Closing the stock markets is naive reasoning at best
2 min read.Updated: 23 Mar 2020, 11:13 PM ISTVivek Kaul
One school of thought that has emerged over the last few days suggests the stock market should be shut down to prevent a further fall. Mint takes a look
How much is the latest fall vis-à-vis earlier?
The biggest fall of Sensex before this was 12.8% on 28 April 1992. This was in the aftermath of the Harshad Mehta scam that had hit the stock market then. On 17 May 2004, the Sensex fell 11.1% after the Sonia Gandhi-led United Progressive Alliance registered a surprise win in the Lok Sabha elections over the Atal Bihari Vajpayee-led National Democratic Alliance. In fact, such a big fall wasn’t seen even when the financial crisis broke out in mid-September 2008, with Lehman Brothers, the fourth-largest bank on Wall Street, going bust. On 24 October 2008, the Sensex had fallen 11%.
What’s the idea behind closing stock markets?
With a lockdown currently enforced in Mumbai, employees of stock exchanges (BSE and NSE), along with employees of stock brokerages and other financial institutions that support the functioning of the stock exchanges, are finding it difficult to reach their workplaces. Besides, there is a fear of the further spread of the coronavirus infection. Many investors feel that if stock markets are shut down, investors will stop selling, share prices will stop falling and, in the process, the indices, which represent the overall state of the market, will also stop falling. This is naïve reasoning at best.
Why is shutting down the stock exchanges a bad idea?
Stock markets do not wait for things to happen. They discount possibilities in advance. Let’s say the stock market regulator decides to shut down stock exchanges. If investors get a whiff of it, there will be an en masse sale. The regulator will end up creating precisely the situation it was trying to avoid. This can’t possibly be a good thing.
Any other reasons why closure is a bad idea?
People and institutions invest in stocks because of their liquidity. Liquidity can be defined as the fact that investors can get in and out of stocks at any point of time.This is something that needs to be always taken into account, so that the overall trust that investors have in the functioning of stock markets is maintained. Also, if the stock markets are not shut down when they are going up to levels not justified by company earnings, why should they be shut down when they are falling?The logic needs to be consistent both ways.
How much more will the Sensex fall?
Many stock market experts are of the view that the worst is behind us. But the point is, does anyone really know? The Sensex has fallen 38.1% from a peak of 41,952.63 points on 14 January. In 2008, it fell from 20,873.33 as of 8 January to 8,451 as of 20 November—a drop of 59.5% in a little over 10 months. While the stocks that make up the Sensex have changed since, history tells us that markets have seen worse and that the worst may still not be behind us.