Capitalmind
Capitalmind
Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial
Commentary

Good Things Happen, Because Bad Things Are Allowed To: Karachi Stock Exchange Version

Good-things-happen.jpg

Markets are going to be volatile, because that’s by design. If you curtail volatility, forcibly, it doesn’t end well.

Oh, and people have tried.

In Pakistan in 2008, they framed a rule: markets cannot go down. Meaning, stocks prices would have a lower bound, limited to the price of the previous day. You couldn’t bid the price down below that price. This was set by the SECP, the securities regulator of Pakistan.

This soothed some fears as the Karachi Stock Exchange index had already plunged from 15,000 to 9000, with a 15% drop in a week. If you don’t allow prices to go down further, then life would be so much better!

A strange thing happened. There were just no buyers for stocks. People wanted to buy, no doubt, but not at current prices. And without a buyer, there was nothing a seller could do but to place his orders at the lowest possible number – the high of the previous day.

Between September and December 2008, as the world was crashing and burning (the NSE Nifty fell about 40% in this period) the Karachi Index was at exactly the same level, because no one was willing to buy higher, and you were not allowed to sell lower.

When reality dawned, and apparently it took three months then, the authorities decided to remove the price “freeze”. Consequently the stock market dropped another 40% and only then stabilised and returned to go up more than 10x from the lows.

KSE Freeze on stock prices Pakistan 2008

Of course, that time looks tiny in the expanse of time, but look at how the index moved after it fell (and it fell over 50% from the “freeze” levels)

Note that carefully: After they unfroze prices, the market plunged ANOTHER FIFTY PERCENT.

That’s like saying, stop me and I’ll make things a lot lot worse than I can.

Pakistan exchange long term chart

Even now, the stock market there has fallen about 40% from the peak, but hopefully, people there have learnt the lesson: If you set a lower bound to prices, you’re actually setting an upper bound to prices.

Context: In India, there’s talk of creating a stressed asset holding vehicle for unsold houses and apartments. Even Raghuram Rajan said this recently. And that, when residential house prices have barely fallen! This sort of protective outer covers will do nothing but set up a temporary lower bound which will eventually become an upper bound because no one will want to pay more. And that asset pool has to come to the market someday anyhow. India loves real estate, and will lap it up at prices 30% to 40% below, if they are made available – buyers exist when you let prices drop enough.

I love quoting Finding Nemo – that’s a treasure trove of quotes. In a scene, when Nemo’s father, Marlin, is depressed when he can’t find his son, because he’d promised to not let anything happen to Nemo. Dory says, “Well, you can’t never let anything happen to him. Then nothing would ever happen to him.” 

The point is that good things happen, because bad things are also allowed to happen.