By Granville Perera –

The market is seen buoyant with stocks rallying up. The overall market sentiment is positive. This sums up the current outlook of the share market. As the CSE flirts at Institutional investors/manipulators etc, some commentators may say that the market is getting a bit overheated. But are we at the verge of a burst of a bubble as that happened not so long ago? Clearly not so, I believe. The good news the Market is led by fundamentally strong stocks.

The current situation does not look like a market top. Market tops are usually associated with excessive speculation on fundamentally week stock and irrational investor exuberance, neither of which characterizes the present market. However, interim market corrections are, in my opinion, to be expected.

On a closer look at the current rally, it is explained on a large part by the low interest rates – the lowest that had prevailed for at least the last 30 years.  Investors are looking for viable avenues of investment, offering a decent return and, as can be expected, they are channelling a sizeable proportion of their investments into stock. However, this investor quest for higher yield has not so far driven them into riskier shares.

Foreign funds too seem to be finding home in the Sri Lankan capital market. This infusion is to be welcomed as a demonstration of confidence in our market.

However, it is not news that our stock market is to a large degree illiquid, in that, the free float of most company shares is a single digit fraction of their issued number. This illiquidity coupled with the high demand for fundamentally strong stocks have led the prices of these stocks to soar. Fundamentally strong stocks are trading at lofty levels with PE ratios of approximately 20 times over earnings. With the market actually outpacing the actual growth of the economy, the probability of a market correction, it seems, is rising. This, in my opinion is not going to be a repetition of the crash of two years ago or the start of a bear market.

The lurid fall of two years ago was the result of an orchestrated rally of primarily weak stock. In fact, some notably weak shares were trading at alarmingly high rates of over a staggering 1000 over earning. And these stocks which were fundamentally weak were leading the market. The market at the time, in no uncertain terms, was unhealthy and could not have been sustained.  The crash from 7800 to 4500 points was no surprise to those versed in share markets.

The investors were hooked on easy money and that made them to ignore the real vulnerabilities that were lurking. Innocent investors walked unaware into a market that was tottering on the verge of collapse. A collapse that was propelled by the manipulation of bed ridden stock.

What would have the market been today if not for this collapse? , one might question.  If prices of these weak stocks were not manipulated, the market would have plateaued at around 6000 points and held ground. A rise from 1500 points after the ending of the war opened up an otherwise suppressed market.  At 6000 points, commentators avow, the market would have displayed a healthy PE ratio and remained in essence strong.  Such a  fundamentally strong market would have ensued  to reach 10 to 11,000 points today , over the course of two and a half years of a modest average growth 25% with the impact of the war victory. The market capitalization, it is estimated, would have been over a staggering Rupees five trillion!

It serves well to stop and deliberate over the loss of “value creation” occasioned by this very preventable and foreseeable crash. The Sri Lankan economy lost some two trillion by it, which is equivalent to the cost of 40-50 Katunayake express highways.

Looking at the recent data on stock valuation and corporate performance as a whole, a market correction is to be expected. This is not the start of a bear run. However, both investors and regulators must be vigilant to detect overheating fuelled by manipulation of frail stock. It has happened before and can thus happen again.  Given the lack of liquidity in our market, this is a real danger with severe ramifications. So let the “bull run” but not go on rampage.