The upcoming danger in the stock market
Wednesday, 27 April 2011
A F M Mainul Ahsan from Texas
The bubble in the stock market has already busted. With help from market regulators and policy makers, millions of investors were "looted" in broad daylight. And it is the right time to raise some questions. Why such a bubble in the stock market was formed in the first hand? What actions were taken by the Securities and Exchange Commission (SEC) to defuse the bubble or to inform investors about it? What does the Bangladesh Bank did to disable the bubble? What role has the Finance Ministry played in this regard? Why is the SEC or the government still trying to save those culprits? After the 1996 crash, other then dematerialization, did the authority take any measures at all to lift the market efficiency? What happened with those cases that were filed against the manipulators in 1996? Is it just a coincidence that both stock market crashes happened when Awami League is in power? Do you have to be stock market illiterate to be a policy maker in the stock market in Bangladesh? While our readers try to find answers to these questions, let's focus on the upcoming danger for which we need to know some basics about the market crash cycle. A stock market crash refers to significant and sudden decline in share prices. Crashes are generally associated with a bubble which could take years to form. However, crashes are sudden and generally last less than a week. The financial aftermath of a crash in the stock market can last for years. The story of financial bubbles and crashes has repeated itself over the centuries and in many different countries since the famous tulip bubble of 1636 in Amsterdam, almost without any alteration in its main global characteristics: ¢ Stage 1: At this initial stage, market seems to act "normal," and the bubble starts smoothly without any particular sign. It is hard to follow when a particular bubble actually starts in the marketplace. However, some might observe additional momentum in the overall trading volume. Khondokar Ibrahim Khaled's inquiry report says that the momentum of the recent market crash started in 2007, right after the army-led caretaker government came to power. ¢ Stage 2: The attraction to investments with good potential capital gains then leads to increasing investments. This leads to price appreciation too. This stage not only attracts investors but also encourages manipulators. ¢ Stage 3: At this stage, investors build "castle in the air" and thus, the behavior of the market becomes practically decoupled from the intrinsic value of the stocks. Getting leverage from different sources becomes cheap and easily accessible. Most of the stocks in the market become overpriced in terms of the price to earning ratio. For instance, price-earnings multiple on April 13, 2011 is almost half compared to that on December 5, 2010. ¢ Stage 4: At this phase, the market attracts investors with little or no knowledge about the stock market. For example, the total number of BO accounts opened in 2010 was 1,572,700. The total number of BO accounts opened in January was 106,500. In addition, at this phase leveraging is further augmented from novel sources, which leads to the demand for shares rising faster. For example, some of the brokerage houses provided more margin loans than permitted by the SEC. Financial institutions like banks put some of their deposits in the market which provided enormous liquidity in the market. At this stage, manipulators get ready to get out of the market. ¢ Stage 5: As the price skyrockets, manipulators entered the speculative market decreases and the market enters a phase of large nervousness, until a point when the instability is revealed. Market participants tend to imitate the opinions of their peers which deteriorate further the situation and the market collapses. The General index that touched 8918 points on December 5, 2010, in February 14, 2011 the same index declined to around 5579. ¢ Stage 6: At this stage, the "Animal Spirit" evaporates and investors lose confidence. The market goes into hibernation for a notably long period. Leverage becomes expensive to manage. The extent and intensity of the hibernation period varies from market to market. Of course, the policy-makers can influence - both positively and negatively - the length of the hibernation period if they want to. However, not a talkative or stock market illiterate policy-makers but a prudent leadership can reduce the upcoming dormant period. At the end of this phase, the market enters into stage one again and the cycle keeps repeating. A whole cycle could take years or even decades to complete. Though the first five stages take no time, the last stage, i.e., the hibernation period, could be as long as few decades. The 1996 crash took about 14 years to complete the whole cycle: few months to finish the first five stages and stayed in the last phase - dormant- for about 12 years. In the 2011 crash, the market has completed the first 5 stages in about two years, and has now entered into its last phase, i.e., hibernation period, which could take years or even decades. At this point, an investor may ask when the stock markets in Bangladesh can be expected to recover. What world history shows is that the road to recovery from a catastrophic crash and thus the bear market can be distressingly l-o-n-g. For example, the U.S. stock market took 25 years to rise decisively above its 1929 pre-crash high. After the 1987 crash, global investors recouped their losses in two years. During the 1973-74 bear market, when the UK was the worst hit market with a fall of 73 per cent, and, after adjusting for inflation, it took investors over eight years to recoup their losses. Since their 1989 high, Japanese stocks have fallen more than 75 per cent in a seemingly endless bear market, and their recovery time could span several more decades. What about the recent financial crisis in the U.S. that started in 2007? The Dow hit an all-time high of 14,164 on October 9, 2007; how long will it be before the Dow regains its high? Finance professor Elroy Dimson of London Business School estimates that the U.S. has to wait seven more years before the Dow, including dividends, hits its 2007 high again. And history suggests there is no guarantee of quick rebound in the stock markets in Bangladesh either. After the crash in 1996, the market has hibernated for more than a decade. If we consider the DSE general index, the Bangladesh stock market took about 12 years to rise above its 1996 pre-crash high. After adjusting for inflation, dormant period will be even more. Unless any miracle happens, given historical background and policy makers' attitude towards the stock market, it is conservative to conclude that the Bangladesh stock market has to wait about 10 more years or so to rise above its 2010 pre-crash high. However, the good (or bad) news is that policy-makers can influence the span of the dormant period: irresponsible comments or actions will augment the hibernation period while impartial and appropriate moves will shorten it remarkably. And if we do not want to wait one more decade to see the market rise to its 2010 pre-crash high, the policy-makers have to act prudently. Will they? The writer is from the Texas Tech University, Texas, USA and he can be reached at e-mail : mainul.ahsan@ttu.edu
The bubble in the stock market has already busted. With help from market regulators and policy makers, millions of investors were "looted" in broad daylight. And it is the right time to raise some questions. Why such a bubble in the stock market was formed in the first hand? What actions were taken by the Securities and Exchange Commission (SEC) to defuse the bubble or to inform investors about it? What does the Bangladesh Bank did to disable the bubble? What role has the Finance Ministry played in this regard? Why is the SEC or the government still trying to save those culprits? After the 1996 crash, other then dematerialization, did the authority take any measures at all to lift the market efficiency? What happened with those cases that were filed against the manipulators in 1996? Is it just a coincidence that both stock market crashes happened when Awami League is in power? Do you have to be stock market illiterate to be a policy maker in the stock market in Bangladesh? While our readers try to find answers to these questions, let's focus on the upcoming danger for which we need to know some basics about the market crash cycle. A stock market crash refers to significant and sudden decline in share prices. Crashes are generally associated with a bubble which could take years to form. However, crashes are sudden and generally last less than a week. The financial aftermath of a crash in the stock market can last for years. The story of financial bubbles and crashes has repeated itself over the centuries and in many different countries since the famous tulip bubble of 1636 in Amsterdam, almost without any alteration in its main global characteristics: ¢ Stage 1: At this initial stage, market seems to act "normal," and the bubble starts smoothly without any particular sign. It is hard to follow when a particular bubble actually starts in the marketplace. However, some might observe additional momentum in the overall trading volume. Khondokar Ibrahim Khaled's inquiry report says that the momentum of the recent market crash started in 2007, right after the army-led caretaker government came to power. ¢ Stage 2: The attraction to investments with good potential capital gains then leads to increasing investments. This leads to price appreciation too. This stage not only attracts investors but also encourages manipulators. ¢ Stage 3: At this stage, investors build "castle in the air" and thus, the behavior of the market becomes practically decoupled from the intrinsic value of the stocks. Getting leverage from different sources becomes cheap and easily accessible. Most of the stocks in the market become overpriced in terms of the price to earning ratio. For instance, price-earnings multiple on April 13, 2011 is almost half compared to that on December 5, 2010. ¢ Stage 4: At this phase, the market attracts investors with little or no knowledge about the stock market. For example, the total number of BO accounts opened in 2010 was 1,572,700. The total number of BO accounts opened in January was 106,500. In addition, at this phase leveraging is further augmented from novel sources, which leads to the demand for shares rising faster. For example, some of the brokerage houses provided more margin loans than permitted by the SEC. Financial institutions like banks put some of their deposits in the market which provided enormous liquidity in the market. At this stage, manipulators get ready to get out of the market. ¢ Stage 5: As the price skyrockets, manipulators entered the speculative market decreases and the market enters a phase of large nervousness, until a point when the instability is revealed. Market participants tend to imitate the opinions of their peers which deteriorate further the situation and the market collapses. The General index that touched 8918 points on December 5, 2010, in February 14, 2011 the same index declined to around 5579. ¢ Stage 6: At this stage, the "Animal Spirit" evaporates and investors lose confidence. The market goes into hibernation for a notably long period. Leverage becomes expensive to manage. The extent and intensity of the hibernation period varies from market to market. Of course, the policy-makers can influence - both positively and negatively - the length of the hibernation period if they want to. However, not a talkative or stock market illiterate policy-makers but a prudent leadership can reduce the upcoming dormant period. At the end of this phase, the market enters into stage one again and the cycle keeps repeating. A whole cycle could take years or even decades to complete. Though the first five stages take no time, the last stage, i.e., the hibernation period, could be as long as few decades. The 1996 crash took about 14 years to complete the whole cycle: few months to finish the first five stages and stayed in the last phase - dormant- for about 12 years. In the 2011 crash, the market has completed the first 5 stages in about two years, and has now entered into its last phase, i.e., hibernation period, which could take years or even decades. At this point, an investor may ask when the stock markets in Bangladesh can be expected to recover. What world history shows is that the road to recovery from a catastrophic crash and thus the bear market can be distressingly l-o-n-g. For example, the U.S. stock market took 25 years to rise decisively above its 1929 pre-crash high. After the 1987 crash, global investors recouped their losses in two years. During the 1973-74 bear market, when the UK was the worst hit market with a fall of 73 per cent, and, after adjusting for inflation, it took investors over eight years to recoup their losses. Since their 1989 high, Japanese stocks have fallen more than 75 per cent in a seemingly endless bear market, and their recovery time could span several more decades. What about the recent financial crisis in the U.S. that started in 2007? The Dow hit an all-time high of 14,164 on October 9, 2007; how long will it be before the Dow regains its high? Finance professor Elroy Dimson of London Business School estimates that the U.S. has to wait seven more years before the Dow, including dividends, hits its 2007 high again. And history suggests there is no guarantee of quick rebound in the stock markets in Bangladesh either. After the crash in 1996, the market has hibernated for more than a decade. If we consider the DSE general index, the Bangladesh stock market took about 12 years to rise above its 1996 pre-crash high. After adjusting for inflation, dormant period will be even more. Unless any miracle happens, given historical background and policy makers' attitude towards the stock market, it is conservative to conclude that the Bangladesh stock market has to wait about 10 more years or so to rise above its 2010 pre-crash high. However, the good (or bad) news is that policy-makers can influence the span of the dormant period: irresponsible comments or actions will augment the hibernation period while impartial and appropriate moves will shorten it remarkably. And if we do not want to wait one more decade to see the market rise to its 2010 pre-crash high, the policy-makers have to act prudently. Will they? The writer is from the Texas Tech University, Texas, USA and he can be reached at e-mail : mainul.ahsan@ttu.edu