A make-believe crisis in the stock market
A number of newspapers recently reported that in the past few days, nationalised commercial banks and financial institutions have been actively buying in the stock market in order to â€śbring normalcyâ€ť to the market. I guess the definition of normalcy is price appreciation every week in the magnitude of 2-3 percent, for an annual return of over 100 percent. Otherwise, in a market that has a price to earning (PE) ratio of over 30, how does the fall of stock prices by a mere 15 percent in total can be construed anything but normal?
Even after recent corrections, the PE ratio is over 25. Putting in perspective, if investors depend only on earnings of the invested companies for return OF their capital (let alone any return ON capital), they would have to wait a long 25 years. No other comparable stock markets have a PE ratio over 20. In the past 10 years, even Bangladesh stock market traded at a long-term average PE of 20. If such is the case, why a market that is overvalued by at least 25 percent needs state support? When correction in the market is overdue and is actually a healthy development, why the state is pouring good money into a flawed system, and to whose benefit?
What bothers me most is the mode of the intervention. The news reports state that the Investment Corporation of Bangladesh (ICB) received Tk 2.0 billion (200 crore) â€śfinancial assistanceâ€ť from the central bank to intervene in the market. ICB used this money, along with its own funds as well as funds from its mutual fund portfolios to purchase stocks whose prices were falling. I guess the same is true for other state-owned banks and financial institutions, as well as some private financial institutions.
The whole process is wrong, offensive, foul and reckless in a number of ways. First, this is a clear transfer of state funds to speculators without any accountability. Bangladesh capital market is nowhere near to being an important contributor to national growth that it would have to be propped up by transferring public wealth to rowdy speculators.
Second, there seems to be no accountability or policy direction by the government for ICB or others as to what securities should be purchased with this â€śfinancial assistanceâ€ť. It means these parastatals can use this fund to purchase any stocks they wish to please any group of investors they want.
Third, ICB is reported to have used cash from their mutual fund portfolios to purchase stocks whose prices were falling. The assets and the cash in the mutual fund portfolios do not belong to the ICB, to the ministry of finance or to the government. They belong to the mutual fund investors. What right does the ICB have to use their money and hurt their interests while implementing governmentâ€™s policy decisions? This is a gross violation of investorsâ€™ constitutional right to own assets without government meddling.
Finally, what is a normal state of the market where such intervention stops, at a PE ratio of 100? By a process called â€śreversion to meanâ€ť, the market shall and must come down to a realistic level, no matter what the size of the intervention. In this case, normalcy may mean a historical PE ratio of 20 or lower. By postponing the day of reckoning, what does the government achieve?
It is understandable that a political government would not want another stock market crash on its watch, and it would do everything to avoid such embarrassment. However, such embarrassment could be nipped in the bud many months ago. The whole affair started with banksâ€™ excessive venture in the stock market. As soon as the market PE surpassed the historical average, the central bank should have slowly limited banksâ€™ exposure. Instead, platitude substituted for sound policies. When the horse left the burn, the central bank has been forced to take (or withdraw) measures, which are ignominious to the prestige of the institution.
Instead of banks having to adjust by January 15 their loans diverted from industrial accounts to stock market, they now have unlimited time. A time-tested safeguard such as single borrower exposure limit has been relaxed. Finally, it is reported that the central bank has been asking banks not to sell their shares in a depressed market. Since when is it the job of the central bank to maintain the level of stock prices? Sooner or later the market would adjust downward and the banks would be left with losses from these investments. Is a weaker banking system more desirable than a weaker stock market? It appears that the discipline achieved through the Banking System Reform of the last decade could be lost while trying to defend a weak capital market.
The knee-jerk, reactive policymaking that is the hallmark of the Securities and Exchange Commission (SEC) seems to have spread upwind. I would also put the blame squarely on the media that unnecessarily magnified the stock market and its subsequent fall. Robert Shiller in his book â€śIrrational Exuberanceâ€ť attributes excessive media coverage of the stock market as one of the causes for speculative bubbles. That surely was the case in our market. The recent market correction should have been ignored and viewed as what it was â€” a necessary lesson for foolhardy speculators. Instead, we are wasting valuable time, resources and political capital to remedy a make-believe crisis.