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Politics and stock market myth

24 Aug 2015 - {{hitsCtrl.values.hits}}

Politics and equity markets are inseparable. Political conditions influence the performance of an equity market. However, an equity market should not be politicized as it would hinder the performance of the market and economic growth.

The performance of the Colombo Stock Exchange (CSE) attracted the attention of many during the last few months as certain groups attempted to misinterpret the performance of the market. It is timely to infer into these statements.

Determinants of stock markets

Many scholars attribute the arrival of new and unanticipated information as the key cause for changes in stock prices. Information can be shaped by changes in macroeconomic policies, investor tolerance of risk, political situations, civil security situations and global events.

The CSE has been showing a certain degree of volatility, which could be attributed to the diverse nature of new pieces of information, news or events investors are faced with during an election/political transition. An election process creates market uncertainty as investors speculate or develop expectations regarding potential winners and the future macroeconomic policy.

Market volatility during an election is nothing new in Sri Lanka. Investors who have been in the market for a few years would have experienced similar phenomenon. Investors should bear in mind that Sri Lanka went in for a presidential election in January that put an end to a political tenure of nearly 10 years.

It is normal for political transition to bring about a certain degree of uncertainty and speculation until new policies fall into place. The situation was intensified with the expectation of a parliamentary election that increased speculation.

Increase in market volatility and speculation during an election is visible even in developed economies. Experts believe that the parliamentary election in England that concluded in May would have had an impact on the equity market. It was interesting to note that the FTSE 100 Index experienced volatility and short-term market fluctuations during this period. The prices decreased since the beginning of May 2015 and reversed upward after the Conservative Party was re-elected on May 7, 2015. The aforementioned phenomenon could be explained further if we look into the political history of England (Refer Box 1).

Stock markets should not be politicized
Politicians/social groups/media and supporters entangle themselves in a deadly trap of increasing their votes before an election. This would drive them to give false interpretation to certain phenomenon in order to attain political means.

During the last few months certain groups failed to understand the volatility in the market and interpreted the market movement as a crash. When inferring into the data provided below its evident that this argument lacks solid reasoning.

A stock market crash is a concept that is loosely used by people due to their ignorance. Hence, it is important to clearly define this concept. A stock market crash is a significant drop in the total market. In most cases it results from a burst of a bubble. It creates a situation where the majority of investors are trying to flee the market at the same time and consequently incurring massive losses. Attempting to avoid more losses, investors during a crash engage in panic selling, hoping to unload their declining stocks onto other investors. Panic selling contributes to the declining market, which eventually crashes and affects everyone. How can a growth of 2.7 percent be perceived as a crash? If so, how would we perceive the performance of the market during 2008 and 2011/2012? The market went down by 41 percent in 2008.

Performance of CSE is satisfactory

 The ASPI Index is nearing the highest value recorded in the history of the CSE.

The market reached its peak when the ASPI reached 7811 points in February 2014. By August 19, 2015, the market closed at 7498.78 points. If the ASPI goes up by 313 points it will be able to reach the highest recorded levels in the market (Refer Figure 1).

 ASPI and S&P SL 20 Index recorded positive growth levels.

The ASPI has witnessed a growth of 2.7 percent during the year in spite of the increase in speculation witnessed during the election. The market was able to withstand various unhealthy information and rumours. Moving on, the S& P SL 20 Index has recorded a growth of 1.8 percent. This signals that fundamentally strong stocks continue to play a vital role in the market.

The past few months have been rather dull even for global markets (Greek crisis intensifying, the currency war, the market crash in China, etc.) and its adverse effects have trickled down to equity markets. Table 1 summarizes growth levels of selected markets. In comparison to these markets, it could be argued that the performance of the CSE is satisfactory.

 Market capitalization recorded a growth of 2.6 percent.

Market capitalization that stood at Rs.3,104 billion by the end of 2014 increased to Rs.3,185 billion by August 19, 2015. Further on, foreign contribution as a percentage of the total turnover for the current year is around 30 percent while it was only 27 percent during the previous year.

 Average daily turnover exceeds Rs.1 billion

The average daily turnover for the current year is Rs.1,142.9 million while the average daily turnover for last year was Rs.1,414.6 million in spite of the ASPI and S&PSL 20 Index increasing by 23.4 percent and 25.3 percent, respectively.

 Inability to grasp the behaviour of foreign investors.

Many individuals who carried out false propaganda on the market failed to understand the behaviour of foreign investors and questioned foreign inflow-outflow of funds. Usually foreigners buy at low levels and sell when the market is going up. It could be argued that they are exiting from stocks they purchased at low price levels few years ago. They would enter the market to collect stocks when they witness a considerable drop in prices. It is also interesting to note that Sri Lanka has performed relatively well when compared to its Asian counterparts (Refer Table 4) during the last few months. As economists point out the global economy is slowing down. Hence, it is inevitable for foreign participation to reduce.
It is disheartening to note that individuals who attempt to label the market with inappropriate slogans have failed to do their homework. They lack adequate knowledge on the local market as well as foreign markets.

Deadly price of politicizing the equity market
An equity market signals the performance of an economy. An equity market contributes to an economy by mobilizing savings to the most important investments (businesses) in a country. Investment is a key towards economic growth.

At a time the country is looking at increasing foreign direct investments it is vital to maintain efficient markets as it is accepted that an equity market is a reliable barometer to measure the economic condition of a country.

Another important factor that we should not undermine is the role of equity markets in promoting accounting standards and good governance in the corporate world.

Any economy would strive to achieve an efficient price discovery mechanism. An efficient stock market helps to value the securities on the basis of demand and supply factors. Valuation of securities is useful for investors and creditors as well. Investors can know the value of their investment and creditors can value the credit worthiness.

At a micro level, an equity market gives householders (investors) an opportunity to increase their income when they purchase shares. Further on, investors could lose confidence when false rumours about the market are spread. This would definitely hamper the aforementioned process. Economic prosperity and the performance of the market rest in our hands. It is our responsibility to think wisely, speak cautiously and act vigilantly and interacting with the market.

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Politics and stock market myth

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