Record-high stock market: Najib's election year manipulation or global phenomenon?

Speculation is rife that Malaysian Prime Minister Najib Razak will soon call for snap general elections, with government insiders citing a slew of positive factors including returning public confidence in his leadership.

Now whether this is true or not, the country's benchmark share index is certainly behaving like a typical election-year stock market - typical for Malaysia anyway.

On Monday, the FBM KLCI, hit a new record high of 1,603.96 points, boosted by positive news of infrastructure, oil and gas deals although trading volume was only moderate.

While technical analysis and the charts predicted this, many fundamentalists were puzzled because just the week before the Malaysian authorities had to peel back Najib's own overly rosy growth forecast made less than 6 months ago. Malaysia's GDP is now forecast to grow at between 4-5% in 2012 instead of 5-6% as Najib had previously announced.

So, is there some sort of artificial support going on in the Malaysian market so as to give a false sense of confidence and dupe voters that the Najib administration is indeed performing marvelously? Maybe there is. It is after all not difficult to manipulate the FBM KLCI given that it is basically dominated by Government-Linked-Companies or GLCs, which are in turn managed by political appointees rather than hard-nosed market professionals.

Be that as it may, what's happening in the local market - while it may be exaggerated by election-speculation factors - also tracks what is happening in the bourses around the world.

Bullish biased

If we look at the charts of most stock markets in the world, the trend seems to be bullish biased. It is always bullish and will remain so in the future. Just look at the following 50 years chart. The Dow had been going up since the 1960s and is still going up because it is always long term bullish biased.

The question is how can the market be so bullish when economic data suggest otherwise?

For example just take a look at America’s problems which include $15 trillion in funded and $135 trillion in unfunded debts, budget deficits of more than $1.3 trillion in 2011 fiscal year, more than 8.5% unemployment rate, 46 million Americans on food stamp, Debt/GDP had already surpass the 100% mark, 23 million workers are either unemployed or underemployed and the lists can go on and on ad infinitum.

How can the Dow Jones be trading at about 13,200 (03/04/2012 closing) which is only less than 1000 points from the all time high of 14,164 points? And yet most of our portfolios are no where near all time high, in fact most of them are now below last year’s level.

In one of my previous articles ‘The Danger of having a Weak Economy and a Strong Stock Market’, I discussed the issue on market overvaluation and why the need for it. Now I am going to show you how they do it.

Overvaluation and the need for it

I am sure a lot of us are frustrated at why our stocks are not making new highs but in fact a lot of them went below the price that we bought?

Take for example yesterday the Indonesian market, their Composite Index IHSG managed to close at an all time high of 4215 after besting the 4196 level, which is set on 01/08/2011. The market performance was 124 Up, 120 Unchanged and 202 Down. Since the Composite made an all time high, why are there more down than up counters? Why most stocks did not test their new high? In fact they perform worse than last year. The answer can be found in the following.

1) Firstly, new stocks are added every year through IPO. At the meantime old stocks that are not performing or went into bankruptcy are delisted from the exchange. There are more new stocks added to the list than being taken out and hence the list of stocks grows every year. The Darwinian Law on survival of the fittest also applies to the stock market. Hence every year bad and poorly performed stocks are taken out of the list and new and healthy ones are added to the list.

If you look back at the records of Dow Jones for the last 100 years, less than 3% of the stocks managed to maintain their original name. For the past 50 years only less than 10% managed to do that. What does this tells us? A lot of the companies did not survive intact throughout the years, many of them either delisted, gone during a Merger, Acquisition or being Takeover exercise. And again along the way many new stocks are added while old ones are pushed out from the list

This is one of the reasons why the stock market is always going up.

2) Secondly, the Composite Index is made up of only a handful of Stocks. Like the Dow is made up of 30 stocks, KLCI has 100 and so on. Normally these stocks have large market capitalization and hence also their weightage on the Index. Again it is the same old story, ‘not performing or tired’ stocks are taken out of the group and new ones are added into it. So this can be regarded as cheating and they can do continue doing this as long as the index keep going up.

This is also similar to Hedge Funds when they apply survivorship bias in their reporting. Since they are not under the jurisdiction of the Securities Exchange they are not required to report to them. In other words, they are free to cook their books. Under perform quarterly figures are discarded from their annual reporting and hence their reporting is always better than their actual performance.

So why do they want the market to go up? In my earlier article I mentioned that an overvalued market benefit everyone from the stock brokers to the politicians. Only us suckers got squeezed in the end because when the music stops, we are the ones will be the last to leave the party.

3) Thirdly, we only have ourselves to be blamed. Due to the propaganda by the market promoters and propagandist from the corporate mainstream media we are more or less afflicted with a disease called ‘Normalcy Bias’.

Normalcy Bias refers to a situation where the mental state of the people failed to estimate the possibility and effects of a disaster that is looming. When facing a stock market crash instead of taking evasive action to cut loss we tend to focus on the unexpected event and enter into a state of paralysis. It is normal for investors to be overwhelmed by losses and hence failed to do the right thing and that is to get out of the market. This is because we are constantly fed with ‘good and soothing’ stories by the mainstream media and condition our mind to accept that things are always in good hands and order. Consider the following quote,

"The man who never looks into a newspaper is better informed than he who reads them; inasmuch as he who knows nothing is nearer to the truth than he whose mind is filled with falsehoods and errors." – Thomas Jefferson

Market manipulation

So what lesson do we learn from here? How can we counter this kind of market manipulation? One way is to imitate what they do. Remember how they frequently tossed out bad stocks and replaced them with good ones? The reason being that the Composite Index will always make up of good and healthy stocks and hence will always go up.

So in order to beat the market we need to do the similar thing and that is to ‘chuck the bad and keep the good ’stocks in our portfolio. Remember to rebalance our portfolio every 3 months and I can tell you your portfolio will perform much better than what you expected.

Later, I will be addressing the issue on ‘Why using Fundamental and Technical Analysis produce mediocre performance in The New Stock Market?’

Malaysia Chronicle