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The market returns has been amongst the world's highest over the period. Even in 2010, only Sri
Lanka (+110%) and Mongolia, has probably beaten our market where prices grew roughly by about
90%. Now while this sounds great, people frequently forget the risks of investment in such times of
"irrational exuberance".
Coming back to the point. I have been thinking for quite a while that the market will undergo a
correction. However, for better or for worse the market stuck to its upward trajectory. But I believe
that this has made the situation even riskier. Lets first look at what made the market go up in the first
place.
What caused the market to act this way?
The first half of 2009 was a bad time for the capital market. Firstly, investor confidence in the
economy was low following the 2 year stint of the caretaker government. But most importantly, the
world was experiencing the phenomenon called the "global financial crisis". Even though Bangladesh
is relatively less correlated with the global economy, most economists were projecting a bleak macro
outlook. Consequently, stock prices suffered.
From mid 2009 the situation started improving thanks to heavy investment in the capital market by
state owned banks and financial institutions. This brought back the confidence in the capital market
and since the stocks were at extremely cheap prices (I remember AB Bank trading at a trailing P/E of
around 6) all stocks looked like a bargain. After that we saw positive surprises in our GDP growth
rate (5.7% growth achieved despite global slowdown) and also corporate earnings. But the biggest
factor that led to the current state of the capital market was what we call "excess liquidity". To explain
that let me use bullet points.
1. Because of power and infrastructure shortages most entrepreneurs could not invest in the real
sector (meaning industries).
2. Bangladesh was having current account surpluses (thanks to huge remittance flows). So more
money was coming in than going out.
3. Interest rates went down. So, it was not a good idea to get around 8.5% interest per year (before
tax) when inflation was around 5-7%.
So suddenly, people had a lot of idle money which they were unable to invest anywhere. Anywhere
except the stock market that is. Thus the joyride of equities (stocks) began and that situation is still
continuing. Because of this excess flow of funds by both general investors as well as institutions
(Banks, NBFI's and Insurance companies), multiple attempts by the regulator failed to cool down the
market. I can't blame anyone because no alternative investments were available. Plus, when you can
earn 30% return in 7 days why would someone invest elsewhere?
Bangladesh) a few years ago the stock market had tremendous performance. The whole idea was
economic growth. But the market fell because the prices being paid for growth were not justified by
fundamentals. Please go to the link below and choose the 5Y graph to see the Vietnam market
performance.
http://www.bloomberg.com/apps/quote?ticker=VNINDEX%3AIND
When will the crash occur?
It is virtually impossible to predict a crash. The higher stock prices go up, the more confident
investors become and the more risk they take. Right now we are at the peak of investor confidence
due to which regulators cannot do anything to the market. So, the crash can happen in the next 1-2
month or it might even take 1-1.5 years. But we probably need a catalyst to dampen the investor
confidence. Such possible catalysts could be
1. Big investors and big institutions like banks and NBFI's getting out of the overvalued market.
2. Any natural disaster (Happened in Pakistan recently. The flood there had a major impact on the
share market. Pakistan market P/E is about 7 right now whereas Bangladesh is about 30).
3. Any sort of political unrest
4. Lower than expected earning figures.
Can we expect a slow correction instead of a crash?
While it is possible, I would assign a very low probability to a slow correction. Why? Because, if that
was the case then investors would have started to move out of the market. Everybody understands
that the market is overheated. However, everyone also thinks that they can earn another 15-20% and
have the perfect exit. Unfortunately perfect exits are quite impossible. So, once a big downward
movement starts everyone will just jump on the bandwagon.
Our present situation has surprising similarities to the housing bubble that happened in the west.
When housing prices skyrocketed (beyond logical limits) Wall Street knew very well that houses are
overvalued. However, because everybody assumed that house prices would just continue going up
they should not lose out on the marginal profit. Now here we are doing the same thing. Almost all
investors will tell you that stock prices are too high (compared to earnings off course) but only a
handful are acting on the conclusion that they are making themselves due to "expectations" of
greater returns.
What should my strategy be?
1. Risk averse investors can sell all their shares and wait for the market to come down.
2. Those with more appetite for risk can partially offload their shares and keep the rest of the money
in defensive shares with solid fundamentals. Staying away from any company whose earnings
depend on the capital market would be strongly advisable.