Lessons from meltdowns

Investors, in particular retail investors, should be vigilant and not be carried away with market rumours or stocks in play due to the meteoric rise of a particular stock.

TIME and again, the local stock market experiences a major meltdown related to certain companies whose share prices plummet as they hit one limit-down after another.

The catastrophic nature of the selloff typically spreads to other stocks perceived to be manipulated or held up for the longest time, creating a contagion impact.

In the 1990s, the stock market’s frenzy was led by companies like Repco Holdings, Aokam Holdings, Hwa Tai, PWE Industries, Cash, Idris Hydraulic, Sin Heng Chan and North Borneo Timber, whose share prices come crashing down.

Repco and Hwa Tai even had the distinction then of being among the most expensive stocks in the market with share prices above RM140 and RM200 per share, respectively.

In the mid-2000s, we had another round of major market selloffs and this time it was the emergence of new manipulated stocks, which among others, were Fountain View, Liqua Health, Suremax, DVM Technology, Iris Corp and Lii Hen Industries.

According to reports on some of the companies then, the share price increases were carried out via manipulative activities conducted through a complex layering of the origination of the orders and transactions.

Those involved collectively used numerous trading accounts to create an artificially strong demand and one that did not result in any change of beneficial ownership of the companies involved.

Some of those involved were caught and sentenced to fines and imprisonment, but in other cases, those involved were acquitted on appeal, or by merely paying a measly fine.

Fast forward to 2024 and we have again witnessed another round of major market selloffs involving some companies.

What we have witnessed since the start of the year, and more so last week, is some sort of contagion impact from one particular group of companies linked to a particular individual to other companies, as the rug was probably pulled out for these stocks where some hidden hands have been propping up the shares of the companies for the longest time.

UMA ineffective

In some of these companies, their share prices were slowly brought up to a level over a period of one year, held up so well almost daily for about six to seven months, and then, out of a sudden some weakness began to emerge and the stock prices failed to close at the elevated level, and in the last month or so, the stock went down 80% to 90% from the peak levels with increased market volume.

When there is a sudden surge or collapse in the market price of a listed security, it is not unusual for Bursa Malaysia to issue a query to the listed company to explain the reasons behind the significant price movement.

Unusual market activity (UMA) falls under Bursa Malaysia’s Main Market listing requirement under paragraph 9.11.

Where unusual price movements, trading activity, or both occur, a company must immediately undertake a due enquiry to seek the cause of the unusual market activity in its securities and disclose accordingly.

In most instances, other than potential deals in some cases whether big or small, UMA usually attracts a standard response whereby the company would likely respond by saying it is unaware of the reasons for the sharp movement in its share price, whether up or down.

Margin financing

As listed securities are traded daily and have a market value, some shareholders (both majority or even minority) may have taken financing using their shares as collateral at a time when the market prices were rising or at their peak.

This could have been done with either a group of investors or directly with broking firms or even banks.

According to Bank Negara’s statistics, share financing activity is relatively small when measured against system loans or even the market capitalisation of Bursa Malaysia.

Based on the latest available data, financing provided by the banking sector for the purchase of securities stood at RM80.9bil as at the end of November last year.

This represents 3.8% of total bank lending and approximately 4.6% of the total market capitalisation of Bursa Malaysia.

However, as share financing is based on margin and assuming a margin of 60% is rather common, the value of share financing is equivalent to 7.7% of Bursa Malaysia’s total market capitalisation.

It is all well and good when margin financing is provided based on certain observable criteria which allows those providing the financing some leeway should share prices drop from the price level when the financing is provided.

But if the share prices cannot be sustained, or if the facility has not been serviced in the form of interest payments, the lenders or brokers would have no choice but to either call for a top-up in the margin account, failing which, a forced sale is carried out in the market to cover the shortfall.

When prices fall rapidly, it will be a race to the bottom as margin calls will continuously be made until the situation is stabilised. In a worst-case scenario, the major shareholder may even lose all his holdings to the market as lenders are forced to sell down.

Fundamentals matter

The recent episode is not the first, and perhaps not the last time, for our market to observe such a massive meltdown of certain individual stocks, which could also trigger a loss of confidence among investors. But every meltdown teaches us a lesson in investing.

Firstly, investors, in particular retail investors, should be vigilant and not be carried away with market rumours or stocks in play due to the meteoric rise of a particular stock. Two, chart-wise, these stocks will look superb on the chart and will attract the newbies, but at the end of the day, it is the fundamentals that matter. Therefore, investors should carry out their homework before investing and understand the company’s business, earnings, balance sheet, debt level, prospects, factors that could influence the company’s performance, management and the who are the major shareholders.

Three, avoid investing in stocks that are being churned, especially if it is a group of stocks with the same shareholders behind. Fourth, this goes to the bankers, brokers, or those providing margin financing. Please review how these facilities are granted as looking at the top 10 or 20 most active stocks is certainly not the answer to the liquidity of the stock as the liquidity will dry up when the music stops.

Elevated price levels too are not a reflection of true value as providing margin financing based on market price may be flawed if the fundamentals do not justify such market prices.

A high market price, for example, for a company like Nestle (M) Bhd that trades at RM120 per share is very different from using the same margin facility guideline for another company that has weak fundamentals but trades at lofty valuations.

Regulatory action

In response to the recent mayhem, both Bursa Malaysia and the Securities Commission (SC) issued a joint statement that it would continue to conduct proactive surveillance of corporate transactions and disclosures, as well as real-time monitoring of all trading activities to ensure an efficient, fair, and orderly market. The SC and Bursa Malaysia also reiterated that it will not hesitate to take the necessary regulatory actions to preserve the integrity of the market where irregularities are detected.

Separately, Bursa Malaysia in response to another query by a weekly business publication, also highlighted that they do have a dedicated team of analysts, supported by its surveillance system, who are fully equipped to identify and mitigate any instances of manipulative trading activities in real-time.

It also said that it has a broad range of measures to intervene should any irregular trading patterns be detected and mitigate such activities.

While, the statement from Bursa Malaysia is reassuring, and rightly so, the failure to see the patterns in some of the recent stock sell-off before the meltdown is left much to be desired.

In some of the cases that we have seen, there are clear signs that the company shares have been manipulated for the longest time. In some of them, they were just recently listed and the stock price has tripled in such a short time.

Certainly, there are hidden hands in this type of movement and Bursa Malaysia should investigate if manipulation has taken place.

We cannot afford to have another mayhem or situation where investors lose their pants in trading where hidden hands have been keeping the stock prices high for a foreseeable time using all sorts of methods, including the pump and dump method.

Remember, the minority shareholders of Serba Dinamik Holdings Bhd are still licking their wounds while the perpetrators behind the fiasco walked away with some measly fines.

Curbing manipulative trading activities is paramount in restoring market confidence.

Pankaj C. Kumar is a long-time investment analyst. The views expressed here are the writer’s own.