Aminul Haque

Capital market outlook – remainder of 2011

August 10, 2011
Photo: bdnews24.com

Photo: bdnews24.com

If investors and general public are fed up by the vagaries of the capital markets, they may take solace in the fact that this has been the bane of investors for the last five centuries. There is chronicled history about share market excess and subsequent demise, which left large impact on the mainstream economy and state affairs. Here is an excerpt from Daniel Defoe on share market manipulation, written about three hundred years ago –

“Some in clandestine companies combine;
Erect new stocks to trade beyond the line;
With air and empty names beguile the town,
And raise new credits first, then cry ‘em down;
Divide the empty nothing into shares,
And set the crowd together by the ears.”

Sounds familiar in the Bangladesh context? It must have because we saw a similar phenomenon once before in 1996. The cautionary signals were all there, but still people got carried away and chased unrealistic returns. One did not have to go too far to find “air and empty names”; there were plenty in the likes of CMC Kamal, Chittagong Vegetable and Summit Alliance Port. The exact reason is not known why the party came to an end. It could have been tighter control of credit by the central bank, tweaking with the margin lending by the SEC, or talking down of share prices by manipulators who subsequently lost control. Or it could simply be the loss of investors’ nerve en masse, which sooner or later happens in an overheated market.

We all know what followed next. A major correction in January 2011 naturally caused investor anger and street venting of such anger and frustration. A complicit government, which has been repeatedly alerted to such an event, produced further hot air in pronunciations, declarations and accusations. A government probe committee came out with surprisingly candid, honest and informative account of the market manipulation. Of all the recommendations made by the committee, only one has been implemented so far, which is the reconstitution of the SEC. The new SEC is still to prove its effectiveness.

Despite so many unresolved issues, the market is trying to move forward. This has been demonstrated by the higher trade volumes in the last few weeks. The investing public simply cannot give up hope; after all, it was only last year that provided a 100 percent return. It is difficult to let go of the euphoria of a four-year bull market and a 250 percent return.

However, the advances also proved very tentative; a major retracement followed every short rally. The latest rally was driven by a government decision; that of allowing undeclared wealth in the market. The investors seem to be willing for the market to take off, but there are few tricks left. Whether you like it or not, we seem to be in for a bear market. The following factors will put further downward pressure on the market.

Lack of liquidity because of government borrowing
After running an inflationary monetary policy for several years, the central bank has opted for a contractionary one. While credit growth is desired, it will be allowed to happen only in productive sectors. It does not seem that credit expansion in the stock market is a high priority. Consequently, the capital market will be squeezed out of liquidity in a number of ways – through a control of margin lending, a higher capital requirement for margin lending and limit of lending against capital market assets.
Diminishing middle-class savings
Despite a perception that stock market investment is concentrated among a few large investors, small investors provide a major part of the invested capital. As climbing food and essential prices squeeze the savings of small investors, their contribution to the capital inflow has diminished. There is no sign in the economy that middle-class income would improve in the immediate future. Shutting off of the middle-class from the capital market would further reduce demand pressure.

Absence of foreign portfolio investment
Emerging market investors represent smart money; it follows opportunities anywhere in the world. When emerging markets are depressed because of domestic weakness, foreign portfolio investors take advantage of such buying opportunities. This outside investment helps to stabilise the market. Both Pakistan and Sri Lanka benefited from such portfolio investment inflow. This is less likely to happen in Bangladesh.

In the last few months, Bangladesh capital market has drawn attention for the wrong reasons, including an unusual rally followed by a precipitous drop, street demonstrations by irate investors and wrong policy responses. Thus far, the government has not done very much to establish that this is a normally functioning market. Even emerging or frontier market investors have a limit to their risk-taking.

Animal spirit fades away with time
Nothing succeeds like success — a bull market draws more new investors and creates its self-perpetuating momentum. The reverse is also true. A market that does not advance or loses momentum also loses the confidence of its investors. If our market fails to hold a healthy rally in the near future, it will start losing followers. No longer will it dominate the conversation at the tea-stalls or the water-coolers. Casual investors will just liquidate their positions and hang up their hat. One has only to remember the period between 1996-2004.

Political tensions
Better leave it to political commentators to foretell the political landscape in the next two years. Whatever way it turns, it would have a direct effect on the economy and the capital markets.

Where to invest
No doubt, the outlook is not too bright. However, those that do not regard the stock market as a casino and do not expect to double their money overnight can still take advantage of the unfolding scenario. All one has to do is pay heed to Rudyard Kipling, that “IF you can keep your head when all about you are losing theirs … yours is the Earth and everything that’s in it”.

In other words, when everyone panics, sells and leaves the market that is the perfect time for the savvy investor to buy and build his portfolio. Some high-quality stocks are returning to earth from their stratospheric levels, especially the multi-national companies. Most of these companies operate in vital and essential economic sectors and should maintain their revenue and margins despite a slowing economy. They have some semblance of corporate governance, honest accounting and disclosure. Their dividend yield is already respectable (about 5percent) and will improve if prices fall further. The banking sector is also an attractive investment option because of potential growth of banking services in Bangladesh. However, one has to be cautious in selecting banking names.

Preparing for the future
While the market falls, slows down and fades away from public discourse, the regulators should not go on hibernation. Some significant reforms were accomplished during the period 1996-2004 when market activity was limited. Those included activation of a central depository system, introduction of paperless trading and separation of investment banking from brokering.

Latest market crisis proved that while those reforms were useful, those were not sufficient. A long list of changes and reforms needs to be carried out. I hope that once the SEC gets over its fire-fighting mode, it shall focus on the necessary reforms. More on that later.

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Aminul Haque is an investment analyst.

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