Mar 2016 Financial News

Stock market boom in 2015 was not a bubble - BOJ

Mar 09, 2016

The Bank of Jamaica (BOJ), in an assessment of the performance of the Jamaica Stock Exchange (JSE) in 2015, has concluded that the extraordinary upsurge in stock prices during the period did not constitute a bubble or other phenomena unrelated to market fundamentals.

“A technical examination of the recent stock market appreciation,” was published this week as a part of the quarterly monetary policy report for the period ending December 31, 2015.

During 2015, as noted in the analysis, the JSE Main Index increased by 97.4 per cent “to an unprecedented level”, while the value of stocks traded increased by 400 per cent to $64.6 billion from $12.8 billion.

Most of this value change in the index — 71.0 per cent — occurred in the last three months of the year.

The acceleration, the BOJ said, “raises the question as to whether the upswing has been predominantly driven by sound economic fundamentals or fuelled by speculation”.

The report defines a stock market bubble as “significant growth in asset price that is unrelated to changes to its fundamental value”.

Said the BOJ: “A number of factors could create a stock-price bubble but two common causes often prevail. These are a sudden influx of funds in the financial system and herding behaviour based on market speculation on future price increases.”

The central bank says bubble-driven stock price growth creates “undesirable consequences for the economic system”, as when this bubble “bursts” there will be a “reversal of any initial wealth effect, lowering consumption spending and reducing the ability to repay debt — which will weaken economic activity”.

The bank further opines that negative consequences from a reversal is linked to the degree of leverage and debt used to fuel previous asset purchases.

As to the fundamentals on which stock price should be based, the BOJ said that stock market prices should broadly reflect future profitability and, as a result, potential dividends offered by the participating businesses.

“Stock prices should also be influenced by the discount factor which itself is determined by, among other things, the inflation rate, the risk premium, level of liquidity, and investors’ time preference of consumption,” the central bank also qualifies.

Referencing the Generalized Sup Augmented Dickey-Fuller (GSADF) test, the BOJ said that when applied to stock market data, the test indicates the existence of a bubble “if there is a significant measurable divergence between stock prices and dividend payments”.

The BOJ used data on end of quarter prices and dividends paid within each quarter by firms on the JSE Main Index to calculate price-to-dividend ratios for each quarter from the December 2007 quarter to the December 2015 quarter.

The conclusion was that there was no bubble in the market activity during 2015.

“The GSADF tests on this sample provide no evidence that the recent stock appreciation in 2015 reflects an asset-price bubble. These findings are consistent with observed price growth that has been mirrored by growth in dividends,” it concluded.

The bank adds several caveats, the first of which is that even where movements in stock prices are shown to have been driven by fundamentals, there is “still some probability of a large unforeseen negative price movement”.

Secondly, it said, stock-price movement, particularly in developing markets such as Jamaica, can be easily influenced by non-domestic market factors. Third, it said identification of stock-price bubbles is not a perfect science.

Explaining its reasons for the investigation, the BOJ noted that prices of financial assets influence the allocation of economic resources. It added that policymakers are interested in understanding the developments in price behaviour and asset valuation as these inform monetary policy.

 

Source:
Jamaica Observer
Wednesday March 9, 2016    

http://www.jamaicaobserver.com/business/Stock-market-boom-in-2015-was-not-a-bubble---BOJ_53937