Few things seem to bother ordinary citizens than the prospective returns from the local share market.  Many have dabbled in stocks with the mistaken belief that one can turn a quick Rupee.  My sabbatical over the last three months from these pages have alowed for various questions on the topic dominate my inbox.  Here in [...]

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The Sundaytimes Sri Lanka

Myths, lies and damn lies about the stock market

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Few things seem to bother ordinary citizens than the prospective returns from the local share market.  Many have dabbled in stocks with the mistaken belief that one can turn a quick Rupee.  My sabbatical over the last three months from these pages have alowed for various questions on the topic dominate my inbox.  Here in no particular order are some answers to what seems to be the most pressing issues.

Is it a good time to invest in  Sri Lankan shares?
No. Not only from a valuation perspective (across multiple measures).  Price-to-Earnings ratios are too high, dividend yields too low and price-to-book ratios (or the inverse for adherents of Farma and French) multiple standard deviations away from reality.  Worse, investment now is a bet that there is some semblance of fair price discovery in the current market.  Nothing is further from reality.  Crony capitalism once reserved to the likes of government ministries  and public works contracts have made its way in spades to market makers.

To put it in to some context, analysing the returns profile of the liquid Milanka Index using Barra risk models show that momentum has been the largest risk factor in returns over the last three years.  In simple English, all investors have been herding towards shares based on turning a quick profit and based on past price performance.

Will I be able to recover the massive losses I’ve ncurred?
Yes in some cases, and no in others.  Good businesses, with strong earnings and decent management have got trashed alongside decrepit zombie companies with questionable businesses.  Central to recouping losses would not only depend on you holding good companies, but on how long you are willing to wait.  The recovery may take anywhere from one year through to 10.  If you are really unlucky (say like a Japanese investor in 1987) get ready to wait for over 20 years.  The problem with waiting for a “long time”, as the great British Economist John Meynard Keynes once said, “We’ll all be dead”.

Should changes in personnel at the regulator worry me as an investor?
Yes.  To lose one Chairperson is unfortunate. To lose two in under a year is downright disgusting. As a retail investor and small share holder your interests are protected by a strong regulatory framework.  The framework, when implemented, provides a degree of fairness to small investors who can’t have the execution power of institutional investors.  Unfortunately, these protections have started to give way as thugs try to recoup losses from bad businesses to cover their dues to still other thugs.  They see a strong regulator as a nuisance on their journey to steal from the little guy to cover their losses. Sort of like a perverse Robin Hood.

What are the implications of a market that goes flat for a few years (i.e. no growth and perhaps not much of a fall either)?
That depends on your investment horizon and whether you have alternative funding sources.  A sideways market will hurt an individual investor who was planning on using investment gains for consumption spending elsewhere.  The impact on the two large pension funds in the country (the EPF and ETF) is much more nuanced.  Given the potential long term inflation-plus returns required to honour their obligations, managers will be forced to look for alternative investments, including private assets.

There is also nothing unusual about a side-ways market for a while.  Such an outcome would validate one of the longest running principles of investing that all returns must revert to the mean.  Years of very strong growth (think 2008-2010) must be followed by a few years of mediocre growth in order for the trend line to come back to the long term average.  Changing personnel at the regulator does not lead to a rewriting of the history of share markets.

What can be done to restore faith in the local market?
In most countries the brokers and investors involved in the current crisis would have ended up in jail a few months back.  As the “Wonder of Asia” our response will obviously be different.  The beauty of crony capitalism is that “cronyism” is relative.  Right now the thugs are having a field day.  Pretty soon, senior management of some of the blue chip listed companies will start to say good bye to their careers, at which point their stock options will need to be cashed out.  The important question thus becomes in a classic two-factorial “Prisoners Dilemma” game, whose self-interested motives triumph?  The thugs or senior corporate executives (who both have equal access and power with the all important political class)? Having studied bubbles and market behaviour of the last 200 years, I would place my money on senior corporate executives winning this battle.  Such an outcome would benefit ordinary investors and as thugs recede, animal spirits will reinvigorate amongst investors.

Can any good come out of all this?
Yes.  Investors would finally learn what “risk” actually means.  They will also learn that stocks don’t only go up.  More importantly, they will appreciate that regulations are essential if they are to make money from investing.  One good outcome for the broader investment community should be the development of an effective private market (private equity and debt) as good companies will shy away from listing for sometime yet.  This would also be a good time to start developing a deeper corporate bond market in the country to help companies tap into cheaper sources of funding and provide investors with an alternative investment.

(Kajanga is an Investment Specialist based in Sydney, Australia.  You can write to him at kajangak@gmail.com).




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