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OP-ED: Dhaka stock exchange: Two decades of misery

  • Published at 12:00 am June 9th, 2020
graph stock market down red chart info

What purpose does it really serve?

I have heard stories of people going bankrupt, crying on the streets after realizing the share certificates acquired from the open kerb market were only worthless pieces of paper. Having witnessed people lose faith in the markets as the DGEN tumbled more than 500 points within a single trading session in 2010, I cannot help but wonder, “what purpose does our stock market really serve?”

The stock markets are intended to build wealth in the long run. Companies float their shares and raise equity to finance long-term operations. In exchange, shareholders gain when listed companies continue to expand, and their prospects are reflected via an increase in their stock price.

Unfortunately, the stock market in Bangladesh is still in its nascent stages. The fundamentals are usually overpowered by the exuberance of whimsical investors.

Markets all over the world are driven by fear and greed. When stock prices drop, many investors sell their positions fearing further price drops. Similarly, many investors hold on to their stocks longer than required when prices go up, with the hopes of further magnifying their fortunes.

A fall in stock prices is nothing unusual in an overheated bull market. But for the last two decades, the DSEX index (previously DGEN) has only continued to slide down despite various regulatory measures. This has further demotivated new investors from exploiting the opportunities available.

After a brief pullback in 2016-2017, an imposition of applying mark-to-market in valuing securities caused most financial institutions to sell off their holdings to adjust their positions. This sudden increase in supply caused prices to go down steadily over the last two years.

A similar stance by Bangladesh Bank in 2010 caused a massive sell-off when banks were told to increase their CRR and SLR requirements, leaving margin loan holders in disarray. While it is known now that banks and financial institutions were the ones who pumped excess liquidity into the market, an abrupt selloff triggered the biggest crash in Bangladesh’s capital market history.

But then again, if 2010 was a crash, this constant demise in the DSEX index can be deemed as a “crisis.” An existential crisis if one wills, questioning the reasons for the existence of the capital market.

The market is increasingly coming under scrutiny for deviating from its core purpose ie raising equity for industrial activities. The hype about real economic growth continues to bamboozle small investors as dealers within the primary market continue to reap the rewards.

Poor governance, omnibus BO accounts, unfavourable private placements, and a book building method filled with loopholes were problems back in 2010, and are still problems now.

Lack of investment opportunities in productive and transparent companies have failed to lure foreign investors. Excluding a handful of multinational corporations (MNCs) or domestic market leaders, no one seems to have faith in the audited accounts of most companies.

With untrustworthy accounts and a failure to reflect fundamentals in pricing, many investors were enticed to invest in highly speculative stocks, mostly within the “ Z  ” category. Speculation is primarily done by traders, who rely on technical analysis to predict the future.

Inputs such as volume and price action are incorporated to predict the probability of future price movements displayed via different charts. Although these are terms only professionals should be dealing with, the expectation of supernatural returns entices the “average Joe” into pouring most of their life savings on those particular stocks.

Changing ticker prices are what makes stock markets unique. But experts state that the changes should have a viable explanation. A positive earnings report, a higher dividend payout, a growth of 20% quarter-on-quarter all imply positive changes in fundamentals which should draw in funds from optimistic investors taking up the bidding price. But if the company reports a decline in profits on a regular basis, investors look to abandon the stock, and prices continue to plummet.

However, the market swings are momentous, and their random walk fascinates academics and practitioners alike. Many believe in the efficient market hypothesis, yet when a revelation of a crash seems probable, they tend to blame it on the last minute, melodramatic info released prior to the crash.

Our capital market has undergone many regulatory reforms, but the impacts are yet to be seen. If the speculators were to become investors, they would need reassurance. Reassurance in the form of “diversified” financial instruments available at their disposal.

Investors don’t have the luxury of a fully functioning bond-market to hedge their positions when equities decline in value. For passive investors, mutual funds provide little diversification benefit since even big asset managers don’t have sufficient choices to hedge their positions.

They too invest in just equities, the only financial instrument available in our market excluding long-dated illiquid government bonds. The absence of ETFs or index funds doesn’t help either. The lack of derivatives, such as call and put options, make matters even worse.

When markets continue to go lower, many investors make money through put options. The value of a put goes up as the price of the underlying goes down. The availability of these instruments would have definitely prevented the crisis we are in today.

If traders could hedge their positions and make money by short-selling or through put options, the fall in prices could have been less severe since investors would have the option to obtain returns from either side of the table, not just by going long. To prevent further price declines, BSEC introduced a floor price mechanism on March 19.

However, its effectiveness is yet to be seen. A similar initiative was taken by the Karachi Stock Exchange (KSE) during the global financial crisis to reduce a sharp fall in its market index. There was an adverse impact on trading volume due to the price freeze, similar to what some investors also witnessed at DSE.

After the floor price system was removed (resumption of active trading), the price of the securities declined significantly. Market liquidity also deteriorated, and price volatility increased following the relaxation in floor prices. The decision made by the KSE’s board to implement a lower cap on prices for an extended period was deemed ineffective.

It seems that policy-makers don't learn from the past. Dividends being tax-exempt up to Tk 50,000 would have little impact if investors didn’t observe transparency in the market. The added pressure of having to keep the markets closed for more than eight consecutive weeks has led foreign accessors to kick the DSE bourse out of the global MSCI index.  

There is no doubt that the stock market is being side-lined due to the money market crisis. When a group of investors had finally started to show their trust in the market after two decades, the heydays of 2010 seemed to be on repeat. Many banks that had formed their subsidiaries for securities trading in 2010 are now suffering from a lack of capital adequacy and non-performing loans.

In 2010, they could pass the losses involving security trading on to their “losing omnibus accounts” and keep the bank’s personal accounts relatively clean. But during the last couple of years, those “negative equity” accounts, combined with the failure to recover a majority of the loans, have dried out the market from a surplus of liquidity.

Banks are not particularly interested in stock trading, and investors with colossal margin loans are not capable of injecting additional capital into the markets, which is why the market has been experiencing a serious dearth of funds.

Sayeed Ibrahim Ahmed is an experienced investment analyst, currently working as a Senior Lecturer in Finance at American International University Bangladesh (AIUB) pursuing research along the lines of capital markets and economic policy.

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