Small investors beware
Thursday, 25 October 2007
WHILE the world's major stock markets are having a roller-coaster ride in the recent past, the Bangladesh stock market seems to be on a roll. Stock markets in the USA, the UK, France, Germany, Japan, and Hong Kong have been rattled by the sub-prime mortgage crises emanating from the US economy and spreading to other markets through inter-linkages between financial institutions across the developed world. Fortunately, Bangladesh stock market is immune to these capital market developments due to the lack of foreign portfolio investment together with the non-convertibility of the capital account in our balance of payments.
As of October 21, the Dhaka Stock Exchange(DSE) general index has risen 70% for the year and is not showing any signs of relenting, save for occasional corrective movements. It is a relief to observe that the DSE index has not been impacted by capital market developments in the major global markets. Lest we get lulled into complacency, some cautious reflection is warranted by all stakeholders in this area, especially the small investors who are likely to suffer the most in case of a sharp market correction -- an inevitability in all stock markets. The timing and depth of such correction is unpredictable, to say the least. Continuously rising stock prices in a bull market could be heady for those counting paper profits. For some, it could take the form a of an addiction. It is in these times that a tactless investor might throw caution to the winds. It is in these times, therefore, that words of caution from such agencies as the equity market watchdog -- Securities and Exchange Commission(SEC) -- make good sense.
The critical point to reflect is whether the appreciation of the share price index -- or any particular share price -- reflects current or projected profitability of listed firms. In its true sense, a stock price appreciation reflects the future flow of dividend income. In a high-performing economy, profitability of private firms generally rise, dividend payments are up, and shareholders are enriched. In these circumstances, a bull market would not be a surprise. If, on the other hand, there are no robust signs of improvement in economic fundamentals, but the stock market is getting ahead all the same, it would be a good time to pause. It is in such circumstances that a rise in stock prices could be triggered by speculative behaviour called "herd mentality" in stock market jargon. Alan Greenspan, the former Chairman of the US Federal Reserve Bank, coined a now famous expression -- "irrational exuberance"-- to describe what he thought to be inordinate rise in the US equity prices in the late 1990s.
In the context of our equities market, the point to reflect is whether the balance sheets of listed firms tell as good a story as their share price movements. Confidence in published balance sheets is important. It is pertinent to ask whether publicly traded firms are compliant with International Auditing Standards. Fortunately, financial institutions, whose stocks have been the best performing, are under strong scrutiny of the Bangladesh Bank and have to comply with high reporting standards. One would like to ask whether similar confidence can be reposed on balance sheets of other companies whose stocks are performing rather well.
How much of the appreciation in stock prices is backed by strong economic fundamentals, one may ask? How much of this is driven by speculative maneuvers? It is the speculative price bubble which small investors must beware of in order not to lose hard-earned savings. Let us not see a repeat of 1996 when the stock bubble blew up on many faces!
As of October 21, the Dhaka Stock Exchange(DSE) general index has risen 70% for the year and is not showing any signs of relenting, save for occasional corrective movements. It is a relief to observe that the DSE index has not been impacted by capital market developments in the major global markets. Lest we get lulled into complacency, some cautious reflection is warranted by all stakeholders in this area, especially the small investors who are likely to suffer the most in case of a sharp market correction -- an inevitability in all stock markets. The timing and depth of such correction is unpredictable, to say the least. Continuously rising stock prices in a bull market could be heady for those counting paper profits. For some, it could take the form a of an addiction. It is in these times that a tactless investor might throw caution to the winds. It is in these times, therefore, that words of caution from such agencies as the equity market watchdog -- Securities and Exchange Commission(SEC) -- make good sense.
The critical point to reflect is whether the appreciation of the share price index -- or any particular share price -- reflects current or projected profitability of listed firms. In its true sense, a stock price appreciation reflects the future flow of dividend income. In a high-performing economy, profitability of private firms generally rise, dividend payments are up, and shareholders are enriched. In these circumstances, a bull market would not be a surprise. If, on the other hand, there are no robust signs of improvement in economic fundamentals, but the stock market is getting ahead all the same, it would be a good time to pause. It is in such circumstances that a rise in stock prices could be triggered by speculative behaviour called "herd mentality" in stock market jargon. Alan Greenspan, the former Chairman of the US Federal Reserve Bank, coined a now famous expression -- "irrational exuberance"-- to describe what he thought to be inordinate rise in the US equity prices in the late 1990s.
In the context of our equities market, the point to reflect is whether the balance sheets of listed firms tell as good a story as their share price movements. Confidence in published balance sheets is important. It is pertinent to ask whether publicly traded firms are compliant with International Auditing Standards. Fortunately, financial institutions, whose stocks have been the best performing, are under strong scrutiny of the Bangladesh Bank and have to comply with high reporting standards. One would like to ask whether similar confidence can be reposed on balance sheets of other companies whose stocks are performing rather well.
How much of the appreciation in stock prices is backed by strong economic fundamentals, one may ask? How much of this is driven by speculative maneuvers? It is the speculative price bubble which small investors must beware of in order not to lose hard-earned savings. Let us not see a repeat of 1996 when the stock bubble blew up on many faces!