This article first appeared in The Edge Malaysia Weekly on January 22, 2024 - January 28, 2024

WHEN asked about the financial fiasco of 1720, known as the South Sea Bubble, and the surge in The South Sea Company’s stock price, Sir Isaac Newton famously responded, “I can calculate the motions of the heavenly bodies, but not the madness of the people.”

Perhaps this popular investment anecdote aptly sums up the recent selldown in certain small-cap stocks on Bursa Malaysia over the past two weeks.

Last week saw the shares of 11 companies, including Jentayu Sustainables Bhd, Sarawak Consolidated Industries Bhd (SCIB) and Silver Ridge Holdings Bhd, hit limit down and receive an unusual market activity (UMA) query from the bourse regulator. Intraday short-selling (IDSS) was suspended for five stocks given the persistent heavy selldown.

The week before Rapid Synergy Bhd hit limit down, its sister company YNH Property Bhd and Imaspro Corp Bhd saw heavy selldowns. Bursa Malaysia froze the lower limit of the share prices of Rapid Synergy, SCIB and YNH following a sharp plunge in the counters.

Often referred to as one of the largest asset bubbles and speculation manias the world had ever seen, the South Sea Bubble led some of the greatest thinkers of that era to succumb to its allure. Estimates vary, but Newton, one of the greatest geniuses who ever lived, reportedly lost as much as £40 million in today’s money in the scheme.

The sell-off of these small-cap stocks on Bursa is far from being as catastrophic as the South Sea Bubble. Nonetheless, some quarters see it as the bursting of a valuation bubble, given that most of the share prices had doubled or more over the past 12 months before the equity bears emerged.

Last Friday, the Securities Commission Malaysia (SC) and Bursa said in a joint statement that they were closely monitoring the recent market conditions amid the heightened volatility in certain stocks.

To calm the jittery sentiment, particularly among retail investors, the regulators insisted that the significant decline in share prices was limited to a few small-cap stocks and was not widespread. They highlighted that the affected counters made up about 0.17% of the total market capitalisation of the local bourse and 8.3% of the total traded value for the year.

“The SC and Bursa Malaysia assure investors that the Malaysian stock market’s fundamentals remain strong and there should not be any cause for concern,” they stressed in the statement.

Nonetheless, the increasing number of stocks on a slippery slope has puzzled the investing fraternity, who want to know the cause of such an intensive sell-off. Did the banks and brokers pull margin lines? If they did, what were their reasons? And why now?

After talking to stockbrokers, investment bankers and fund managers, The Edge looks at some possible scenarios, gleaned from previous episodes of similar meltdowns.

A heavy selldown could be caused by shares that are kept under “warehousing activities”, which in general are legitimate. Warehousing refers to individuals holding shares on behalf of another person.

Usually, such activities come with put and call options for the individuals to sell the shares to whom they have held on behalf of. In return, these individuals charge a fee of 8% to 10% of the investment value for carrying out the warehousing activities.

However, if the transaction does not pan out as planned, things are likely to turn ugly. Individuals who carry out warehousing activities and do not manage to exercise their put option to sell the shares may have to dump them on the open market, especially if their cash flows are getting tighter as they continue to hold on to the shares.

“If your shares are wrapped up nicely within your warehouses and between people you know, then you could be fine. But if your shares are parked with outsiders or under margin, then you will be in trouble,” a stockbroker explains.

Warehousing activities are usually short term, in the range of three months to a year or so. Stockbroking houses and investment banks provide financing for these activities.

For longer tenures, investors buy shares using a margin financing account that is funded by a stockbroking house or investment bank. Investment banks or stockbrokers could pull the credit line for margin financing for various reasons, including financial troubles at the company or of the margin account holders, a change in stock market conditions or even the economic climate.

In this scenario, investors will receive the so-called margin call, asking them to top up their accounts with cash. If they fail to do so, the financial institution will force sell their shares.

“Many names are hit down by margin calls and reduce margin capping, and hence create a contagion effect on other counters. This is a typical knock-on cascading effect. One broker does it and it sets a trigger,” says an investment banker.

The investment banker cites a scenario where related stocks succumb to selling pressure at the same time. This could happen because the common shareholders use the same credit lines to finance their margin accounts and are possibly similar groups of warehousing individuals. When the credit lines are tightened or pulled by financiers, it will trigger the forced selling of these stocks together.

“While pledging listed securities for financing is rather common, it is risky if substantial amounts of securities are pledged to external parties,” Tradeview Capital Sdn Bhd CEO Ng Zhu Hann tells The Edge when asked about the cascading effect of margin calls.

This is because when there is a triggering event such as a margin call that leads to forced selling, it will cause a domino effect whereby all shares pledged by various parties have to be redeemed immediately. Otherwise, the financial institution has the right to dispose of the pledged shares on the open market indiscriminately.

“This will drive the share price down fast and furious with no support whatsoever, especially if the listed companies in question do not have any fundamentals such as earnings, yield or assets to support their valuations,” Ng elaborates.

Amid the sell-off, investment banks, one after another, will require cash up front to buy certain stocks and warrants. Some even go as far as to disallow the trading of selected stocks, while others advise their clients not to trade certain counters due to the unusual trading volume.

“Many of the counters that got battered last week are speculative stocks. If you look at the top 20 stocks with the highest trading volumes on Bursa, I think about 15 were loss-making and the rest had high price-earnings ratios (PERs). He who lives by the gun dies by the gun,” a seasoned investor tells The Edge.

Having seen the sagging share prices of the group of stocks, investment banks and stockbroking houses are demanding upfront cash payment for the purchase of these securities. This is applicable to non-margin trading accounts.

“When people need to come up with cash to buy stocks, how will the prices go up? Of course, they will go down. There is no confidence in the market at the moment. When there is no buyer for a thinly traded stock, the share price will fall even sharper,” says a market watcher.

Vision Group managing director Chua Zhu Lian says that in the short term, the market is akin to a voting machine that can tolerate a higher level of valuations on the expectation of future growth prospects.

With the availability of margin facilities and facilitative margin caps, the valuation premium may stretch even further above its intrinsic fair value.

But in the long term, the market will become a weighing machine that ascertains the fair intrinsic value of a company. Valuation premiums, if any, will be much more difficult to maintain unless they are strongly justified by earnings growth and business fundamentals.

“Corrections are bound to happen when the valuations of companies are hovering at above-average levels. When the company’s fundamentals, predominantly earnings, do not catch up to adjust valuations back to fairer levels, the company will have elevated probabilities of a correction, regardless of margin calls and reducing margin caps,” Chua tells The Edge.

In the last two weeks, at least 14 companies saw their share prices plunge and either hit limit down, receive a UMA query from the bourse regulator or had their IDSS suspended. In total, these 14 companies have lost more than RM8.36 billion in market capitalisation year to date.

The triggering event for this whole limit down episode seemed to have coincided with the sell-off of YNH, Rapid Synergy and Imaspro Corp, which are linked to investor Datuk Dr Yu Kuan Chon.

In fact, even Hong Leong Capital Bhd — in which Yu has 3.13% equity interest, of which 2.54% is held via his pledged securities accounts at Maybank, AmSec and TA — was not spared from the sell-off.

The downfall of Yu’s counters then spread to Artroniq Bhd’s cluster of companies, including SCIB, APB Resources Bhd and Globetronics Technology Bhd. The three Mr Ks, namely Kee Wui Hong, Ku Chong Hong and Kang Wei Luen, have directorships in some of these entities.

Also noteworthy is that Press Metal Aluminium Holdings Bhd co-founder Datuk Koon Poh Tat is the single largest shareholder of APB Resources, which in December last year proposed to acquire a 10.41% stake in Globetronics.

The contagion then spread to other names such as Leform Bhd, Mercury Securities Group Bhd and Jentayu Sustainables, followed by Tanco Holdings Bhd, Mestron Holdings Bhd, Silver Ridge Holdings and Widad Group Bhd.

Last Friday, Heitech Padu Bhd became the latest casualty.

Nevertheless, it should be noted that most of these stocks have been climbing all this while. For instance, before the sell-off, Rapid Synergy’s share price had tripled over the past two years, while Imaspro’s had doubled.

Simply put, what goes up must come down — Newton’s law of gravity.

See also “Rapid fall of Dr Yu’s shares shatters his invincible image” on Page 45 

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