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Whilst the short-term effectiveness has been proven for trading halts, history suggests otherwise for market shutdowns. During the 2011 Arab spring, the Egyptian stock markets remained closed for eight weeks amidst the political crisis. However, when reopened the index dropped by 10% and displayed extremely high volatility
By Rohan Senanayake
Stock markets across the globe are responding with fear and volatility as COVID-19 pandemic continues to cause panic and uncertainty on all market participants. Some global markets shut down, and some halted as circuit breakers triggered as traders started to panic sell-off their positions worrying a market collapse.
Trading halts and shutdowns have been very rare across the globe. There is no evidence on the effectiveness of a market shutdown, however, there is evidence for the short-term effectiveness of automatic interventions such as circuit breakers and market halts. The NYSE Composite index on the NYSE triggered the circuit breakers on 9 March at 11,298 points, resulting in a market halt, however on 10 March, the stocks rebounded with the index rising by 4.38%.
Whilst the short-term effectiveness has been proven for trading halts, history suggests
otherwise for market shutdowns. During the 2011 Arab spring, the Egyptian stock markets remained closed for eight weeks amidst the political crisis. However, when reopened the index dropped by 10% and displayed extremely high volatility.
A similar pattern can be witnessed analysing the Philippines, as well as Chinese stock markets that were closed due to the COVID-19 pandemic when reopened after the shutdown. The Philippines was the first to shut the markets following the COVID-19 breakout. On 17 March, the regulators decided to shut the market and it was reopened after two days on 19 March.
However, when reopened the stocks plunged 13.3% as foreign investors as well as local investors rushed to exit from their holdings. Foreign investors sold $ 480.5 million net of local stocks this year and this has been recorded as the fastest withdrawals since Bloomberg began tracking the data in 1999.
Chinese authorities extended the Lunar New Year break by three days thereby being able to keep stock markets closed starting from 24 January to 3 February. The Shanghai Composite plummeted 7.7% and the Shenzhen Component Index fell nearly 8.5% on their first day of trading as markets reopened on 3 February.
The effectiveness of a market shutdown can be evaluated based on the volatility of the market prices. If the volatility reduces than if the markets had been opened, then the shutdown could be concluded to be an effective shutdown. It would also prove that the market participants were panic sellers following the herd mentality trying to dump their holdings fearing market collapse.
Also it can be argued that the shutdown provided time for the information to flow so that the market participants could take level-headed decisions and rethink on their investment strategies. However it can also be argued that Government-mandated shutdowns can make the situation worse.
This is clearly prevalent in the Sri Lankan stock exchange after the four-day shutdown from 16 – 19 March. The situation clearly portrayed the panic and fear that had been building up as the stock exchange plummeted when resumed for a shortened trading day on 20 March.
A very important point to note is the notion going around that a falling market means the valuations of the companies are irrational and deeply discounted. What needs to be noted however is that these companies will most definitely be facing lower earnings and discounted multiples; therefore the low valuations can be justified with the fallen prices.
On another note, the markets been closed for such a long period of time is a negative signal to foreign investors who could conclude that the market is not necessarily a free market and cannot be relied upon which would risk foreign investments in the future.
Analysing the frontier markets prior to the COVID-19 pandemic, it was evident how all the frontier markets were witnessing net foreign sell offs as investors withdrew their holdings from riskier markets to invest in US stocks and the dollar started to appreciate.
Another point to note is that a trading halt can create an inefficiency in the market. There will be a delay in the stock prices to adjust for any fundamental information that comes in during this halt. In general, the markets should be open to allow the demand and supply to discover the price. This creates uncertainty in the mind of investors over time as they question the accuracy of the price afterwards.
The frontier markets have witnessed a large percentage of negative foreign purchases. Even in Sri Lanka this has put a lot of pressure on the rupee. Sri Lanka has kept the markets closed for the longest period of time in comparison to other countries during the COVID-19 pandemic.
Whilst majority of the other markets face volatility, the markets still remain open to allow for the free flow of liquidity and price discovery through its natural price mechanism. It needs to be agreed that Sri Lanka has a long path to recovery and it is important that we keep our avenues to foreign investment open.
Whilst it is respected that the Government is focusing on the health and betterment of the citizens, it is also important that the regulators look into the economy and financial stability of the country when making decisions.
A point that needs to be noted is that as the CSE is operated on an electronic platform, and it›s very much possible to keep a market open without the involvement of many trading staff at the floor. The manner in which many stock markets operate currently is evidence for this.
The settlement risk, which might be a concern in this instance, can be addressed by independent stock broking companies by taking necessary steps by resorting to online payment methods such as RTGS and CEFT transfers to mitigate the settlement risk. Any client that finds it difficult to find an effective payment methodology should not be given the ability to purchase, but should be given the flexibility to divest their investments at their discretion.
The most important point to note at the moment is keeping a stock exchange closed for so long can create a negative sentiment among the current as well as future potential investors to this market. This is something that we as a frontier market needs to keep in mind. The continuation of this will result in the stockbrokers as well as the entire country facing many challenges for the times to come.
