The stock market situation: What to do about it?

Bangladesh's stock market performance, measured in terms of the stock price index, has been
one of the best globally for a number of years. Its upward surge defied global and regional market
developments. When almost all markets across the globe collapsed during the global economic
crisis, DGEN was perhaps one of the very few which defied the global trend and maintained its
upward progression fueled by local developments/conditions.

When it started its upward trend in 2007, the market was certainly undervalued, and there were
fundamental economic reasons for it to go up. At that time the average Price/Earning (P/E) ratio
was in single digit and the market capitalization was less than 10 per cent of gross domestic
product (GDP). The sustained upward surge, however, went beyond what could be justified by
economic fundamentals by early 2010.

Since mid-2010, as the index crossed the 5000 mark, the market has clearly been driven by
speculative forces. During the last two-month period leading up to the peak, the index increased
by more than 2000 points before crossing the 8900 level on December 5. To put it in proper
perspective, the index level was at about 1500 until this recent surge started in 2007. Daily
market turnover increased 30 fold about Tk. 1.0 billion to Tk. 33 billion over the three-year period.
Clearly, economic fundamentals cannot support this level of valuation gain and turnover, and the
market is bound to correct itself once it runs out of steam.

The recent drop in the stock market index needs to be evaluated in this context. Even after a
more than 2500 point decline, the index is still well above its mid-2010 levels. The corrections and
volatility in the price index that we have experienced in recent days is nothing uncommon, and
fully in line with what has been observed in many other important, and much larger stock markets
across the globe. For the market to start consolidating, it needs to shed itself of speculative
elements, and that can only happen once market valuations come back to their fundamental
levels.

Global experience indicates that once stock markets get into a bubble phase, there is very little
that regulators or policy makers can do to stabilize it. This has been seen in major markets in the
US (NASDAQ in particular) and Japan, and in emerging markets like China and the Gulf Co-
operation Council (GCC) countries in recent years. A broad and deep market in the US did not
prevent the NASDAQ index from crossing the 5,000 level and crashing back to the 1,600 level in
a matter of weeks. The experience of Japan is even more pathetic, with the Nikkei crossing the
33,000 level in 1991, and following the crash, is currently flirting with the level of 10,000 after
almost 20 years. More recently we have seen the Shanghai stock index crossing the 7,000 level,
crashing down to well below 3000 after the correction. We saw an even worse development in
Bangladesh in 1996 when the index dropped from 3,600 to below 800.

The authorities should not panic due to the overdue correction observed in Bangladesh market in
recent weeks. Their main concern should continue to be ensuring macroeconomic stability and
sustaining real economic activity and employment generation. The stock market collapse would
not necessarily hurt Bangladesh's growth and employment prospects if the process is well
managed. The recent tumble in the index should be seen as the inevitable outcome of irrational
exuberance on the part of market participants. What worries me is not the correction, but the
panic created by both in the streets and at the level of policy makers. What the retail investors are
doing in the street is certainly not going to change the course of the market. It only shows how
illiterate the Bangladeshi retail investors are as a class. Time and again, informed analysts and
policy makers have warned against the state of market overvaluation. We can have sympathy for
them, but there is very little the government can do to save those investors who are driven by
greed and speculation, and ignore professional advice. Certainly the market is not for these types
of investors, and the sooner they realize their mistakes and get out of the market, the better it will
be for the market itself and for themselves. When we see people in every office have the stock
market tickers on, and people leaving their productive jobs and becoming day-traders, we know
there is something fundamentally wrong with what was happening. The stock markets should be
the domain for long-term investors and market oriented professionals. Retail investors should
invest in the market through instruments like mutual funds which are managed by professionals.

As regards policy makers, their objective should be to help ensure a softer landing, and let the
market find its fundamental valuation level. It is bothersome to observe the administrative
interventions undertaken a few weeks back when the index fell to 7200 level to engineer
artificially a massive 16% rebound in the index in one day. As reported in the press, Bangladesh
Bank directly intervened through Investment Corporation of Bangladesh (ICB). The Securities and
Exchange Commission (SEC) and other authorities might have also pressured state owned
commercial banks (Shonali, Rupali, etc.) and other financial institutions to get into the market and
provide an artificial support. Such a policy never works when the market is misaligned, as we
observed last week. Public money may have only bailed out some smart/lucky investors but
weakened the financial institutions further.

To put it into perspective, countries like Saudi Arabia, Kuwait, the UAE, and China, with
enormous amounts of financial resources could have bought the entire stock market several
times if they wanted to do so. But those authorities did not try it because such interventions
create morale hazards, and if continued would tantamount to nationalizing a large segment of the
economy. Certainly, Bangladesh, with its meager resources and with the size of its stock market
at 45-50% of its GDP, cannot afford to get into such misadventure.

What should the authorities do now? This is not the time to panic and bring about short sighted
regulatory changes. The experience of the last few weeks clearly indicates that whatever sensible
move the SEC and Bangladesh Bank may consider would act against them and trigger a negative
development for which the regulators will be blamed. This is a perfect example where you intend
to do good things, you will be blamed, and if you don't do anything, you will still be blamed (for
inaction). The policy makers and regulators would, however, need to prepare themselves for two
initiatives: 1) assess the impact of a major stock market correction on the domestic economy and
determine what kind of policy response the government may have to undertake to mitigate the
dampening effect on the real economy through various transmission channels; and 2) the SEC
and other policymakers should prepare a comprehensive set of reform measures which can be
initiated once the market settles down at the proper level. Nothing major should be done now,
when the market is in a correction mode.

The market will find its floor when stock prices would become attractive for the institutional
investors, who are probably waiting in the side lines with lots of cash and other liquid assets for
future investment at attractive prices. The critical issue is should we call the prices attractive at
the average price/earning (P/E) ratio of 23? This reported P/E ratio of 23 should also be taken
with a grain of salt since much of the record profit gains recorded by the financial institutions
would certainly disappear in 2011 and the adjusted or prospective P/E ratio will be much higher
than the reported level. It is normally believed that an average P/E ratio of 12-15 would be
attractive for long-term investors. Thus it would be irrational to expect institutional investors to
jump into the market and provide a floor for the index at the current level.

Policymakers should therefore not push or force the financial institutions to buy at these high
prices. Commercial banks and their subsidiaries have certainly made hefty profit gains in this
episode and these institutions should therefore be expected to provide some floor to the market
and also protect valuation of their own shares. It would be much more prudent however if
Bangladesh Bank first determines how much adversely these banks and other financial
institutions have been impacted through their un-cashed portion of stock holdings, the losses
incurred by their borrowers through margin and other form of borrowings, and indirect exposures
of their clients to the stock market. In some instances, the capital base of the banks may have
been significantly eroded and it would be the first order of priority for the Government and
Bangladesh Bank to recapitalize these financial institutions by preventing all financial institutions
from distributing their profits. The record profits earned by financial institutions should first be
used for loan loss provisions and to boost their capital base. Healthy financial institutions are
 must for a healthy real economy and only healthy financial institutions will provide the floor for the
stock market when the valuations would become attractive.

It would be a serious mistake to force or pressure the financial institutions to enter the stock
market prematurely. Bad assets (in terms of valuation) to be accumulated by these institutions in
this process would only weaken their balance sheet and may lead to collapse of weak financial
institutions, thereby transmitting the impact of the stock market collapse to the real economy on a
bigger scale. As a matter of fact, Bangladesh Bank may have to be ready to inject liquidity to the
financial system in the event some banks are hit seriously by their direct and indirect exposures
to the stock market. The emergence of liquidity crisis in the financial system in recent weeks may
be an early manifestation of that problem.
A Few Milestones in DSE in 2010 (Author: Author: BDStock--Amit J.)
Posting Date:2011-03-27

Few Milestones in DSE in 2010

The Bangladesh capital market continued to rally handsomely in 2010 even though U.S and
European market had to recover from recession effect. The market capitalization to GDP ratio
has been increased over the year from 30% to 50%. DSE General Index (DGEN) has gained its
peak at 8,918.51 point in December 5, 2010 and the lowest value was at 4,568.40 point.
Over the year, DGEN increased 82.78% and reached at 8,290.41 point at the end of the year.
The total market capitalization of all shares and debentures (excluding t-bills and t-bonds) of the
listed securities at the end of December, 2010 also stood higher at USD 49.4 billion, indicating a
gain of 84 percent which was higher than USD 26.8 billion at the end of December, 2009. The
total turnover has increased from USD 0.13 billion to USD .25 billion which indicates a 91%
growth. Along with other factors, at least a portion of the upward movement of the market can be
explained by the inadequate number of securities and huge fund flow in the capital market. The
market was not able to uphold its bullish position from the beginning of December, 2010.
During this time institutional investors had the tendency to realize profit from the market and it
was expected that the market would remain flat in this time. However, the actual steep downward
trend was not expected. One of the primary reasons for this abnormality could be the Bangladesh
Bank’s decision regarding CRR (Cash Reserve Ratio) and SLR (Statutory Liquidity Ratio) in the
hope of curbing the inflationary pressure. Following the actions, call money rate has soared
significantly and it rose as high as 180%, breaking the earlier record of 150% hit on March 30,
2006. From June to November, 2010 excessive liquidity decreased by 28% (see the table below).

Name of Stock Index Fig as on Dec 30, 09 Figure as on Dec 30, 10 Percentage (%) change
BSE Sensex 17464.8 20509.1 17
Karachi 100 9386.9 12022.5 28
DJ CBN China 600 29052.8 26701.3 -8
Bangladesh DSE general 4535.5 8290.4 83
S&P 500 1115.1 1257.6 13
Heng Seng 21872.5 23035.5 5

Bangladesh markets vis-a-vis global markets

During the year 2010, the DJ Global Index experienced 12% gain, whereas Bangladesh capital
market (83%) outperformed all the developed markets like USA’s (12%), UK’s (9%) and leading
emerging markets like India’s (17%), Hong Kong’s (5%), China’s (-8%). This outstanding
performance (see the table below) positioned the Bangladesh capital market in the top three
performers of the world. On the other hand, Bangladesh capital market has been exposed to
greater risk since PE ratio rose from 19.9x to 29.71x from January, 2010 to November, 2010. It is
the highest in the Asian regional markets.
Price Earnings in market
Towards the close of 2010, the average P/E in Bangladesh market for the stock index moved up
to 29.71 times the expected anticipated earnings of index stocks, which was much higher than
those noticed in the neighboring Asian pacific markets from emerging economies like India at
23.89, Hong Kong at 16, Sri Lanka at 24.69 and Singapore at 18 times. This increase reflects the
bullish outlook among the investors. However, it is expected that PE ratio may be reduced to
sustainable level considering earnings growth of the listed companies and steady growth of the
overall economy.
Historic year for Bangladesh markets
The calendar year 2010 was a historic year in Bangladesh in which the stock market went
through some breakthrough changes, to transform the functioning of capital markets in the
country. These included: 1. Removal of all the paper shares from the stock exchanges and
replacement of same by demat transactions. 2. Introduction of Book building method for the first
time. 3. Making compulsory submission of quarterly Financial Statements by the listed
companies, almost in line with other countries, to help investors gain more knowledge of the listed
companies. 4. Fixing the tenure of Closed-end mutual funds. 5. Allowing mutual funds to
participate in the Book Building process. 6. Government started offloading of SOE’s (State
Owned Enterprises) shares through a plan of disinvestment to ensure better funds generation by
government. 7. Imposition of Ten per cent Capital gain tax on institutional investor. 8. Highest
number of SEC directives issued.
These transformations have put the Bangladesh stock market on a fast forward track, particularly
inviting institutional confidence from FIIs in putting funds in Bangladesh stock markets due to
higher corporate transparency and improved compliances and governance in place in markets.
Sector performance
During the year under review, all the sectors experienced an upward trend. As per the sector
indices, Life insurance sector was the highest gainer providing 170% return. The other notable
sectors - General Insurance (114.45%), Foods and Allied (154.74%), Engineering & Electrical
Sector (122.12%), Bank (125.29%) and Leasing & Finance (156.29%) - doubled during the twelve
months. Mutual fund was the least performer during the year which was 0.2%.
Everyone Talking About Recent Market Volatility (Author: BDStock--Amit J)
Posting Date:2011-02-06

The calendar year 2010 was a unique year in the history of Bangladesh stock markets for more
than one than one reason. While the markets managed to attract billions of FII inflows into
Bangladeshi stock markets for the high rate of returns as the benchmark indices advanced by
over 82 per cent in course of within a single year, yet the volatility noticed in the Bangladeshi
stock markets was almost at its peak, due to several regulatory changes and monetary changes,
brought about by Securities & Exchanges Commission and Central Bank late in the year. The
Dhaka Stock Exchange (DSE) passed through an eventful year amid records and ups and
downs. However, the last few days of 2010 was quite reverse to its yearly trend when the DSE
witnessed a shortfall of fund following two Bangladesh Bank directives.
The year also witnessed the approval of the largest Initial Public Offering (IPO) in the history of
the premier bourse of the country in terms of money. The amount of turnover in the year was Tk
4,009 billion which is 171.8 per cent higher on the level of the previous year.
The benchmark DSE General Index (DGEN) advanced by as much as 3,722 points, or 82 per
cent, to finish at 8,290 on Thursday, last trading day of the year. The All Share Price Index (DSI)
also added 3,104 points, or 82.24 per cent, to 6,878.
The year was positive in terms of enlisting new companies with the market. A record 21
companies floated shares to the DSE worth Tk 29.74 billion were listed through Initial Public
Offerings (IPOs). Last year a total of 18 IPOs worth Tk. 23.15 billion hit the market. The SEC also
relaxed the IPO rules by reducing total paid up capital to Tk. 18 crore for listing with stock
markets. It is estimated that in view of on overall bullish trend in stock markets in 2010, the
market capitalization to GDP ratio may have also reached to the high level at 45 per cent.
The amount of total market capitalization also reached to a new high to Tk 3508 billion which is
83 per cent more than that of the previous year. The government collected a total of Tk 3.16
billion as tax as source from the DSE while the amount was a nominal Tk 624 million in the
previous year.
The government also announced its decision to offload more shares of eight state owned
companies listed with the bourses.
However, the entire rise of equity cult in the markets amidst the investors and saving community
did not come without any risks or major tremors of volatility. The country’s main bourse suffered
the worst ever single day fall of 552 points, or 6.72 per cent on December 19, reminding investors
of a major collapse in 1996. Throughout the year, the market regulator’s frequent changes in
regulations and imposing abrupt directives attracted strong debate and criticism. Finally all the
measures appeared to have failed when they were repealed on the wake of the free falls of DSE
indices at the end of the year. It was a roller-coaster ride in last few weeks of the year, with the
indices hitting a record high on 5 December, having climbed 80% since the start of the year. But
on 8 December it nosedived, prompting protests in Dhaka and towns elsewhere. This was
followed a strong fall of over 6.7% on December 19, which prompted many protests on street
from investors.
The major fall in index was triggered by a central bank interest-rate hike. The central bank raised
the mandatory Cash Reserve Requirement (CRR) of the banks to six per cent, which contributed
to reduce the turnover and raise the volatility in markets, prompting institutions to withdraw from
stock markets.
The regulators also took some measures in December to restrict money supply into the share
market after concerns that stocks were overvalued, leading to a free fall in the market following
withdrawal of FII funds from stock markets that was termed as ‘hot money’ leading to strong bull
run in the Dhaka stock market. The move forced big institutional investors to withdraw from the
market, triggering panic among individual investors. Prompted by the high volatility in stock
markets and strong protests by investors, regulators finally agreed to relax some of the
conditions, hoping that will increase the money supply and stabilize the market in future.
The sudden spurt in the inter-bank call money rate to 175 per cent in December, which was
earlier pegged at 60 per cent, due to ongoing liquidity crisis in the money market, also affected
the stock market and led to a steep decline towards the middle of December. Though the
regulator raised the margin loan ratio to 1:1, it failed to uplift the market, as the financial
institutions themselves are suffering from low liquidity due to high call money rate. Apart from
same, the Bangladesh Bank’s directive in December against diversion of industrial credit to the
stock market was also partly responsible for the fall in markets witnessed in December.
Apart from same, Banks and other financial institutions, some of which had invested 75 percent of
their deposits in the stock market against a cap of 10 percent in the past and made huge profit in
2010, held back on further investments recently, leading to a check from further rise in
Bangladesh stock markets.
Prices of shares nearly doubled in 2010, encouraging a stream of new investors into the markets,
but prices have crumbled since early last month after the market regulator and central bank took
measures to cool the market, prompting frequent street protests. The country's dire economy had
earlier made stocks an attractive investment option. The number of individual investors has risen
to more than 3 million from fewer than 500,000 in 2006.