The monetary policy for the second half of 2013 (Calendar year) is
coming up. There are widespread rumors that this will be an expansionary
monetary policy with a potential policy rate cut. Some even go to the
extent of saying that reserve requirements will be reduced. As an
analyst I strongly believe that an expansionary monetary policy would be
the wrong move and maintaining status quo would be the more prudent
policy decision.
Before I delve into my arguments let me try to understand what can
prompt central bank to go for monetary easing. The only factor that
comes to my mind is the sharp decline in private sector credit growth
which stood at 11.43% at the end of May 2013. Despite the decline in
loan demand, lending and deposit rates remained quite sticky and have
not been coming down as much as central bank would have liked. So, maybe
central bank believes that further easing would cause interest rates to
decline and thus spur on credit growth and investment in the economy.
I have two major points against this theory.
First, I believe that the slowdown in credit growth was less due to
high interest rates and more due to the global economy, political
violence etc. We have also seen from the past that credit growth comes
down during the election year and thus 2013 was no exception. No
businessmen in his right mind would go for heavy investment in such an
uncertain situation. If that is the case, then going for further
monetary easing would not really spur on growth at all. Credit demand
would normalize once the election is over by itself without a monetary
stimulus.
Secondly, we do know that there is enough liquidity in the banking
system. As per a Financial Express report, loanable excess liquidity
rose to BDT 695 bn in April 2013 from BDT 456 bn in June 2012. M2 growth
is around 18% as of March 2013 driven largely by unsterilized dollar
buying by the central bank. This is quite high by any global standards
and going for further monetary easing is quite risky from an
inflationary standpoint. The situation reminds me of 2009-10 periods
when central bank went for unsterilized dollar buying to prevent the BDT
from appreciating. The result was a stock market bubble and double
digit inflation. The real estate market also was in a bubble like
situation and has been correcting ever since. We surely do not want a
repeat of that situation.
I think that the policymakers should put more attention to supply
side bottlenecks such as energy and infrastructural constraints. Trying
to boost GDP growth during times when ‘real’ demand is low, will only
haunt the economy in the future.
Friday, July 12, 2013
Monday, May 20, 2013
How herding behaviour deters capital market price efficiency in Bangladesh
Co-authored by Asif Khan, CFA and Sajib Hossain, Lecturer of finance at Dhaka University. Original article appeared at Dhaka Tribune Website.
Identical investments in the Bangladesh capital market, without any
significant shifts in economic fundamentals, can be explained partially
by the herding behavior of investors. This is where investors discard
their fundamental analysis of stocks and follow the crowd. A high level of herding may be evident from the fact that when the stock market falls, all participants go down the same path. Similarly, when the index experiences some upward trend, market participants follow. Surely, such herding behaviour can also be attributed to a poorly
regulated environment, lack of quality and timely disclosures, and the
type and sophistication of both retail and institutional investors.
Many investors, believing some particular stocks to be very risky or overvalued, or vice versa, still buy or sell the same stocks discarding their personal opinions, which is a market phenomenon here. Sometimes such behaviour turns into a pattern that deters market efficiency. Investors do not seem to have taken any lesson from the recent bubble and burst in the market, as they keep on repeating the same behaviour.
Rational investors, especially institutional ones, are expected to make an investment decision taking into account full financial and operation aspects, and the growth prospects of stocks being considered.
They are also expected to be independent of market noise and bias. Now, if such investors were really rational, they would get analytical information in advance, and use that while investing. Other participants would then follow the informed investors, resulting in efficient pricing of market instruments.
However, reality reflects something different. Perhaps, rational investor behavior is ignored by other participants, resulting in irrational behavior in the overall market. Or perhaps, the size and participation of rational investors is not large enough to have an effect on irrational investors.
Investment sophistication and financial skill and knowledge among market participants are rapidly growing in our market. However, free flow of information, more research based periodic reviews and quality corporate disclosures are not increasing at the same pace.
Herding in emerging markets, like Bangladesh, may also be attributed to incomplete regulatory frameworks, especially in the area of market transparency. Insider traders have been consistently taking undue advantage, and are able to persuade the crowd to follow them, ignoring fundamental information. The Bangladesh Securities and Exchange Commission either fails to detect and prevent such insider trading, or the market regulator fails to take punitive action because of undue influence or lack of sufficient means. Moreover, deficiencies in corporate disclosures and information quality create uncertainty in the market, throw doubt on the reliability of public information and impede fundamental analysis. A recent study (unpublished) by Accounting for the Capital Market Development, a research project sponsored by WB and UGC, found that audited financial statements of a good number of listed companies contained unqualified audit opinion by reputed firms and were not prepared according to international standards.
So, it is reasonable to assume that investors will lose belief in analysis-driven investment strategy, and thus, prefer to base trading on their peers' actions. Alongside intentional herding, unintentional herding also occurs in the market here due to simultaneous reaction to a common signal.
However, herding does not always result in an inefficient outcome that impedes proper functioning of the market. Herding can have an efficient outcome, provided it comes from the simultaneous reaction on fundamental values. In this case, it speeds up price adjustments, making the market more efficient.
But herding not based on fundamental values may drive prices away from the latter, which can result in subsequent return reversals. In this case, asset prices will fail to reflect fundamental information.
Herding behaviour, especially of retail investors who are dominant in daily trading, can destabilize markets, with the potential to create, or at least contribute to, bubbles and crashes in the capital market.
Therefore, properly scrutinizing and assessing the types, causes and extent of herding and ensuring that such behavior is driven by fundamentals are essential for efficient functioning of the capital market in Bangladesh.
Many investors, believing some particular stocks to be very risky or overvalued, or vice versa, still buy or sell the same stocks discarding their personal opinions, which is a market phenomenon here. Sometimes such behaviour turns into a pattern that deters market efficiency. Investors do not seem to have taken any lesson from the recent bubble and burst in the market, as they keep on repeating the same behaviour.
Rational investors, especially institutional ones, are expected to make an investment decision taking into account full financial and operation aspects, and the growth prospects of stocks being considered.
They are also expected to be independent of market noise and bias. Now, if such investors were really rational, they would get analytical information in advance, and use that while investing. Other participants would then follow the informed investors, resulting in efficient pricing of market instruments.
However, reality reflects something different. Perhaps, rational investor behavior is ignored by other participants, resulting in irrational behavior in the overall market. Or perhaps, the size and participation of rational investors is not large enough to have an effect on irrational investors.
Investment sophistication and financial skill and knowledge among market participants are rapidly growing in our market. However, free flow of information, more research based periodic reviews and quality corporate disclosures are not increasing at the same pace.
Herding in emerging markets, like Bangladesh, may also be attributed to incomplete regulatory frameworks, especially in the area of market transparency. Insider traders have been consistently taking undue advantage, and are able to persuade the crowd to follow them, ignoring fundamental information. The Bangladesh Securities and Exchange Commission either fails to detect and prevent such insider trading, or the market regulator fails to take punitive action because of undue influence or lack of sufficient means. Moreover, deficiencies in corporate disclosures and information quality create uncertainty in the market, throw doubt on the reliability of public information and impede fundamental analysis. A recent study (unpublished) by Accounting for the Capital Market Development, a research project sponsored by WB and UGC, found that audited financial statements of a good number of listed companies contained unqualified audit opinion by reputed firms and were not prepared according to international standards.
So, it is reasonable to assume that investors will lose belief in analysis-driven investment strategy, and thus, prefer to base trading on their peers' actions. Alongside intentional herding, unintentional herding also occurs in the market here due to simultaneous reaction to a common signal.
However, herding does not always result in an inefficient outcome that impedes proper functioning of the market. Herding can have an efficient outcome, provided it comes from the simultaneous reaction on fundamental values. In this case, it speeds up price adjustments, making the market more efficient.
But herding not based on fundamental values may drive prices away from the latter, which can result in subsequent return reversals. In this case, asset prices will fail to reflect fundamental information.
Herding behaviour, especially of retail investors who are dominant in daily trading, can destabilize markets, with the potential to create, or at least contribute to, bubbles and crashes in the capital market.
Therefore, properly scrutinizing and assessing the types, causes and extent of herding and ensuring that such behavior is driven by fundamentals are essential for efficient functioning of the capital market in Bangladesh.
Sunday, May 12, 2013
In search of excellence
"Human beings are imperfect".
Sounds pessimistic, but in reality is just the opposite. This is a sentence about endless opportunities. It means that we have infinite potential to improve and improvise. The potential to be better at almost everything because we can never reach perfection as mortals.
The idea of writing something on this topic came to me after reading a book called "Made in America" by Sam Walton. Sam Walton is the founder of WalMart. This book tells the story of how WalMart grew from scratch to the corporate giant that we know today. What did I learn from the book? A great deal indeed.
As one reviewer wrote, he learned more in this book about management than he did in college. Just like him, I learned that hard work really pays off. I learned that the customer always comes first. I learned that we should learn from everybody and even from our competitors. I learned how important it is to get good people to run our companies. If we find the right talent we should chase that person for months and even years if required.
However, the most important thing that I learned was that we must continuously strive for improvement. The willingness to improve the current practices and procedures must be there all the time. At times we will make mistakes in our attempt to try out new things. But as the writer/philosopher Nassim Taleb said "Mistakes that are reversible aren't really mistakes". Mistakes make our systems and processes much more robust.
The strive for excellence is not only limited to our personal self but the whole culture can be incorporated in communities, societies and organizations. Actually, that is exactly how the great companies of the world came to become "great". They stuck to their core values, but everything else was dynamic. This dynamic nature is what enabled them to adapt and survive while other big companies perished.
Personally, I am trying to identify my weaknesses and make a conscious effort to improve upon that. I know that if I try enough and God willing, I can become a better employee, a better husband, a better son and a better almost everything.
Sounds pessimistic, but in reality is just the opposite. This is a sentence about endless opportunities. It means that we have infinite potential to improve and improvise. The potential to be better at almost everything because we can never reach perfection as mortals.
The idea of writing something on this topic came to me after reading a book called "Made in America" by Sam Walton. Sam Walton is the founder of WalMart. This book tells the story of how WalMart grew from scratch to the corporate giant that we know today. What did I learn from the book? A great deal indeed.
As one reviewer wrote, he learned more in this book about management than he did in college. Just like him, I learned that hard work really pays off. I learned that the customer always comes first. I learned that we should learn from everybody and even from our competitors. I learned how important it is to get good people to run our companies. If we find the right talent we should chase that person for months and even years if required.
However, the most important thing that I learned was that we must continuously strive for improvement. The willingness to improve the current practices and procedures must be there all the time. At times we will make mistakes in our attempt to try out new things. But as the writer/philosopher Nassim Taleb said "Mistakes that are reversible aren't really mistakes". Mistakes make our systems and processes much more robust.
The strive for excellence is not only limited to our personal self but the whole culture can be incorporated in communities, societies and organizations. Actually, that is exactly how the great companies of the world came to become "great". They stuck to their core values, but everything else was dynamic. This dynamic nature is what enabled them to adapt and survive while other big companies perished.
Personally, I am trying to identify my weaknesses and make a conscious effort to improve upon that. I know that if I try enough and God willing, I can become a better employee, a better husband, a better son and a better almost everything.
Thursday, May 9, 2013
Knowledge based Bangladesh
I am planning on a new project to bring students and professionals into closer contact to improve knowledge level of the students. It will also help them gain more practical knowledge. Here is a video that explains the strategy.
Knowledge based Bangladesh (Introduction) by freerudite
Knowledge based Bangladesh (Introduction) by freerudite
Tuesday, May 7, 2013
Moral hazard and our RMG industry
This article was published in the Dhaka Tribune on May 7, 2013 in the opinion segment. Here is the link.
Risk and reward should ideally go hand in hand. If we take excess risks, and it leads to success, then the reward is usually high. However, when excessive risk results in something bad, we must be ready to bear the costs of that decision.
In economics, “moral hazard” refers to a situation where one party takes excessive risk because that party knows that it would not have to bear the costs of that risk. Such an environment promotes excessive risk taking which is usually detrimental to the whole society and the economy.
The best recent example of moral hazard is the US government’s bailout of the financial sector that fell into problems after the sub-prime bubble burst. The financial sector had earlier taken huge risks in real estate and also reaped the benefits through huge profits and personal bonuses. However, when things went south, they got bailed out by the general people of the country.
What does RMG have to do with moral hazard? A lot, actually. The typical RMG factory owner knows that if there is a problem in their factory caused by their negligence (Tazreen Fashions and Rana Plaza are both cases in point), their associations will come to their rescue. So by giving less attention to worker safety they are able to lower some costs and take higher risks because they know they will be bailed out.
The other interesting information that I came across was that banks have decided to raise around Tk1bn for the Savar victims.The newspaper article mentioned that they did it on the request of the central bank. A few might have taken initiatives at their own discretion but I would contend, for most, the central bank request had a lot to do with it.
Why should banks pay for a mistake made by garment factory owners or building owners? Even though some people believe that banks should be more responsible before lending to organisations, I think that banks should stick to their core operation. The responsibility of checking whether a building meets construction standards is not the core operation of a bank and thus should be left to relevant authorities like Rajuk. Banks are already in a fragile situation due to loan scams, political problems, real estate slowdown, etc, and asking them to pay for others’ mistakes is a recipe for disaster.Tomorrow if banks get into trouble, who will bail them out? Of course it will be the average citizen of the country who did nothing wrong.
Being an optimist I honestly believe that most of the factory owners do care about the safety of their employees. It is a few rotten ones that are causing the image crisis we presently face. But we can still blame BGMEA on the grounds that they are not penalizing the rotten ones for their failures.
So, it is the responsibility of the factory owners, the foreign buyers and the BGMEA to pay for the rehabilitation of the victims and not the responsibility of banks. Of course people are free to donate of their own free will but making an innocent group pay for the mistakes of other people will only exacerbate the problem.
Risk and reward should ideally go hand in hand. If we take excess risks, and it leads to success, then the reward is usually high. However, when excessive risk results in something bad, we must be ready to bear the costs of that decision.
In economics, “moral hazard” refers to a situation where one party takes excessive risk because that party knows that it would not have to bear the costs of that risk. Such an environment promotes excessive risk taking which is usually detrimental to the whole society and the economy.
The best recent example of moral hazard is the US government’s bailout of the financial sector that fell into problems after the sub-prime bubble burst. The financial sector had earlier taken huge risks in real estate and also reaped the benefits through huge profits and personal bonuses. However, when things went south, they got bailed out by the general people of the country.
What does RMG have to do with moral hazard? A lot, actually. The typical RMG factory owner knows that if there is a problem in their factory caused by their negligence (Tazreen Fashions and Rana Plaza are both cases in point), their associations will come to their rescue. So by giving less attention to worker safety they are able to lower some costs and take higher risks because they know they will be bailed out.
The other interesting information that I came across was that banks have decided to raise around Tk1bn for the Savar victims.The newspaper article mentioned that they did it on the request of the central bank. A few might have taken initiatives at their own discretion but I would contend, for most, the central bank request had a lot to do with it.
Why should banks pay for a mistake made by garment factory owners or building owners? Even though some people believe that banks should be more responsible before lending to organisations, I think that banks should stick to their core operation. The responsibility of checking whether a building meets construction standards is not the core operation of a bank and thus should be left to relevant authorities like Rajuk. Banks are already in a fragile situation due to loan scams, political problems, real estate slowdown, etc, and asking them to pay for others’ mistakes is a recipe for disaster.Tomorrow if banks get into trouble, who will bail them out? Of course it will be the average citizen of the country who did nothing wrong.
Being an optimist I honestly believe that most of the factory owners do care about the safety of their employees. It is a few rotten ones that are causing the image crisis we presently face. But we can still blame BGMEA on the grounds that they are not penalizing the rotten ones for their failures.
So, it is the responsibility of the factory owners, the foreign buyers and the BGMEA to pay for the rehabilitation of the victims and not the responsibility of banks. Of course people are free to donate of their own free will but making an innocent group pay for the mistakes of other people will only exacerbate the problem.
Friday, May 3, 2013
Knowledge from unconventional sources
This is a video I made to promote unconventional methods to attain knowledge which can be complimentary to classroom education. I think these are great ways to learn and I used them extensively in my life.
Knowledge from unconventional sources by freerudite
Knowledge from unconventional sources by freerudite
The perils of the retail investors in Bangladesh
Co-authored by Asif Khan, CFA and Sajib Hossain, Lecturer of finance at Dhaka University. Original article appeared at Dhaka Tribune Website.
The Bangladesh stock market is still in an infant stage when we consider the maturity of investors, the quality of corporate disclosures and the strength of the regulators. Therefore, it is no wonder that the market in Bangladesh is highly driven by momentum where investors have short holding periods.
In the short run, the market tends to act like a zero sum game. If someone wins, someone else has to lose. This is the perfect situation for the slaughter of small retailers.
Let us go through the problems one by one:
Quality of earnings and financial disclosures:
The first major problem is related to the “quality of earnings” and the level of financial disclosures. Quality of earnings refers to the sustainability and trustworthiness of earnings numbers. At present, other than a handful of listed companies, it is very difficult for knowledgeable investors to trust the financial statements. The blame, to some extent, goes towards the auditing firms. However, the first step in preparing clean and transparent financial statements has to be taken by the companies themselves.
Secondly, the accessibility to financial statements is a big problem in itself. Many of the companies do not have websites, and even if they do, the statements are not uploaded in due time. The solution to this problem is to upload statements in the stock exchange websites.
Without access to trustworthy and timely financial statement it is not possible to do fundamental analysis.
Insider Trading:
Insider trading refers to the trading of shares by people who have access to material news flow, like earnings and dividends, before they are disclosed to general investors. Examples of such investors would be company management, audit firms, company directors etc. This harms the retail investors who get the news flow only after it has already been priced into the share.
The problem lies in the lack of a strong legal framework, along with the enforcement of such laws. For example, if a person earns Tk10m from insider trading and is fined Tk100 thousand, he will happily pay the fine. Therefore, in order to discourage insider trading, the scale of the punishment has to be increased by a large magnitude. We do realize that the regulators might not have adequate manpower to catch all cases of insider trading. However, even if they could set some examples by penalizing few high profile cases, that should work as an example to others.
Pump and dump strategies:
Next, we have pump and dump strategies. By cornering shares (reducing liquidity) and spreading rumors, some manipulators jack up the stock prices in order to dump their holdings on to the unsuspecting retail investors.
As the stock market is a sensitive issue, regulators and governments are sometimes afraid to take steps against market manipulators for fear of the market coming down. In the short run, that is a possibility. However, in the long run, these steps would be much more beneficial to all the stakeholders.
Lack of knowledge of investors:
The lack of knowledge of retailers, and even some institutional investors, is also a problem. Even today, stock bonus is considered to be something great and causes stock prices to go up significantly. When the target victims are not smart enough and need to rely on rumors to make money, they are likely to lose money in the stock market.
The players who will continue to make money will be the “insider trader” and the “large retailer” because of information and capital advantage. If these guys continue to make money, then someone else will lose it.
Lack of transparency in asset management industry:
The stock market is not for everyone. Not everybody has the time to study or learn it. Therein lays the importance of professional fund management. However, the present state of the managed fund business would deter most of the investors who would like to give funds for professional management.
Before giving funds to a management company, an investor needs to look at its track record, investment strategy, background of fund managers and top holdings. None of this information is available in Bangladesh. However, by not promoting transparency, not only are many investors forced to take a shot at investing by themselves based on rumors, the asset management industry is also not growing as much.
Conclusion
In such a situation, the chances for retail investors to make money will be limited. In the short run, the momentum chasing strategies could work out, but eventually the investor is likely to make losses.
We should not let the stock market turn into another tool for redistributing wealth from the poor to the rich. In a country where saving instruments are limited, the role of the stock market is crucial. Before everything else, we need to focus on corporate governance, minority shareholder rights and quality of auditing.
The Bangladesh stock market is still in an infant stage when we consider the maturity of investors, the quality of corporate disclosures and the strength of the regulators. Therefore, it is no wonder that the market in Bangladesh is highly driven by momentum where investors have short holding periods.
In the short run, the market tends to act like a zero sum game. If someone wins, someone else has to lose. This is the perfect situation for the slaughter of small retailers.
Let us go through the problems one by one:
Quality of earnings and financial disclosures:
The first major problem is related to the “quality of earnings” and the level of financial disclosures. Quality of earnings refers to the sustainability and trustworthiness of earnings numbers. At present, other than a handful of listed companies, it is very difficult for knowledgeable investors to trust the financial statements. The blame, to some extent, goes towards the auditing firms. However, the first step in preparing clean and transparent financial statements has to be taken by the companies themselves.
Secondly, the accessibility to financial statements is a big problem in itself. Many of the companies do not have websites, and even if they do, the statements are not uploaded in due time. The solution to this problem is to upload statements in the stock exchange websites.
Without access to trustworthy and timely financial statement it is not possible to do fundamental analysis.
Insider Trading:
Insider trading refers to the trading of shares by people who have access to material news flow, like earnings and dividends, before they are disclosed to general investors. Examples of such investors would be company management, audit firms, company directors etc. This harms the retail investors who get the news flow only after it has already been priced into the share.
The problem lies in the lack of a strong legal framework, along with the enforcement of such laws. For example, if a person earns Tk10m from insider trading and is fined Tk100 thousand, he will happily pay the fine. Therefore, in order to discourage insider trading, the scale of the punishment has to be increased by a large magnitude. We do realize that the regulators might not have adequate manpower to catch all cases of insider trading. However, even if they could set some examples by penalizing few high profile cases, that should work as an example to others.
Pump and dump strategies:
Next, we have pump and dump strategies. By cornering shares (reducing liquidity) and spreading rumors, some manipulators jack up the stock prices in order to dump their holdings on to the unsuspecting retail investors.
As the stock market is a sensitive issue, regulators and governments are sometimes afraid to take steps against market manipulators for fear of the market coming down. In the short run, that is a possibility. However, in the long run, these steps would be much more beneficial to all the stakeholders.
Lack of knowledge of investors:
The lack of knowledge of retailers, and even some institutional investors, is also a problem. Even today, stock bonus is considered to be something great and causes stock prices to go up significantly. When the target victims are not smart enough and need to rely on rumors to make money, they are likely to lose money in the stock market.
The players who will continue to make money will be the “insider trader” and the “large retailer” because of information and capital advantage. If these guys continue to make money, then someone else will lose it.
Lack of transparency in asset management industry:
The stock market is not for everyone. Not everybody has the time to study or learn it. Therein lays the importance of professional fund management. However, the present state of the managed fund business would deter most of the investors who would like to give funds for professional management.
Before giving funds to a management company, an investor needs to look at its track record, investment strategy, background of fund managers and top holdings. None of this information is available in Bangladesh. However, by not promoting transparency, not only are many investors forced to take a shot at investing by themselves based on rumors, the asset management industry is also not growing as much.
Conclusion
In such a situation, the chances for retail investors to make money will be limited. In the short run, the momentum chasing strategies could work out, but eventually the investor is likely to make losses.
We should not let the stock market turn into another tool for redistributing wealth from the poor to the rich. In a country where saving instruments are limited, the role of the stock market is crucial. Before everything else, we need to focus on corporate governance, minority shareholder rights and quality of auditing.
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