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FINANCIAL CHRONICLE™ » FINANCIAL CHRONICLE™ » Sri Lanka stock market up on post war foundation: technical analyst

Sri Lanka stock market up on post war foundation: technical analyst

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Gainer

Gainer
Associate Director - Equity Analytics
Associate Director - Equity Analytics
Sept 15, 2011 (LBO) - A boom in Sri Lanka's stock markets in recent years was due to underlying fundamental changes in a post-war economic environment and not manipulation, the island's most widely known promoter of technical analysis said.

Sri Lanka's stock market became the world's best performing market in October 2010, extending a rally that began shortly before a 30-year war ended in May 2009.
Peace Factor

"Did it become the best market in the world due to manipulation?" said Sarath Rajapaksha, director of Capital Trust Securities who promotes technical analysis, a study of future price trends based on past behaviour.

"Or is it because for 30 years two-thirds of this country was not available for growth development?"

Sri Lanka's long running separatist war was concentrated on the island's northern and eastern provinces, which were among the smallest contributors to gross domestic product, and which according to popular legend included 'two-thirds of the country's coastline'.

Rajapaksha was speaking at the 8th LBR LBO CFO forum which had as its theme 'CSE: A Blood Bath or a Gold Mine' in Colombo.

"War would have been in the north and the east but you could not have any economic activity north of Anuradhapura (in North Central Sri Lanka) or east of Gal Oya," Rajapaksha said.

"Here (2009) all this ended like switching off a light switch.

"Doesn't it warrant a phenomenal rise like this? Was it created by movers and shakers, pumpers and dumpers? No. That is natural."

Since October 2010 the market's most liquid large cap stocks have beaten a retreat, foreign investors have been net sellers, while illiquid small caps have recording unprecedented gains, leading to widespread perceptions of manipulation and 'pumping and dumping' fraud.

Pumping

Channa de Silva, a former securities regulator and head of LR Global, a foreign owned private equity firm, said "value investors" had started leaving the market due to high earnings multiples.

But prices of illiquid small stocks with weak fundamentals had continued to zoom in to early 2011. Illiquid stocks are easy to manipulate.

De Silva said he found that in one case a company with 10 employees had a market capitalization of a billion Sri Lanka rupees.

In January firms like Asian Alliance, EB Creasy, Guardian Capital, Indo Malay had gone up by more than 100 percent.

"Some of the stocks travelled as much as 450 percent in one month," de Silva said.

Rajapaksha dismissed fundamental investors relying on "price to book values and P/E ratios" saying earnings were easy to manipulate with creative accounting techniques or 'earnings management'.

Technical analysts typically do not worry about justifying stock prices by studying the underlying factors that affect firms, like the macro-economic environment, individual corporate management or performance, unlike fundamental analysts.

Rajapaksha said people who predicted a bloodbath were "opposition activists" who do not want the market to do well during a Mahinda Rajapaksa (Sri Lanka's current president) administration and those who were jealous of people making money.

Rajapaksha said speculation and a gambling spirit was inherent in everyone.

"He has not done anything wrong," Rajapaksha insisted. "A fellow pump, pump, pumps the price up, and takes profits. By pumping a share up he is taking a massive risk. What if nobody buys after he sends it up?

"He will have to be holding the share. For taking that additional risk he gets an additional return."

Unfair Values

Arittha Wikramanayake, a former SEC director general, said unsophisticated investors would end up holding dud stocks when prices fell.

A member of the audience quipped that the Employers Provident Fund, a state managed private sector worker's forced savings scheme would buy them.

The fund, which is managed by the island's central bank has been labelled 'buyer of last resort' by some market participants.

Rajapaksha said regulators should ensure disclosure and act against frauds like insider dealers but not comment on prices.

He said speculation was a motive force in markets and not a mortal sin.

Sri Lanka's regulation is based on disclosure. But recent attempts to check volatility, including the slapping of 'price bands' on the most volatile stocks have bordered on merit regulation, according to critics.

Rajapaksha said it did not matter where the demand came from.

"Whoever creates the demand, the demand is there," he said. "People who feel a share is fairly valued, people who see some potential right and that is what creates a market."

Rajapaksha said he stood for a free market and believed in the people's "right to trade without being constrained as if you want a free market."

In general understanding a 'free market' is an economy where state interference is at a minimum.

However concerns have been raised that many of the stocks targeted for technical analysis as well for 'pumping' are illiquid small cap stocks.

In Sri Lanka's market for illiquid stocks, factors essential for competition are far from perfect. Supply is severely limited in most stocks and some of the larger players have market power to set prices.

Critics have also said that there appears to be collusion among larger players who may be creating a false market. The regulator has started acting on suspected cases of manipulation.

Credit

Rajapaksha said the stock market provided a steady supply of equity capital to the economy.

"A free market cannot survive with bank finance," Rajapaksha said.

He said even after the reduction interest rates were too high.

There have been concerns about the excessive amount of credit given to market players to buy equities. The SEC in fact clamped down on the practice but later relaxed the rule following broker requests on the condition that only their own equity would be loaned.

Commercial Bank chairman Mahendra Amarasuriya said regulation was needed to prevent things from going out of control.

He said the banking collapse in the US showed failure of bank regulation.

Rajapaksha said the US problem was caused by a bubble fired by the Federal Reserve which kept interest rates too low for too long.

The US Fed ultimately broke its own bubble by raising policy rates to 5.25 percent. The impact on the highly-leveraged economy was devastating. Economic bubbles are usually fired by central banks and negative real rates, which causes mal investment.

Analysts have warned that stocks are one place where Sri Lanka's mal-investment took place, as the property sector was recovering from an earlier busted bubble.

Sri Lanka also has had low interest rates - by its standards - with inflation overtaking interest rates and saving rates far below inflation.

Sri Lanka however has a pegged exchange rate, and the balance of payments brings a correction even if the central bank does not raise interest rates in time.

If the central bank is unwilling to devalue the currency and 'validate' the inflationary pressure, liquidity shortages backed by rate increases can swiftly kill credit driven speculative behaviour.

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