Avoid the herd!

* Be weary of speculative stocks, brokers urge investors

The Colombo Stock Exchange is beginning to surge once again but brokers are advising investors to seek fundamentally strong counters and not follow the ‘herd’ in investing in speculative stocks.

Herd instinct saw many unsophisticated retail investors fall pray to market manipulations when the bourse surged after a decades-long conflict fuelled both by positive sentiments and a loose monetary policy.

Share prices of some counters had surged considerably, although the fundamentals of these companies did not warrant such a move. These stocks were called ‘penny’ stocks, ‘junk’ stocks and/or ‘speculative’ stocks by brokers.

These stocks, whose prices were less than Rs. 10 at the beginning or end of quarter, reported an annualised share volume velocity of 17 percent during the 09Q4, surged to 135 percent during 11Q2. The volatility of returns of penny stocks as at 11Q2 reached 21 percent, whereas the overall market was at 5 percent, an analysis by JB Securities showed.

The capital markets regulator, the Securities and Exchange Commission took several measures to contain an overheated market and began investigations into market offences. A group of influential investors and their crony brokers have lobbied hard to impede the SEC, resulting in the resignations of two chairpersons under a year, and the removal of a Director General. It was these investors who leaked to the media that the SEC was investigating market offences.

After investigations, the SEC took action against several investors and brokers last year which were reported in the media and in these pages. There are 17 investigations pending and the new SEC Chairman Dr. Nalaka Godahewa has said he would see these through.

The bourse began to fall considerably because underlying macroeconomic fundamentals began to put pressure on interest rates and liquidity was tightened. Investors who had bought stocks at inflated prices could not offload them and ended up sustaining losses. Some blamed the regulator for this, but others realised that it was largely due to macroeconomic developments (see last Monday’s—August 27—The Island Financial Review, where the market grew despite SEC directives to curb overheating).

With the market expected to boom in coming weeks, brokers are cautioning investors.

"The upswing in the market continued (last) week as well with the re-activation of retail investors. Interest in speculative counters jumped while blue-chip interest also continued side by side. The stable interest rate outlook and the appointment of the new SEC Board seem to have brought back confidence among the retail segment of investors," Softlogic Equity Research said.

 "At a moment where market fundamentals are strong, investors are advised to select counters with strong valuations instead of following the herd on the speculative lot," it said.

"Investors should be cautious when they invest. They should buy shares that they would be happy to hold even if the market was to slump, that is the key. There are dud stocks that some investors are trying to offload, so be careful. The stock exchange is a good place to make money, but being hasty and impatient would not do anyone any good. The country’s economy looks bright and there are good times ahead, think of this when investing too. Avoid the herd, and don’t put all your eggs into one basket," one broker said.

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