects on the U.S. stock market, seeing that it makes the key stakeholders lose an impressive amount of revenues.
The chart in figure 3 above shows a recent drop in the Dow Jones Rates. This trend reveals that the inflation rate in the United States is becoming increasingly positive as reflected in the overall economy. Despite the infamous crisis of 2007–2008 that had radical effects on the US equity market, its performance follows a positive trend at present (Makiinen 119).
According to Makiinen, inflation only poses negative effects on particular stock markets; hence, it can allow the adjustment of relative prices (Makiinen 36). In this manner, it creates room for providing customers with an opportunity to save by developing a more flexible pricing strategy. Nevertheless, when swinging out of control, inflation poses a significant threat to the wellbeing of the stock market. Hence, it is desirable that the inflation rates should be reduced in the US and SAUDI so that the corresponding stock markets could function properly.
Deflation
Likewise, deflation can be viewed as a rather negative factor altering the environment of both the US and Saudi Stock markets. According to the existing definition, deflation is typically identified as a reduction in the price rates in the economy of a specific country or the environment of a certain market: “The standard definition of inflation is a protracted period of generalized price increase, which can occur when too much money causes too few products” (Odekon 202). Therefore, it can be assumed that the specified phenomenon triggers a rapid decline in the profit of the target markets. Indeed, a closer look at the recent changes in the U.S. stock market caused by deflation will reveal that the market has suffered a drastic change.
In comparison, the SAUDI market also experienced a significant drop in its growth rates as the deflation rates peaked in 2010. The specified phenomenon can be attributed to the fact that the organization has been experiencing a significant slowdown in its economic development, in general, and the recuperation of the oil industry, in particular, after the infamous crisis of 2007–2008. As the studies on the subject matter show, the state organizations along with private firms have experienced a significant drop in the stock prices; hence, the necessity to galvanize the state economy by increasing prices for other commodities emerged. Although the SAUDI economy seems to have evaded the trap of deflation, some of its effects can still challenge the further evolution of the state economy. This trend can trigger undesirable results in the development of the economy. For instance, a recent analysis shows that the deflation issue still echoes in some of the areas of the SAUDI economy. “According to HSBC SAUDI Purchasing Managers’ Index, overall input prices continued to increase in the SAUDI non-oil producing private sector during December. The rate of input price inflation eased and was the lowest since September 2010” (John par. 1).
To address the above-mentioned concern regarding the SAUDI inflation rates, which seem to have been unreasonably high since the infamous crisis of 2007–2008, the state government will have to introduce certain changes to the oil industry as one of the most profitable ones in the target market. Indeed, the consistent success, which the target industry has seen, is likely to serve as a major boost to the state economy and, therefore, bring the inflation rates down. In addition, the choice of a supply slide policy should be viewed as an opportunity. There is no need to stress that the specified approach is typically viewed as the most common tool for addressing the inflation issue. However, its consistent use does not make it less efficient. It should be borne in mind, though, that the specified tool can require a significant time to take its effect on the state economy and the wellbeing of the U.S. residents, the outcomes of the policy in question still can be deemed as very strong. Therefore, the specified approach deserves to be taken into consideration as the means of managing the inflation rates in the state.
A closer look at the target economies will reveal that the SAUDI is currently under a threat of facing deflation. Indeed, as a recent analysis of the current economic situation in the state shows, the prices for a range of goods and services have plummeted, thus, leaving a number of organizations suffering from a lack of income and, thus, facing the threat of an untimely demise (Jones par. 8). The rate of deflation in the SAUDI poses a threat to its economy. If the process of deflation gets out of hand, the government is likely to face severe issues regarding the rapid demise of a range of small and even medium organizations, particularly sole proprietorships, which are vulnerable to the changes in the currency rates (Jones par. 8).
When addressing the issue of deflation, one should view the adoption of the above-mentioned approach strategy as an opportunity. Although reducing interest rates seems the first-choice solution, it may lead to no effect in the situations that include the so-called liquidity trap. Defined as “a liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth” (Freenstra and Taylor 87). The latter is likely to impede the promotion of sufficient spending rates among the US population; consequently, the economic conflict in question may spin out of control.
While the effects of the inflation on the US and SAUDI stock market can be viewed as having a partially two-sided effect on the state economy. One still has to admit that, when spinning out of control, they start posing a serious threat to the financial and economic wellbeing of not only the private and state entrepreneurship but also to the citizens. It is recommended, thus, that the governments of both states should consider the introduction of the tools that will help manage the inflation rates in; particularly, the adoption of the contractionary policy as the most popular tool for addressing the inflation-related issues and the tools for increasing the commercial banks revenues should be viewed as the most reasonable options.
Interest rates definition
Is a rate charges or paid for the use of money. Interest rates are often used to control inflation. (interest rate).
Importance of interest rate on economy
It controls inflation by increasing the cost of borrowing on companies & consumers when the interest rate is increased, that will lower customer purchase appetite on credit which lowers the bid in goods & pushes prices lower. The producer gets affected negatively by increase in cost which cut from the profits of the company. Interest rates also affect the strength of the currency of that economy as the higher the interest rate the more foreign inflow will come to this economy. (cheng, 2014)
The relation between interest rates & stock market
The higher the interest rates get the stock market tends to be lower; this drop is the result of the increase of cost cutting from the profit of companies. The increase in coupons paid on bonds which become more attractive to investors, less expanding of projects of companies due to higher funding cost which will lower expectation of performance of companies. All these reasons combined push the stock market lower. (Piana, 2012)
Political stability
A political stability in a country is when the ruling government is favored by the population & doesn’t experience any strong indicators of social unrest. It is a country that doesn’t have wars or any amount of violence. (ask)
The relation between political stability & the stock market
Political stability is one of major reasons to encourage foreign investors to invest in the stock market of an economy & request lower risk premium. When a country faces political instability, that tends to push stock market lower, & investments in the market to fly to safety in another country. (Surkhou, 2011)
Effect on Markets
Analyzing how the markets are affected by the factors
Analysis of Oil effect on both the US and Saudi Stock Market
There is a little correlation between the movement of Oil prices and the stock market prices. Sometimes oil prices follow the stock market and sometimes they head in opposite directions. This movement will definitely have an effect on supply and demand going on, as an increase in oil prices will increase input costs and drive consumers to spend more money, thereby reducing the corporate earnings of other businesses. The opposite is totally true; a drop in oil prices is believed to be good for the market. It lowers production costs and saves consumers’ money.United States and Saudi Arabia are the world’s largest producers of oil. They might be affected by the change in oil prices more than other countries therefore; they are affecting on each other’s stock market. (4)On 19 October 1987, the stock market crashed ranking a big percentage in decline in Dow Jones index to be called “Black Monday”.As per (Thomas Therramus 2009), every stock market crash had occurred shortly after a large and sharp change in the price of oil. (4)The 1987 crash was assumed to be a result of a fluctuation in oil price that led to a conflict within the Organization of the Petroleum Exporting Countries (OPEC).
On September 20, 2008, it was Dow Jones lowest dropping point in stock market known by the “Financial Crisis”. As this crisis hindered the economic growth, so consumer demand declined, and therefore impacted negatively on oil price movements.
Another stock market crash was the “Black Friday” on 28 November 2013 with a decline of 10%. The reason for this decline was that Saudi Arabia refused to reduce the oil production as suggested by the OPEC members. Saudi Arabia wants to express new production in the world as per OPEC. (4)
Oil effect on the US Stock Market
The United States stock market is negatively affected by the high oil prices, as the country is one of the major oil consuming countries. The result is complicated by the firm ability to recover the cost increases to consumers and that leads to inflation (inflation rate was estimated by 3.2 per cent in 2006). (8)The world oil prices has had been stable at around $110 per barrel from 2010 to 2014. But by June 2015 the prices of US crude went down to $48 per barrel.There are reasons for this change in prices: economic growth that led to weak demand in many countries, high US production and OPEC determined not to cut production as a way to sustain prices.However, the chief U.S. economist in Bank of America said: “If you think oil prices are dropping because the global economy is sick, then you are less likely to see lower prices as a windfall.” Harris meant that the low oil prices are because of the increase of supply and not of the global economy. Therefore, these prices will offer a great improvement to the U.S. economy and the stock market. (8) The reason why oil prices are pulling down stock prices may have to do with stocks themselves. Up until last August, with stocks prices hitting new highs, the market seemed to be perfect.
Oil effect on the Saudi Stock Market
As Saudi Arabia is an oil-based economy, major changes in the prices of oil are likely to be followed by changes in the stock market. These changes could be sentimental that affect the stock market immediately or real changes that affect the stock market over longer time.The reduction in oil prices does not have an immediate impact on the growth of the economy or corporations of the Saudi market because 10% of the it is represented by institutional investors. However, when a big decline in the international oil prices takes a place, it will have an immediate impact on the stock market of Saudi Arabia. The longer-term real effect of oil price fluctuations can be divided into two interrelated paths, one is the public and the other is the private sector. (6)
The Public sector
Long period of low oil prices will have an impact of the government expenditure as oil revenues represents more than 80 percent of the government revenues.
Maintained high oil prices for more than one year will result in accumulated financial balances that will increase the growth of GDP rate and the profitability of corporates and ultimately can be converted into a positive effect of the stock market. However, maintained low oil prices with have exactly the opposite effect.
The Saudi market has come through three periods where continued low oil prices have resulted in low government gross capital:
The first was between 1981 and 1986, when oil prices declined an average of $35 per barrel (pb) in 1981 to $14.5 pb in 1986.
The second was between 1992 to 1994. The decline in oil prices was from $19 pb to $15 pb. In 1995 oil prices recovered slightly.
The third was when oil prices dropped in 1997 and 1998, and then was recovered immediately after.
The Private Sector
The impact of the private sector on the stock market will be less immediate as there is more varied adjustment. If oil prices increase or decrease beyond the short term, businesses will start making plans for future investments.
Looking over the same periods in which oil prices fall, there is a more varied adjustment in private sector, unlike the government capital expenditure, which is usually adjusted to lower or higher oil prices within one to two years.
As noted above, movements in the price of oil will influence investment by both the public and private sector, which will in turn affect the stock market. The correlation of the Saudi stock market to oil prices over this period is not very strong although the economy is depending on oil. There has been a clear deviation between the Saudi stock market and oil prices for much of the recent past.
Interest Rate Impacts on the US and Saudi Stocks
Two of the most crucial factors that influence the economic growth of a country are the stock exchange and interest rates. Changes in the interest rates affect the stock prices besides influencing government policies, risk management practices, and the assessment of financial securities. The relationship between interest rates and stock exchange prices determines the level of confidence to policy makers, investors, and other key players in the economy. This part examines the impact of interest rates on the stocks of the United States and Saudi Arabia.
US Stock Market
In the United States, changes in monetary policies such as the Federal Funds Rates (FEDs) greatly affect the stock prices (Jochem and Stefan 268). Research indicates that highly cyclical industries react more sensitively to the changes in the interest rates. These industries fall into technology, communication, and cyclical consumer commodity. They are highly affected by monetary policies relative to others s while the Saudi economy cannot be damages by short-termed alternations in prices.
During the period between 1964 till 2014, the Fed has been tightening pumping money into Wall Street which was to keep interest rates low to encourage hedge funds and other investors to borrow and speculate. This free money and the results of speculation have affected the stocks. Fed tightening has often been followed by a decline in stock prices.
The period between 1964 to 1980,there were three big tightening phases during this period shown on the blue line, and three big stock drops shown in the red line. During the period of 1975 to 1982, the Fed started tightening in 1976 at which point the market declined and then flattened for four years. Steeper tightening cycles in 1979 and 1980 were also followed by price drops.
From 1978 to 1990, there were two drawdowns as well as another tightening cycle followed by flattening stock prices in the late 1980s. This tightening precedes crashes.
Lastly, from the period of 1990-2014, a sharp tightening cycle in the mid-1990s which did not lead to a crash. However, two tightening cycles, one in 1999 to 2000 and another from 2004 to 2007, were followed by major stock market crashes.
Saudi Stock Market
The Saudi Arabia stock market is allegedly opening up for foreign investors. This move has been regarded as a game-changer in the region. While foreign investors look forward to storming the stock market in the KSA, factors affecting the stocks such as interest rates remain critical variables for consideration (Alam, Md Mahmudul, and Md Gazi 43). Increasing the interest rates can derail the prospective foreign investments in the country while lowering them can create a favorable environment for foreign traders. Figure 1.1 shows the KSA stock exchange index that investors need to scrutinize closely before entering the stock market.
Figure 1 and Figure 2 show the changes of Reverse Repo Rate used for Interest rate in Saudi Arabia and TASI (Tadawul All Share Index) over the years. In 2007, the interest rate started to decline by almost 2% with TASI increasing in that period reaching its maximum level by 11,492.1 points in the 4thQ of 2007. In 3rdQ of 2009, the interest rate reached its lowest level since 2007 to become less that 1%. At the same time TASI increased during that period to 6563.5 points after it reached its lowest level in the beginning of 2009 by 4269.9 points due to other factors. Between 2010 and 2013 the interest rate was almost steady for that period whereas TASI was increasing and decreasing between 6141.6 points and 7895.3 points. TASI was fluctuating during that period affected by other factors. These two figures are showing the relationship between interest rate and stock prices. They show negative correlation where it is seen in the Saudi Stock Market. Thus, whenever the interest rate declines, the stock process will increase accordingly and vice versa.
Figure 3 shows SIBOR (Saudi Interbank Offered Rate) and Loan growth rate changes during the years. In 2007, SIBOR started to fall by more than 2% which in return loans growth increased by almost 5%. This has affected TASI during that time in which TASI increased to its maximum level by 11,492.1 points. By 2008, SIBOR increased by 2% which has led loans rate to decrease by more than 5%, which in return led TASI to decline to 7,458.5 points in the 3rdQ of 2008.
Political stability impacts on the Stock Markets
Political instability is a situation in a specific county where the political system experiences tensions. This situation can appear in terms of wars, turmoil, or other events that can cause tension in the political regime. Political instability is characterized by non-convenience situation and it can hurt the economy of a country. In fact, a political instability of a specific country doesn’t only affect its stock market; rather it affects all international stock markets across the globe as some countries depend on others for their financial growth and survival. It has been found that there is a quite strong relationship between the frequency of political events (instability) and the overall variability of stock prices. (1)
The impact of political stability on the US Stock Market
The United States has a strong, democratic political system. However, the United States has been a part of international wars (i.e. in Syria, Iraq, and Libya) that impacted its economy and accordingly the stock market prices.
On 2003 in Iraq, the day after the United States had started the air attack, the prices of stocks had dropped by 11% as S&P. (3) However, after the second war against Iraq (end of 2003), the initial stock market was positive with an increase of 2% along with the related risk that later on had negatively affected the other financial variables as for example the value of the US Dollar. (4) By the end of 2011, the average stock had gained 84.7% since the day the Iraqi war was declared. (2)
In Libyan war, on March 19, 2011, the US stocks fell by 5%. However, they rebounded after the fighting started, rising 1.5% the first day of trading after the military attacks, and up to 4% by the end of the month. (3)
In Syria war on May 2013, the U.S. military action has put pressure on stock prices to fall by 2% and not to go up sooner.
The US stock market is somehow on balance rose during and after each war of the last years in which the U.S. was actively involved. (2)
The impact of political stability on the Saudi Stock Market
The Kingdom of Saudi Arabia is one of the main players in the Arab world. The political system of Saudi Arabia was shaped by King Faisal (1964-1975), and supported by the ulama (leaders of religious orders). Saudi Arabia has formed a strong political and military relationship by being economically independent as an oil-exporting country. However, the Saudi stocks fell when the country opened up its market to qualified foreign investors (QFI) on June 2015, to attract more international investment that will help to reduce its dependence on oil. (6) The benchmark stock index fell 0.9%. (6)
Similarly to the United States, wars have a major effect on the Saudi stock market. On October 2015, Saudi Arabia has begun selling off major portions of its European stocks during the increased cost of its interference in Yemen and the decreased prices of oil. (7) As Reuters reported on May 2015, Saudi Arabia has sold off $1.2 billion of its $9.2 billion holdings in European equities. Reuters also estimated that Saudi Arabia would spend $175 million per month for bombings and $500 million for a ground incursion.
In addition to Yemeni war, ISIS attacks have negatively impacted on the Saudi Stocks. As per Bloomberg’s Richard Breslow, the Tadawul All Share Index (TASI) has dropped by 7% in 2 days after the killing of Shiites on October 2015.
Moreover, the Saudi Stock market is very responsive to external and internal political effects. One good example of the internal political effect can be the issuing of bonds of $1.4 billion to overcome the deficit after the war of Yemen. Which leads the Saudi Stocks to go down as the economy growth is in uncertain situation. On the other hand, an example of the external political effect can be the peg of the value of Saudi Riyal currency to the US Dollar at a rate of $1=3.75 SAR. This means that Saudi Stock market will be negatively affected if the value of the US Dollar goes up any time soon.
Summary and Conclusion
Brief summary of the study
Stock markets comprise a significant part of state’s economy nowadays. The level of development of stock markets is largely predetermined by a variety of local, regional, and international factors. The aim of the current paper is to evaluate factors that influence the development of stock markets in the United States of America and the Kingdom of Saudi Arabia. The connection between factors should be analyzed as well. The importance of the investigation refers to the crucial role of stock markets’ in states’ development and growth.
The history of stock markets in the US commenced in the 19th century. Stockbrokers who initiated this market further moved to Wall Stress. The development increased rapidly during the 20th century. NYSE and NASDAQ are two significant stock exchanges in the modern America. The history of stock markets in Saudi Arabia started in the 1930s with the establishment of the Arab Automobile company. Nowadays, Saudi Arabia’s stock markets are the largest in the Middle East.
The significance of the Saudi Arabian stock market refers to the fact that it is larger than markets of all other countries of the Gulf Cooperation Council. Besides, the state starts to open its markets to foreign investments to increase revenues. NYSE stock market of the Unites States is considered to be the largest in the world. The economic prosperity of the US is directly connected to the superiority of its stock markets.
A variety of factors influences the economy and the development of stock markets in countries. These factors include oil, inflation and deflation, interest rates, and political stability. The world economy depends on oil resources greatly. Prices for oil can influence economy differently. For instance, drop in prices is positive for importing countries while exporting countries suffer from low revenues. High inflation is not always connected with increasing stock markets. Deflation is a sign of recession in most cases. Interest rates predetermine the level of inflation and are often used as a means of coping with deflation. Finally, political stability is the last major factor that affects stock markets. War in the country, for example, lowers the capability of stock markets and decreases foreign investments.
Result and Recommendation
It is necessary to evaluate the connection between the US and Saudi Arabia’s stock markets from the perspective of described factors to define their interconnection. Thus, the US and Saudi Arabia are two largest producers of oil in the world. Consequently, their influence each other. The US’s economy suffers from high prices while the Saudi economy cannot be damaged by short-termed alternations in prices.
Interest rates are of crucial importance for the US stock market. As far as Saudi Arabia only opens new horizons, interest rates cannot affect it in the same way as they influence the US. The effect of political stability is the same in both states. Thus, the US intervention in various wars was always followed by the fall of the stock market. The same is with Saudi Arabia.
Recommendations for further research concern the need to evaluate other factors that can influence the development of stock markets in the country. Saudi Arabian expansion of stock markets and acceptance of foreign investments should be a separate topic for investigation. Finally, more emphasis should be laid to the fact that there is a drastic difference between the US and Saudi Arabia in terms of their oil deposits.