Despite a rosy regional economic outlook, the credit crunch has compelled international investors to liquidate positions in Gulf stocks. Speculative bets on currency revaluations have also been reversed because of a stronger dollar.

However, while all the region's bourses are now firmly in the red, the causes are far from homogenous. International investors may have fled Dubai, yet they had little exposure to Kuwait or Saudi Arabia, the biggest Gulf stock markets.

Furthermore Saudi Arabia has been the Gulf's worst performer for much of this year, after a tremendous rise at the tail end of last year when valuations became "a little bit stretched", according to Fadi Al Said, Middle East head of equities for ING. Retail investors have also preferred the seemingly safer returns of real estate and initial public offerings.

Dubai has been the premier victim of the international capital exodus, but is also suffering because of jitters over a possible real estate market correction and the extent of a corruption crackdown.

Some Gulf-wide factors have exacerbated the recent decline. Dubai has had a contagion effect on the rest of the region because it serves as a bellwether to many regional investors, according to Osama Shaker, head of investments at HSBC Saudi Arabia.

Lower trading volumes over the summer and during Ramadan have magnified the downward trend.

In more mature markets, large insurers and pension funds can usually be depended upon for long-term capital, but they are largely non-existent in the Gulf, except some large state-owned vehicles.

Local banks may not face the systemic risk that is spurring their international peers to hoard cash, but central banks have tightened reserve requirements, limiting leverage that could be used to buy shares.

Shorting may also be exacerbating the negative sentiment. As a result of the informal nature of the market in the Gulf, such activity is difficult to measure, but "hedge funds have targeted key companies with massive short-selling", says Mr Al Said. "The markets are very shallow so this created downside momentum."

The region is not alone in its predicament. Emerging markets are now historically "oversold and undervalued", and currently trade at 10.8 times trailing price to earnings, as low as in the trough after the 9/11 terrorist attack, according to Jonathan Garner, global head of emerging markets strategy at Morgan Stanley.

All the Gulf stock exchanges except Saudi Arabia now trade at single-digit ratios of price to estimated 2009 earnings, according to ING.

There are signs, though, that cheap valuations are attracting investors. All Gulf markets rallied on Wednesday.

"Years from now, people will ask themselves, 'how did we miss such an opportunity?'?" says Mr Shaker.

By Robin Wigglesworth

© Financial Times 2008

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