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Starting from mid 2009, the Bangladesh Stock Market has been experiencing a prolonged bull run.

The market returns has been amongst the world's highest over the period. Even in 2010, only Sri
Lanka (+110%) and Mongolia, has probably beaten our market where prices grew roughly by about
90%. Now while this sounds great, people frequently forget the risks of investment in such times of
"irrational exuberance".
Coming back to the point. I have been thinking for quite a while that the market will undergo a
correction. However, for better or for worse the market stuck to its upward trajectory. But I believe
that this has made the situation even riskier. Lets first look at what made the market go up in the first
place.
What caused the market to act this way?
The first half of 2009 was a bad time for the capital market. Firstly, investor confidence in the
economy was low following the 2 year stint of the caretaker government. But most importantly, the
world was experiencing the phenomenon called the "global financial crisis". Even though Bangladesh
is relatively less correlated with the global economy, most economists were projecting a bleak macro
outlook. Consequently, stock prices suffered.
From mid 2009 the situation started improving thanks to heavy investment in the capital market by
state owned banks and financial institutions. This brought back the confidence in the capital market
and since the stocks were at extremely cheap prices (I remember AB Bank trading at a trailing P/E of
around 6) all stocks looked like a bargain. After that we saw positive surprises in our GDP growth
rate (5.7% growth achieved despite global slowdown) and also corporate earnings. But the biggest
factor that led to the current state of the capital market was what we call "excess liquidity". To explain
that let me use bullet points.
1. Because of power and infrastructure shortages most entrepreneurs could not invest in the real
sector (meaning industries).
2. Bangladesh was having current account surpluses (thanks to huge remittance flows). So more
money was coming in than going out.
3. Interest rates went down. So, it was not a good idea to get around 8.5% interest per year (before
tax) when inflation was around 5-7%.
So suddenly, people had a lot of idle money which they were unable to invest anywhere. Anywhere
except the stock market that is. Thus the joyride of equities (stocks) began and that situation is still
continuing. Because of this excess flow of funds by both general investors as well as institutions
(Banks, NBFI's and Insurance companies), multiple attempts by the regulator failed to cool down the
market. I can't blame anyone because no alternative investments were available. Plus, when you can
earn 30% return in 7 days why would someone invest elsewhere?

Why I think that a reversal is imminent?


The simplest of reason is that nothing goes up forever. But since I am supposed to be an analyst in
profession I need to do my job.
1. Market P/E (trailing) is around 30 at the moment. This is probably amongst the highest in the world
right now. High P/E's can only be justified when you expect superior earnings growth. But that is not
the case here. The best companies in BD over the last 10 years have experienced earnings growth
of about 20%. For 20% earnings growth on average, the market P/E should be around 20 and not 30
(which it is at the moment).
2. The P/E is calculated using the earnings reported by the companies. However, not all of these
earnings figures are recurring earnings. Specially for banks and nbfi's a large portion of income is
coming from one-off equity gains that might not be repeated in the future years.
3. Investor confidence is coming back in the real sector as seen by the indicators like loan
disbursement, opening of LC's for capital machinery etc. If this trend continues then at least some
money would come out of the capital market to the real economy and in the process share prices
would fall.
4. Interest rates are going up. Just a few days ago 1 year fixed deposit rates were about 8.5%. Now it
ranges from 10%-10.5%. Since inflation is going up, we can be quite sure of further increases in
interest rates. When that happens some funds will move from the capital market to the banking
sector and other fixed income investments.
I can probably list other reasons as well but since these are the major ones, we can ignore the less
important ones.
But I thought the macroeconomic outlook was improving?
Let me be VERY VERY clear on one issue. There is a big "top down" (or in other words growth) story
in Bangladesh. It is a small country with a large young population. By all probabilities (Inshallah) the
economy will continue doing well and if there are advances made to solve the power and
infrastructural bottlenecks then we are definitely going to grow at a higher trajectory (7-8%).I believe
myself to be amongst the most optimistic people regarding the long term prospects of the country.
Now from common logic
Strong Macroeconomy=Good corporate earnings=Higher share prices.
While this is true there is always a price for everything. Compared to a Dhaka College shirt I am
surely going to pay more for a designer shirt made in Italy but if the price tag is unreasonable then it
is not justified. We do not have to look very far. Even in Vietnam (a frontier market very similar to

Bangladesh) a few years ago the stock market had tremendous performance. The whole idea was
economic growth. But the market fell because the prices being paid for growth were not justified by
fundamentals. Please go to the link below and choose the 5Y graph to see the Vietnam market
performance.
http://www.bloomberg.com/apps/quote?ticker=VNINDEX%3AIND
When will the crash occur?
It is virtually impossible to predict a crash. The higher stock prices go up, the more confident
investors become and the more risk they take. Right now we are at the peak of investor confidence
due to which regulators cannot do anything to the market. So, the crash can happen in the next 1-2
month or it might even take 1-1.5 years. But we probably need a catalyst to dampen the investor
confidence. Such possible catalysts could be
1. Big investors and big institutions like banks and NBFI's getting out of the overvalued market.
2. Any natural disaster (Happened in Pakistan recently. The flood there had a major impact on the
share market. Pakistan market P/E is about 7 right now whereas Bangladesh is about 30).
3. Any sort of political unrest
4. Lower than expected earning figures.
Can we expect a slow correction instead of a crash?
While it is possible, I would assign a very low probability to a slow correction. Why? Because, if that
was the case then investors would have started to move out of the market. Everybody understands
that the market is overheated. However, everyone also thinks that they can earn another 15-20% and
have the perfect exit. Unfortunately perfect exits are quite impossible. So, once a big downward
movement starts everyone will just jump on the bandwagon.
Our present situation has surprising similarities to the housing bubble that happened in the west.
When housing prices skyrocketed (beyond logical limits) Wall Street knew very well that houses are
overvalued. However, because everybody assumed that house prices would just continue going up
they should not lose out on the marginal profit. Now here we are doing the same thing. Almost all
investors will tell you that stock prices are too high (compared to earnings off course) but only a
handful are acting on the conclusion that they are making themselves due to "expectations" of
greater returns.
What should my strategy be?
1. Risk averse investors can sell all their shares and wait for the market to come down.

2. Those with more appetite for risk can partially offload their shares and keep the rest of the money
in defensive shares with solid fundamentals. Staying away from any company whose earnings
depend on the capital market would be strongly advisable.

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