American University of Beirut

Stocks and Shocks from the U.S. to the MENA: Is the U.S. Contagious?

​​​​​​​​​​​​​​​​​​​​​​​​​​​​This article is of particular interest to board members, investors, chief risk officers, and chief financial officers. Executives from both financial and standard lines of business may also benefit from its insights and recommendations. 
Keywords: Equity Market, Financial Contagion, Oil, Gas, MENA, U.S.

“History does not repeat itself, but it often rhymes" – Mark Twain

Take a moment to consider the following historic events: The Great Depression (1929), The Dot-Com Bubble (1995), The Global Financial Crisis (2007), and now COVID-19 (2020). If you are wondering what is common between them, the answer is the stock market crash. The U.S. is the most prominent global equity market, and researchers have been studying the adverse effects of its cyclical changes on the rest of the world. Two particular questions have crossed the minds of some financial economists: Are the effects of market shocks transmitted from US to MENA equity markets?* Are oil and gas markets conduits to the contagion effect? In short, the answer is yes. Interested in the predictability in​ asset markets, AUB OSB Professor Ibrahim Jamali approaches the subject with a multifactor model and examines its relevance to the region.  * Also known as Financial Contagion

US shocks propagate to MENA equity markets through four prominent channels, illustrated in the above graph. The process occurs either directly, or indirectly through: (1) oil markets (2) gas markets (3) the region. The complex relationships of all possible flows, such as more than one indirect route, may also be observed in the animated graph. In essence, though, Dr. Jamali postulates: “COVID-19 may be driving the occurrence of all four paths simultaneously". Similarly, statistical tests conducted on MENA equity markets confirm the notion that economic turmoil aggravates the contagion effects, irrespective of the propagation channel.

Be aware of the buffers and conduits to the contagion effect
In the MENA region, GCC countries are recognized as key oil exporters. This activity is the major source of their national income, which carries substantial risk. It is known, high risk yields high returns, which brings us to the next question: Is oil revenue a catalyst or buffer to the contagion effect? Dr. Jamali cautions: “If you are a Chief Risk Officer in the MENA region, and your economy is oil-driven, you should be keeping a close eye on the US markets". He is quick to point out, however, that this only holds true during periods of turmoil. Likewise, the economies of importing countries contract in parallel to an upsurge in natural resource prices. For example, Lebanon returned significance levels similar to certain neighboring countries in terms of gas, even though its dependence is considered lower. Dr. Jamali notes: “The effect on its equity markets is pretty sizeable for a country that still has unproven gas resources". Initial interpretation is connected to the prospect of discovering gas in Lebanon. Still, the shocks are mainly transmitted to the Lebanese equity market through the region.

Stay focused on your surroundings and plan accordingly
Policymakers, Investors, Chief Risk Officers, and CFOs should take note of the implications and establish strategies to mitigate the contagion effects in times of stress. When the aforementioned foreign or regional stock markets are expected to decline, the consequences and tactics depend on the line of business. In standard, non-financial companies, it is recommended to revise the basics like revenue projections and sales forecasts. In contrast, if listed in the equity market or involved in oil and gas markets, be prepared for declines in the price of your stocks. Whilst the effects cannot be entirely hedged, it provides enough time to alert shareholders that preparations are necessary for an upcoming shock. In some cases, countries may diversify from oil into other sectors to partially lessen the risk, but the results are minimal when the pandemic has caused global calamity. Irrespective of the relative scenario, Dr. Jamali concludes: “Brace for Impact".​

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