Small investors’ anger may turn into big issue!

Published in the Financial Express on 21st December 2010

Recent frustrations and anger on the streets of Motijheel does not come as a surprise to those who take investment decisions by professional analytics of fundamental data, technical indicators and other factual analysis. Probability of a free fall of the stock market and high risk of losing a lot of money, particularly that of the small investors’ and day-traders, was warned in an article in the Editorial Opinion page of the Financial Express of 12th October 2010, titled “Why investors should be careful”.

Weeks ago, while stocks were traded at a very high PE (price to earning) ratio, which is the company’s current share price compared to its earnings per share, investors should have seen clear indications of a possible sharp fall in the market. Generally, a high PE ratio reflects that the investors are expecting higher earnings or that there is a strong chance that they will be able to make a capital gain.

That was weeks ago. But what were the reasons behind the historic fall of the benchmark DSE general index (DGEN) by 551 points or 6.72 per cent on December 19? The reasons are, actually, multi-dimensional, combination of a number of inter-related factors such as the regulator’s uncoordinated, unjustified and too frequent actions, the central bank’s steps on liquidity in the banking system, the International Monetary Fund’s (IMF) warnings on the commercial banks’ over proportional exposure to the stock market, the institutional investors’ year-ending move to present a brilliant success to their shareholders and clients and last but not least the “rumours”. Rumours killed humour of the small investors.

Too frequent, uncoordinated and unjustified measures of the Securities and Exchange Commission (SEC) through controlling the liquidity flow failed to stabilise the market in spite of issuing directive after directive. In fact, too frequent and inconsistent measures by the regulator send signals of uncertainty in the market forcing the investors to a panic reaction.

In August, the SEC instructed the lenders to follow a net asset value (NAV)-based calculation for loan disbursement as well as maintenance. The NAV-based calculation forced a merchant banker or a stockbroker to provide loan on the basis of value of a stock as determined by adding the market value to NAV and dividing the sum by two.

For example, if an investor buys 100 shares at market price of Tk 1,000 each — totalling Tk 1,00,000 — and the company’s NAV per share is Tk 500, the value for a margin-loan buy will be Tk 750 [(Tk 1,000 + Tk 500)/2]. The investor can then buy another 75 shares of the company on margin. The NAV-based calculation was suspended until further notice by the regulator on Sunday last.

On November 21, the SEC reduced the ratio for share credit to 1:0.5 from 1:1, increased it back to 1:1 from 1:0.5 on December 13 and again hiked the ratio to 1:1.5 from 1:1 after the free fall of stock prices on Sunday last.

The SEC on November 25 asked the stockbrokers to double their deposit against any additional trade exposure to the capital market, to tighten the liquidity flow, and directed them to adjust the additional trade exposure by January 2. It was withdrawn Sunday last.

On December 6 last, the commission issued a directive on executing buy orders only after encashment of an investor’s cheque. The next day another directive squeezed “netting facilities” and stopped the investors from buying new shares with funds from another share sale that was ordered but not finalised. The directives of December 6 and 7 were however withdrawn by the regulator on December 8 following a dramatic fall of the general index by 547 points.

Bangladesh Bank Governor Dr. Atiur Rahman promised tough actions if loans are diverted from industrial or other sector to invest in the stock market violating banking rules. The central bank authority has already started surprise visits to suspected financial institutions for investigation on any irregularities in the liquidity management of the banks. In the same week when the central bank authorities had been looking into possible violation of Bangladesh Bank rules a finance ministry official said if the banks go to the share market in this way, the country’s industrialisation will be affected adversely.

The central bank recently increased the Cash Reserve Ratio (CRR) for the banks to 6.0 per cent to contain inflation. CRR is a central bank regulation that sets the minimum reserves each commercial bank must hold to customer deposits and notes. Another previous central bank directive asked the financial institutions to adjust their stock investment exposure by December 2010. Starting from January 2011 no institution will be allowed to invest more than 10 percent of its total liabilities in the stock market. The exposure will be counted based on market price, instead of cost price.

The call money rate, the interest rate at which banks lend money to each other reached as high as 175 per cent on Sunday last. Costlier money also contributed to a squeezed stock market. This volatility in the money market and the central bank’s continued restriction on repo has put pressure on the commercial banks’ lending rates, many of which are capped by the central bank. There is a clear short-term liquidity crisis in the market.

All these send clear messages that liquidity for investing in the stock market will no longer be available as it has been in the past which means less money for more stocks in the market and price is bound to fall.

The International Monetary Fund (IMF) condition to the Bangladesh Bank to seriously address the commercial banks’ overexposure to the stock market also fuelled the unprecedented fall. An IMF mission visited Bangladesh on December 6-15 to discuss the overall macroeconomic situation under Article IV consultation and possible lending arrangements for $1 billion on condition that Bangladesh has to give IMF some formal commitments, such as fiscal reforms, monetary operations and moves to strengthen the financial sector.

The deputy division chief of IMF for Asia-Pacific Mr. David Cowen said that they hoped Bangladesh Bank would work diligently to ensure that banks and their subsidiaries take necessary action to mitigate the risks from stock market volatility. He also said that the IMF team looks concerned with stock market volatility and the banks’ over-involvement in it. Mr. Cowen said the banking sector, as a whole, needs risk-based supervision to ensure new capital adequacy requirements.

Institutional investors, including the financial institutions get more liquidity and trust from their clients and shareholders only if they can present brilliant results at the end of the accounting year showing high return on investments and a solid balance sheet. In order to close their books with high profitability most of the institutional investors and financial institutions started selling off from beginning of December pushing the benchmark DSE general index (DGEN) to all-time high at 8,918 points and breaking all previous records of the DSE turnover of Tk 3,250 crore on the 5th December which was the last glorious day of the year for the investors in the stock market.

After that the stock market took a ride for free fall marking the 19th December as the darkest day for investors at the DSE, so far. In spite of a series of emergency operations or market stabilising measures including very high level meetings between the SEC Chairman and the Governor of Bangladesh, no significant and sustainable improvement of health of the stock market could be recorded. High-power antibiotics or regulatory measures may show some short-term improvements but in fact the stock market of Bangladesh remains in the Intensive Care Unit (ICU), in medical terms, until a painful but natural healing process or corrections begins sometime next year.

This healing process may be very slow and unsustainable due to a number of reasons including tighter but much needed fiscal reforms, monetary operations and moves to strengthen the financial sector as demanded by the IMF, high inflation caused by higher energy, food, housing and transport costs, decreased inward remittance from Bangladeshi workers in the Gulf States and other countries, rise in import payments for petroleum, fertiliser, wheat and rice. Confrontational politics, war crime trial, other political crisis and natural disasters will also put pressure on the stock market. Therefore, further fall of the stock market cannot be ruled out without solving the above mentioned problems.

In Bangladesh, like many other immature markets where small investors and day-traders take investment decisions rather by rumours and gossips instead of analysing fundamental data and technical indicators, investors miss the opportunity of right timing for positioning (buying or selling stocks) themselves in the market, lose most at the end. In addition to that powerful syndicates may be active in the stock market manipulating the market to their advantage. In case anything like this exists in Bangladesh the market regulator and other concerned authorities must take all-out efforts to break such syndicates in their own political interests in first place.

Otherwise, if the small investors and day-traders continue losing money at the stock market their frustration may quickly turn into a big economic, social and political issue, particularly when they get united and join forces to the opposition political party to confront the government. It would be unnecessary burden to the market, government and citizens.

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