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Market boom and money printing: A correlation analysis

31 Jan 2021

[caption id="attachment_116979" align="aligncenter" width="1500"] Bull (stock market speculator)[/caption] Sri Lanka’s market boom soon after a “year of human misery” as The Economic Times of India refers to the year 2020, has been jaw droppingly impressive. The Colombo Stock Exchange (CSE) in January 2021 broke its own records achieved years ago and rose to the second best performing stock market in the world.  Opposition cast doubts over the CSE’s record-breaking performances and stated this is either another “pumping and dumping” saga or “money laundering” by the wealthy of the country who were allegedly bringing in all their “black money” that had been stacked overseas to get “white-washed” at the CSE. However, the CSE, the Securities and Exchange Commission (SEC), and the Colombo Stock Brokers’ Association (CSBA) stood firmly by the performance. It should be noted that the boom is also amidst a money printing spree of the Government in the name of so-called “Modern Monetary Theory”. The prevailing economic despair, but a buoyant market, raises a question whether there is any correlation between money printing by the Government and the boom at the CSE. The Market Mine of The Sunday Morning Business is finding an answer to this question.     Money printing in Sri Lanka    In simple terms, money printing in a country obviously means printing the currency of the respective government by an authority approved by that government. The money printing authority in our country is the Central Bank of Sri Lanka (CBSL) under the Monetary Law Act, No. 58 of 1949, giving the CBSL the authority to do so since its establishment. Before the establishment of the CBSL, a Currency Board System undertook money printing in Sri Lanka. The CBSL prints notes at a British company named De La Rue Lanka plant in Biyagama. The Government of Sri Lanka and De La Rue have an established and successful public-private partnership (PPP) that has been operating for over 30 years and the Government owns 40% equity share in De La Rue Lanka Currency and Security Print (Pvt.) Ltd. in Biyagama. According to De La Rue, originally, the site only produced banknotes for the CBSL. Today however, over 80% of the banknotes produced at Biyagama are for the export market. CBSL Economic Research Director Chandranath Amarasekara on 26 November last year stated that the CBSL at that point held Rs. 566 treasury bills or government securities and it rose by Rs. 2 billion more by 30 November. It went up to Rs. 618 billion on 1 December as the CBSL printed Rs. 50 billion more money within a few days. As of 22 January 2021, the face value of the CBSL’s treasury bill holding value was Rs. 724.24 billion.    Chain of events from money printing to market boom   
  • Pumping printed money into economy 
    Printed money is pumped into an economy to increase the money supply for a particular region or the country as a whole and this is referred to as “money creation” or “money issuance”. Another form of injecting cash into an economy is identified as “quantitative easing”. This is a form of monetary policy used by central banks around the world as a method to swiftly increase the domestic money supply and spur economic activity, particularly during an economic crisis. However, unlike “money creation” or “money issuance”, in this scenario, a central bank purchases government securities from the open market using the money that has been printed in order to increase the money supply and investment. These securities add new money to the economy and expand the balance sheet of the respective central bank.     
  • Pumped money leads to lowered interest rates
    Larger money supply lowers interest rates thereby lowering costs of borrowing. American Economist Anna Jacobson Schwartz stated since the cost of borrowing becomes much more affordable when the interest rates are low, it puts more money in consumers’ hands, making them (feel) wealthier, stimulating their spending. As a response to increased spending from consumers, Schwartz says businesses order more raw materials and increase their production to cater to the increasing demand for goods and services. Eventually, business activity increases along with the demand for capital goods and labour.   While increased money supply makes the cost of borrowing lower, it also gives comparatively smaller return on savings. The lower incentive consumers get from savings encourages them to spend on commodities instead of holding onto money or look for investment opportunities that give them higher returns.     
  • Lowered interest rates make the stock market an ideal place for investment
    When the returns on savings are lower amidst reduced interest rates, investors tend to look for better options that could provide them higher returns. Investing in property is the next option for many investors in Sri Lanka. However, according to the CBSL, the Land Valuation Indicator (LVI) of the Colombo District reached 141.6 during the 1st half of 2020, recording an annual increase of 7.1% while on a semi-annual basis the LVI marginally increased by 2% and both annual and semi-annual percentage changes of LVI showed a declining trend over the recent periods, making property a not-so good investment opportunity.     
  • Defensive investment instruments
    And here comes defensive investment instruments, growth instruments, and shares as alternative best investment options amidst lowered interest rates and declining land valuation.  As the name says it all, defensive investment instruments protect the investor’s money through a market or economic slowdown. According to The Nest: “When the stock market or economy are experiencing a downturn, defensive investments can decline in value, too, but defensive investments generally do not experience as much financial loss as non-defensive securities.”  Defensive investment instruments include bonds, inverse funds, dividend stocks, and commodities. Defensive stocks perform well no matter what the economy is going through.     
  • Growth investment instruments
    Growth investing according to Investopedia is a stock-buying strategy that focuses on companies expected to grow at an above-average rate compared to their industry or the market. Growth investors tend to favour small, young companies poised to expand, expecting to profit by a rise in their stock prices. Small cap stocks, technology, and healthcare stocks and speculative investments come under growth investment instruments. Even though there is no proper definition for small cap stocks, analysts have identified that companies with a capitalisation between $ 300 million and $ 2 billion as a small cap firm and companies within this range are at their early stage of growth, which means their stocks might appreciate in price going ahead. Historically, small-cap stocks have made higher returns and when rising back from a recession, these stocks have managed to perform or recover faster than large-cap stocks. Nevertheless, this type of stocks are identified as stocks with a higher degree of risk due to their volatility.  Meanwhile, technology and healthcare stocks are stocks of the companies that develop new technologies or new innovations in the healthcare sector. Investopedia notes that the stocks of such companies that develop popular or revolutionary products can rise exponentially in price in a relatively short period of time. It also quoted an example.  “The price of Pfizer (PFE) was just under $ 5 a share in 1994 before Viagra was released. This blockbuster drug took the company's stock price to above $ 30 a share over the next five years, thanks to FDA (Food and Drug Administration) approval of the drug in 1998. On occasion, a growth stock can go on a wild ride. Streaming media company Roku (ROKU) surged in the months after its initial public offering (IPO) in the fall of 2017, only to retreat towards the closing price from its first day of trading just a few short months later.” The next type of investment under growth investment instruments is speculative investments. Seekers of thrill target high-risk growth instruments such as penny stocks, option contracts, undeveloped land, and speculative real estates. According to analysts, investors who choose the right speculative investment often end up with higher returns on capital which is sometimes much larger than their initial investment. However, there is also a good chance these investors may lose every cent they invested due to the nature of high risk of these investments.     
  • Shares 
    While covering many of the above investment instruments, share investments are mainly categorised into two main types, namely common shares and preferred shares. Preferred shares generally do not provide shareholders with voting rights while common shares do provide at one vote per share owned. According to Investopedia, the dividend yield of a preferred share is calculated as the dollar amount of a dividend divided by the price of the share. Meanwhile, common shares tend to outperform bonds and preferred shares, and is also the type of share that provides the biggest potential for long-term gains.     
  • These contributed significantly to the market boom 
    The Colombo Stock Exchange (CSE) has been breaking records recently and was even recognised as the second best performing stock market in the world by Bloomberg a few days ago.    ASPI crossed 7,000 points for the first time since 2015   The benchmark All Share Price Index (ASPI) crossed 7,000 points on 6 January this year for the first time since 24 November 2015, closing the trading day at 7,036.76 points. The ASPI crossed the 7,000 mark for the first time on 1 October 2010 and reached its highest points level, recording 7,811.80 points on 14 February 2011. The index and overall market activity continued its upward momentum from 2020 onwards with the ASPI recording a growth of 4% in the first three days of 2021 and the market generating a total turnover of Rs. 18 billion. The ASPI has recorded a 66% increase since reaching its lowest point in over a decade on 12 May 2020.  The S&P SL20 index, which includes the 20 largest and most liquid stocks which declined by four points the same day, also gained 2.4% over the past three days, tracking back points losses as a result of the pandemic back in March 2020 to record its highest since 25 February 2020, closing the trading day at 2,703.19 points. The overall market capitalisation of the CSE also grew significantly over the first three days of trading for the year adding Rs. 115 billion and closing the day at 3.08 trillion – which is the highest recorded since April 2018.    Highest market cap ever and number of trades within a day   CSE recorded two significant milestones on 13 January with the market capitalisation reaching an all-time high value of Rs. 3.25 trillion and recording 52,559 trades, which is the highest number of trades recorded within a market day. The number of trades carried out on that day surpassed the previous record of 49,921 carried out on 18 August 2011.  CSE indices and overall market activity continued its upward momentum with both indices showcasing gains and the turnover figure crossing Rs. 9 billion, recording a daily average turnover of Rs. 7.4 billion, eight trading days into 2021. The ASPI gained 160.99 points closing on the day at 7,443.23, which is the highest recorded since 21 August 2015, showcasing a gain of 75% since falling to its lowest point in a decade on 12 May 2020. The S&P SL20 index, which includes the 20 largest and most liquid stocks, also increased by 39 points to close at 2,782.17.    ASPI sets new all-time high – among the best performing indices globally   The ASPI reached its all-time high index tally on 18 January closing the 10th trading day of 2021 at 7922.66 points. The previous highest points figure recorded was 7811.80 points on 14 February 2011. The ASPI gained 188.09 points on this day recording the eighth highest points gain in CSE’s 35-year history.  The S&P SL20 index continued its upward momentum crossing 3,000 points on this day, reaching its highest point since market close on 4 December 2019, gaining 100.32 points on the same day to end the day at 3,003.30 points. The market continued to showcase increased investor interest with the turnover crossing Rs. 12 billion for the second consecutive day recording Rs. 12.18 billion.  The consolidated turnover recorded for 10 trading days into 2021 is Rs. 83.6 billion, which is 21% of the full year aggregate turnover figure recorded in 2020 and 48% of the aggregate turnover recorded in 2019. The total number of trades recorded that day topped the previous record with 67,153 trades carried out within the day. Since the turn of 2021, the CSE ASPI has also been among the best performing primary indices globally on a year-to-date (YTD) basis. As of 18 January, CSE was the best performing primary index listed on Bloomberg on a YTD basis with a 16.95% YTD return.   Officials too gave credit for low interest rates for the market boom   Speaking to The Morning Business on 19 January, CSE Chairman Dumith Fernando stated that lowered interest rates have made the stock market a preferable alternative investment option for potential investors, and as a result, many people are moving towards the stock market. “This movement was also made easy by the recent digitalisation at the CSE. Also, there is now confidence in our economy as it is bouncing back from the pandemic,” Fernando added. Meanwhile, SEC Chairman Viraj Dayaratne PC also noted that the recent performance at the CSE has been mainly backed by lowered interest rates coupled with the digitalised platform. “More and more people are seeing the stock market as a place to invest, and also because of the awareness and the content that is appearing on social media. Also, trading accounts can be created online now, so people can start trading quickly unlike before. There is also a global factor – global markets are doing well. I would attribute the performance to a combination of these reasons,” Dayaratne added. CSBA President Kosala Gamage also attributed CSE’s recent achievements to lowered interest rates and the digitalisation of the CSE. “The stock exchange has been completely digitalised; this has encouraged a large section of youngsters. Maybe they are not pumping large sums of money, but that has created interest,” Gamage told us. Gamage further noted that as long as interest rates remain low, we can expect this record-breaking trend at the CSE to continue.   How long will this last?   As the above officials noted, the boom will sustain as long as low interest rates prevail. The CBSL during the first Monetary Policy Review of 2021 held in mid-January stated that the low interest rate structure is expected to be maintained.    “Most market interest rates have declined to single-digit levels, while some have reached their historic lows. Although deposit rates are not expected to decline further, the high level of excess liquidity in the domestic money market leaves sufficient space for market lending rates to adjust downward, thereby providing low cost funds to the economy,” the CBSL noted.  Further it added that the expansion in money and credit supply observed in the latter part of 2020 is expected to continue in 2021 supported by persistent low interest rates, yet notable inflationary pressures are unlikely, given the slack in the economy. “Credit to all sectors of the economy is expected to gather pace in 2021 supported by the continued decline in lending rates, implementation of special loan schemes at low interest rates, along with the rising demand for credit, driven by improved investor sentiment and the envisaged revival in domestic economic activity,” the regulator added further. Even though digitalisation of the CSE platforms and booms in foreign markets contributed to the prevailing boom at the CSE, the main factor that contributed to the record-breaking performance is lowered interest rates, which is in turn a result of excessive money printing by the Sri Lankan Government. 


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