The folly of exaggerated expectation

Rashad Ahmad

Photo: Palash Khan

I would like to start with the positive aspects; I think capital markets growth as a whole has been great for Bangladesh and should be nurtured for continuous sustainable growth. In a country where Banks charge double digit interest rate on any kind of loans and there is no alternative funding source such as private equity or venture capital for enterprises to grow , Capital Markets is the only viable low cost option for them to raise capital to expand their business.

I started investing in Bangladesh stock market in a very small way starting in 2006 at the urging of my father-in-Law (god rest his soul), a sponsor director and a founding member of one of the leading financial institution in the country. Though he was an avid enthusiastic investor, the memory of crash 1996 taught him some painful lessons. The crash had the unfortunate consequence of requiring him to sell his sponsor directorship for another insurance firm he was a founding member of because at that time he was heavily investing through margin. I hope the dear reader would forgive me for bringing him up but I also hope to parley his situation in part 2 of the article. He had taught me a lot about the share market in Bangladesh and its whimsical nature. While away in New York, I kept up with my investments and economic events in Bangladesh through scouring the daily news and following the market.

Having been a passive investor in a small way and watching things closely from a far and I believe the current state of affairs in the Stock Market is due to a combination of factors.

Overenthusiastic investors: Unrealistic expectation of investors who for some reason or another seems to think the market would can only go up (taking a longer term view (in decades) this is probably not completely off the mark when you take into account Bangladesh's growing economy, competitive positioning and progressive integration with the world market economy). Anecdotally, I can tell you share market had replaced politics (a good thing) as the main topic of conversation in Bangladesh. When I was in Bangladesh in August 2010, I had an enlightening chat with a driver of a financial institution from my way from the airport. He was bragging about how much money he had made in 2 weeks. When asked why he invested in the script he did, he said it was because it was going up and he's heard from other people it was a good script. Good portion of the investments are trend driven and unfortunately even rumor driven rather than good fundamental.

SEC: Policy failure from SEC to make any meaningful policy change that could have stopped the bubble when market was moving up 3% + every week for months. It's not sustainable or even natural for markets to rise consistently on a daily basis for as it has for the last 9 months or so. While I agree there were some warning from the policy makers, they failed to take any concerted actions to impact the rise in any sustainable ways. And when the SEC did take action, the regulators was flimsy in adhering to the policies, caving under pressure whenever there was protest as often happened when there was a 2% correction. This whimsical behaviour does not exactly lend to its credibility as a market regulator. I draw your attention to the recent impromptu response to the crash. While they could have easily implemented things such as circuit breaker (where a trading of a specific script stops if there is a movement of the stocks 10% either ways gain or loss), they instead acted as if a deer in the headlight and put the entire market in Jeopardy.

Photo: Peter Bono / getty

Bangladesh Bank: There has been view from the Bangladesh central bank that monetary and other policy should not consider the market during policy implementation. I believe this view is outdated, at one point it might have been fine not to do so. As capital markets become more mature, money supply definitely impacts the market as the money finds itself to a rising market and other assets in search for a higher return. Though, I think the Central Bank's year end policy response was too swift in telling financial institutions to shore up bank capital which added extra pressure on the market correction, it was much needed considering majority of the Bank's exposure to the market. My observation is that the swiftness was due to BB's original policy failure, which was that they failed to ensure Bank's adhere along Bank's directive regarding capital ratio requirements (% of money banks should have for the amount of deposits) and exposure to the capital markets (Maximum amount banks are allowed to be exposed to the Capital Markets). Good number of financial institutions was flouting both of these rules. The capital ratio requirement was one of the reason intra bank money rate shot up to 150% when good number of banks had shortfall when it was raised and had to go to market to cover at the same time making cash very dear. This meant that Banks not only had to raise cash (potentially through selling their holding in stocks) but also had to restrict cash outflow (restrict margin loans) contributing to sizable correction at year end. Albeit the Central Bank's hardball tactics to ensure financial institutions comply with its regulation was too late and swift, I believe it was the right corrective measure to ensure sustainable health of the banking sector. So to retreat on that decision means we've just kicked the can down the road. I hope they will be able do a better job in enforcing it gradually but adherence of these policies. Failure to do so raises the risk of severely impacting the Banking sector and potentially cripples the economy as a whole as a result.

Recommendations: I would hope the Central Bank moves swiftly to create monitoring cell that monitors Financial Institution's adherence to the Central Bank's policies and sectors exposure to the market; potentially a cooperative effort staffed with competent personnel from the Central Bank and the SEC. The primary responsibilities of this group maybe are to:

* Actively monitor Financial Institution's direct exposure to the stock market as a direct investor
* Actively monitor Financial Institution's indirect exposure to the stock market (via margin portfolios)
* Coordination and implementation of policies that impact the markets
* Serve as a communication platform between SEC and the Central Bank
* Share intelligence between the two organization
This should help keep a close eye on and alleviate potential fallout from any major market gyration along the way to ensure impact on the Banking Sector and Economy as whole is minimal.

4. Financial Institutions: Majority of the Financial Institution's have become heavily leveraged and exposed to markets both as direct investors, investing surplus capital and indirect exposure via margin loans to retail investors. If anyone happens to follow Bangladesh Banking environment as I “obsessively” do, you would know that just few years ago Bank's were complaining about unproductive “excess liquidity” in its balance sheet and even lowered the deposits rate. Most of this “liquidity excess” and probably then some has found its way to the stock market. As I laid out some points in #3 about Bank's capital and exposure to the market, there are several banks that are viewed to be misaligned to Bangladesh Bank policy as news report suggest. While the Central Bank has given these institutions more time, they have to come within the policy at one point or another.

What does all these means for us regular investors? Unfortunately I think there will more volatility and major corrections along the way. Market prices always reflect its true value longer term; despite the regulators intervention the price will be where it should be at some point or another. I hope the regulators can take a strategic long term view and implement policies accordingly; otherwise there will come a time when we have to contend with our 1929.

Sustainable outlook - Investing for the Long Term
While in part 1 of this article series I discussed current state of affairs and potential regulatory pitfalls regarding the stock market, I would like to focus more on what regular investor like you and I can do to navigate the market. As I outlined the four factors influencing the market at the moment, it would not be irrational to expect a lot more volatility (up and down swings) in the marketplace so I offer the following simple suggestions to navigate the market by investing for the long term.

* Avoid trading with margin: Because if there are big down swing and your account value drops under a certain %, the broker will require additional capital to bring your account in line with the money you borrowed, something called a margin call. If you fail to meet this extra fund requirement, the broker can start selling you shares to bring your account in line with margin %. This is absolutely the worse time to sell because you have incurred so much loss. As I pointed out with my father-in-law who was trading on margin, a margin can make you lose your priced possessions when you have to scramble for cash.

* Invest money you can do without: Invest some of your extra capital that you can do without long term (say for 5 years or more) and not your life savings or money that you would need in the next few months or in case of emergency.

* Invest in good companies: Invest in stocks with Low PE Ratio (you can find this by dividing the price of current share by current earning). Be careful not to just look at the most recent earning, look at the earnings and PE ratio of the company over 3 5 years. One does not have to research all the companies listed in Dhaka Stock Exchange to find good companies. Start researching companies you know and buy things from regularly (Example: Food, Water, Electricity, Household Goods, Shoes and Clothes, Electronics, Gas etc)

* Invest for the long term and sleep easy: Invest for the longer term (Minimum 5 years or more) in companies that pays good dividend. If you invest in good dividend paying companies, chances are that you will accumulate more shares because the company pays good bonus share or you will make small extra income through cash dividend. While you want to track the performances of your investment from time to time, remember you are invested for the long term so don't obsessively check how the share price is increasing 10 Taka here and losing 5 Taka there. I understand being a Bengali, we are always at the extreme of the emotional spectrums (i.e. when angry, angry enough to beat someone to death or when generous, generous enough to give the house away ? etc) so it might not be a bad idea to limit yourself to checking the stock price every few weeks or something like that.

* Do not trade on romours: While it's fine to take suggestion from people you know and doing your own research before investing, do not just buy a script based on what others tell you. Unfortunately a lot of new small investors are sucked into this by friends, family members, associates or colleagues. There are a certain section of investors that spreads unfounded rumours after taking large positions on certain stocks. When the rumours spread and a buying frenzy they slowly exit their position in profit. As with any developing market, I think this will continue for some time until SEC becomes sophisticated and competent enough to monitor this. I would hope staff at SEC gets training from regulators from developed international markets such as UK, US or even from savvy regulators in countries such as Singapore to improve their competency.

To leave off in another positive note, long term (I think in decades), I believe the future of the stock markets and Bangladesh as whole is positive one if a conducive, accountable and sustainable environment is created for enterprises to grow. Along the way, I hope there will be much needed changes for the better in infrastructure development, electricity generation, government accountability and lessening corruptions.

The writer is and has been a direct investor in Dhaka Stock Exchange since 2006. He works as a management consultant serving the financial services industry in New York.
The opinions in this article are that of the writer and in way reflect the opinion of the publication. For full disclosure.