Mercurial fate in chaotic stocks

by Maswood Alam Khan
December 24, 2010

http://www.weeklyblitz.net/1185/mercurial-fate-in-chaotic-stocks

In 1996, one of my acquaintances, an unemployed and unmarried 23-year old man, could convince his retired father that it was the time for the family to make money in stocks and change their fate. The retired father was made to cash all his retirement benefits and hand the whole amount to his son. The unemployed son invested all the funds in a number of prospective shares in the secondary market and in a matter of weeks found 85 percent of all the money so invested evaporated into smoke. The retired father was so broken financially and so shattered emotionally that he officially abandoned his only son.

During the last few days shareholders in the capital markets in Bangladesh have lost between 20 and 30 percent of their portfolios in a landslide crash, with the Dhaka Stock Exchange losing around TK 22,000 crore in market capitalization. Small and new investors have reportedly been the most affected ones by the plunge while most of the big players, who could somehow smell the imminent fall, had withdrawn their major shares after making some profit or before incurring any significant loss. According to investment analysts, a majority of the investors incurred loss in the neighborhood of 20 percent of their portfolios.

The latest bubbling and bursting behavior in the Dhaka Stock Market has evoked horrible memories of the crash in 1996 when many families found themselves completely bereft of their assets and many retirees found themselves robbed blind with their nest eggs drained in the volatile stock market. In 1996, the benchmark index of the DSE had soared from 1,000 to 3,627 in a matter of six months before the market crashed in November and December, marking the tragedy as the biggest share scam in the country's history, when Awami League-led alliance was in power.

Panic played a big role this time for small investors for bulk selling with banks selling off their shares for fulfilling Bangladesh Bank's directive to increase their Statutory Liquid Ratio (SLR), a mechanism to contain inflation and fuel growth, and Cash Reserve Ratio (CRR), the minimum cash reserves each commercial bank must keep with the central bank in proportion to their customers' deposits.

While demand of the banks for money would be strong with the increase in mandatory reserves with the central bank, those reserves should provide the necessary liquidity cushion. Banks' sudden demand for money to realize their SLR and CRR needs evidently prodded the inter-bank call money rate to hit recently a record high of 180 percent.

Small investors in the capital market could have saved the erosion of their investment if they could hold back for a while their panicky urge to offload their shares. They had to understand that the latest fall in the share market is temporary primarily due to the banks' sudden demand for money and once the SLR and CRR requirements were fulfilled the market could have been stabilized.

The regulatory bodies including the central bank should now take immediate measures that may restore the investors' confidence both in the banks and in the stock market. The Securities and Exchange Commission (SEC) on Sunday rightly increased the margin loan ratio and changed some of their decisions in a bid to stop further fall of the capital market. The SEC raised the margin loan ratio to 1:1.50 from 1:1 and suspended the net asset value-based margin loan calculation system. The decision to shift trading of the shares of GrameenPhone and Marico Bangladesh from the spot market to the general market is also a timely step to restore investors' confidence.

Abnormal rise in price during the last few years of some insignificant shares in the market allured the naïve investors to invest their hard earnings exclusively in stocks resulting in liquidity constraints in the banks. As a consequence, deposit growth in the market has for a long time been lagging the advance growth by a large margin. If this trend continues the market may face further liquidity crises in the next few years with more disinvestments in government bonds and more withdrawal of deposits from the banks. Such transfers of money from banks and bonds to capital market may jeopardize the banks' ability to nurture further growth of advance and the imbalance may shoot the rate of call money permanently to 3-digit figures.

Now that the stock market in Bangladesh is showing a sign of tanking, common prudence dictates one to sell his investments and get out before things get any worse. But a reverse action in such a scenario may also be rewarding. When the stock market goes down, one may keep his money in the market. This way, one can ride out the dip and eventually sell at a profit. In fact, stock market lows are a great time to invest even more. Many seasoned investors consider a decline in the market to be a "sale" like the "sell" we find in the malls during and after a festival. In this time of "sell" one may take advantage of the opportunity to pick up some valuable investments that are only experiencing a temporary dip. Though it may sound unbelievable the fact is investors who continued putting money into the stock market during the Great Depression actually fared quite well in the long run.

Unfortunately, one of the factors that prevents many people from becoming financially successful is their false beliefs about money. In fact, some financial myths negatively impact both their short- and long-term net worth. In Bangladesh, rumors and hearsays have been influencing the small investors to plunk down their money in stock market. And those who are educated and know the art of reading a company's balance sheet are also misled by the nice prints on glossy papers of the balance sheets. Directors of most of the companies in Bangladesh know very well only one art which is how to cheat the banks that financed their companies and how to siphon off funds from companies to build their personal fortunes. Small investors who don't know how to analyze the background of a company and its directors and evaluate their worth by investigative researches as to how the company behaved with their banks, how was the company's corporate culture, how honest are the statements of accounts in their balance sheets usually depend on their gurus for their decision making on buying and selling shares. Sadly, some big sharks in the capital market feed those so-called gurus with misleading information with a motive to beguiling the mass investors into plunging into the valleys of financial traps.

The most important issue for Bangladesh government, as the regulator of the capital market, is to safeguard the interest of the small investors like those young people who are unemployed and those vulnerable people who are retired and who think they could earn money for their living by playing in the stock market alone. They all know that it is unsafe to keep all eggs in one basket; but they forget this golden rule of diversifying investment portfolios when they follow the crowd in quest for easy and quick money. The government may find out a mechanism by which very young and very old investors are restrained by a set of strict laws from investing all their savings or retirement benefits all in the stock market alone.

One such rule could be a mandatory provision of investing in government bonds and savings schemes like Sanchay Patra (which must not be allowed to be cashed within at least five years) an amount equal to what one can invest in the stock market. A way, in addition, to attract savings in banks and government bonds is to introduce inflationary protection in savings with banks and bonds. There are banks in many developed countries which offer their clients very low interest rates on savings but they offer an insurance against inflation. Once a saver would realize that his or her savings would not be eaten away by inflation, thanks to inflation protection insurance, s/he would be less tempted to invest money in unproductive areas like buying gold or real estates.

These days, banks in Bangladesh, especially private banks, are offering competitive interest rates for savings accounts. Investors should be content with even 7 percent interest rate to save with a bank for a chunk of their investment portfolio. If inflation protection can guaranteed by way of insurance or by a kind of government's guarantee small investors would be greatly motivated to set aside a good chunk of their investments and put that money even at an interest rate lower than 7 percent in any of the banks which have good track records.

We all should bear in mind that cash in liquid form in a bank is much better than cash in papers changing hands in the stock market when you are too old or too young to play with risks. Plan when you would be needing money for sending your son abroad for higher education, for defraying expenses in connection with your daughter's marriage or for meeting your living expenses in your old age, etc. You cannot really gamble with your money that you would need during your retired life or for sending your son to a university. When, for example, you are 9 years away from needing your money, move 20% of the money from the stocks into a liquid savings account. The next year, you may move another 20% out of the stock market and into a liquid account. Continue moving out 20% for a total of 5 years, when you will have 100% of your money saved safe and sound in banks or government bonds, and away from the hands of the stock market. Look forward to having your money there when you need it. If the markets keep climbing, you might lose out on some extra money, but if it plummets you cannot predict how much you lose.

What is truly needed is education for investors to learn how to invest and when and how to avoid risks in investments. We should remember that many people lost up to 80% of their investments in many tragic crashes in the stock markets. Many people had committed suicide when they could not tolerate sudden loss of their investments in the stock markets. We should not forget that a retired father had to officially abandon his only son when he found all his retirement benefits invested by his son in shares got evaporated into smoke in the great crash back in 1996.

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