Should equity investors be totally fed up?

Investors set bamboos on fire to protest a fall in stock prices in Dhaka which was a common scene during 2011 when the stockmarket went for a massive price correction. Photo: Star/File

Extreme volatility started in the stockmarket nearly two years ago, but the condition is yet to show any sign of improvement. The benchmark general index, DGEN, has been displaying whimsical movement in both directions without any respite rather roiling the confidence of investors down.
Everyday, we hear of the market having jumped “X” hundred points or plunged by “Y” hundred points. Like many hunker-down investors, Hasan is also digesting phenomenal heart churning upside down in the Dhaka market.
Hasan, not his real name, is a 45-year-old investor trading equities. His equity was almost wiped out for trading on margin loan when the DGEN plunged near the 3,600-mark in February 2012. While Hasan was utterly worried about his exposure in stocks in that time, DGEN again started showing a fat tail behaviour touching above 5,500 levels. Hasan affected by the hot-hand fallacy could not offload his shares in expectation of selling them when DGEN touches the 6,000 level.
At that time, Hasan felt relieved while his portfolio return was going up and he started fixing his fancy plans backed by the rising wealth effect. But like a bolt out of blue, DGEN started diving again and lost 1,500 points in successive sessions and now hovering around 4,300 points, which made Hasan worried about the future of his equity investment.
Like Hasan, many investors were also pondering selling everything to get out of the market. But most of the investors like Hasan could not make the perfect market timing, which is a very difficult task, at 5,500 index levels.
In this situation, Hasan was said to remain invested and to discern the point of inflection in economic activities which would be the discreet steps in 2012 and 2013 to spot the recovery. It is always advised that investors in equities should analyse economic factors at first in the way that they affect company earnings, and secondly, in the way that they affect interest rate and overall stockmarket liquidity.
So Hasan kept close eyes since the beginning of 2012 to see whether the inflation comes closer to the target level, whether there is a sign of melting monetary policy and easing of liquidity crisis resulting from low policy interest rates e.g. cutting repo and reverse repo, higher repo acceptance against demand and slashing CRR.
He also wanted to see whether yield spread steepens, whether the government becomes strict to its targeted bank borrowing to finance budget deficit, whether the European debt crisis and economic unrest and anaemic growth in American and China improve.
After nine months since February 2012, Hasan still remains puzzled despite some unfolding positive signs, like the fall of inflation to the single digit target level, fall of difference between the government's actual and targeted borrowing, strong and stable exchange rate with a foreign exchange reserve of historic $12.3 billion, 24.92 percent growth of remittance in the last four months, a positive export growth when most of the peer countries are in the red zone, and the regulator's utmost commitment to implement the proposed incentives to revitalise the stockmarket.
Hasan perceived that the central bank may go for relaxing the monetary policy tools after achieving single digit inflationary target (point-to-point basis) signalled in the HY2 MPS for FY 2012-13, but he can not understand why the banking regulator may not have the luxury to slash rates at least in the second half of 2012.
Hasan may get the answer from a crucial question: “Are our infrastructures or export sectors ready to absorb the monetary easing or would it lead to another bubble in assets or commodity prices?”
We can explain Hasan's current anxieties about the stockmarket from the spectrums of liquidity, corporate earning and sentiment. Though inflation has come down to the single digit target level and we expect it will hover around at the current level amid the on going monetary tightening, Bangladesh Bank is not expected to reduce policy interest rates to spur the economic activities immediately, as excess money supply can not be absorbed given the weak external demand in the international markets and local infrastructure bottlenecks.
Also rising commodity prices in the international market are big concerns. Therefore, liquidity squeezing is expected to prevail at least in the coming months and the situation is likely to prolong even in the first half of 2013 at bad case scenario.
BB will remain hawkish on monetary policy. Also non food inflation for fuel and energy price hike may dent the sliding trend of inflation for some time, but in the coming years this price adjustment will yield fruitful result and a more balanced fiscal regime.
In the bottom of the business cycle, performance of listed firms is not perceived to be rosy for down economic realities. Export-oriented and local manufacturing firms listed with the DSE have started feeling the stress in the bottom line amid sluggish activities and high interest rates in local economy, recessionary situation in Europe, slow growth in BRIC and other destinations and prolonged economic weakness in the United States.
Apart from declining commission income from trading and sliding return from the capital market activities, some regulatory changes, tight liquidity and rising non-performing loan have severely hammered the profitability of banks and financial institutions. Upswing of local and European economic activities are imperative to see the bottom line growth in those cyclical sectors.
Some of the concerns like uncertainty on mega projects, growing political uncertainty and most importantly unwanted comments from responsible bodies downplaying the importance of the stockmarket highly weighed on the sentiment of investors since the last one and a half year.
Though the negative tail risks, volatility and uncertainty are not likely to go away in the near future, Hasan is still advised to remain invested in the stockmarket.
That is really significant as the time has witnessed political instability -- 1/11 -- cyclones, floods, world financial crisis, and the recent market debacle. But over the same period, has Hasan been able to generate same return? If he bought high and sold low, it would not have been possible.
We can highlight a fact of Estrada (2009), who examines more than 110,000 daily return of 16 emerging equity markets and finds that if an investor missed the 10 best performing days, the terminal value of his portfolio would have been 69 percent lower.
Furthermore, these 10 days constituted only 0.15 percent of the days examined, which means that market timing in emerging markets would be very challenging, if not impossible.
Therefore, we urge Hasan to keep his long-term goals in mind commensurate with his willingness and ability to take the risk and not to try timing the market. This is probably the hardest to do.
But Hasan is still confused why the quality stocks that he has picked at extremely lucrative level of valuation are even declining by the musical pipe of Mr Market. Hasan may feel relieved seeing a Morgan Stanley research completed in early May of 2012 in USA, nearly 70 percent of a typical stock's performance is determined by forces linked to macroeconomic shifts in current economy rather than issues specific to a company, such as earnings or management changes.
So in Bangladesh, market can not be considered outlier if short term mercurial macro and behavioural factors dominate the shift.
Hasan should not destroy his investment discipline relying on weekend worries and anxieties and should not try to make money in the short-term betting.
Peter Lynch, one of the most successful fund managers in the world, said that often there is no correlation between the success of a company's operations and the success of its stock over a few months or even a few years.
In the long-term, there is 100 percent correlation between the success of the company and the success of its stock. This disparity is the key to making money; it pays to be patient, and to own successful companies.

The writer is the head of research at LankaBangla Securities Ltd.