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KLCI Came Tumbling Down, Tumbling Down, Tumbling Down...

The Kuala Lumpur Composite Index saw RM51.52 billion worth of capital wiped out in one day. How much longer will it continue to plunge? It's impossible to say.

Written by johnleemk on 4:05:07 am Mar 6, 2007.

The recent massive stock price declines across the globe have continued hitting people where it hurts — and few countries have had it as bad as Malaysia.

Yesterday, the Kuala Lumpur Composite Index saw a fall of 53.99 points or 4.64% — the worst in almost seven years. The last time we had it this bad was after the September 11 terrorist attacks.

Perhaps these numbers seem small, but to make the impact of this clear, it's worthwhile to note that RM51.52 billion of market capitalisation was wiped out in one day — and this is just one in a run of several bad days for the stock market.

How many more bad days are there to come? I don't know. The stock market is a wily thing, and not exactly governed by reason. Several theses exist to explain the market's behaviour.

One of the more famous ones is the efficient markets theory. This theorem suggests that it's not worth participating in the market because the market automatically factors anything relevant into its pricing — in other words, the market efficiently sets prices.

Another famous theory which lent its name to the famous book, A Random Walk Down Wall Street, states that stock markets follow a "random walk". You can't find a rational and consistent way to explain their behaviour.

Certainly, there doesn't seem to be much of a way to explain how markets move. After all, what was so different between March 4 and March 5, to the point that RM51.52 billion worth of capital was wiped out?

What was it that has made the stock market decide that all the gains it has made during the year 2006 are no longer real, and deserve to vanish?

I can't say, and I doubt many economists can. (Indeed, it might surprise you, but most Nobel Prizes awarded for economics are given to economists who have barely or never touched the field of stocks.)

Predicting the market's behaviour in the long run, of course, is easy. Stock markets grow capital very quickly. An investment made 50 years ago in the stock market as a whole (i.e. investing in the index, not in one or two individual stocks) would have greatly grown in size today, despite all the recessions and depressions between then and now.

The trouble is that as John Maynard Keynes famously remarked, in the long run, we are all dead. How do we predict the stock market's short run behaviour? It seems impossible.

Making matters worse, of course, is that so many people pretend they can actually do this — and to top it off, one of them was the Malaysian Prime Minister, Abdullah Ahmad Badawi.

Abdullah suggested that the total capitalisation of the KLCI could soon top its historic high of 1,350 points. Without any basis for stating this, except for a few meaningless economic indicators (such as the infamous "one billion ringgit in trade" figure), Abdullah declared his full confidence in the share market.

Whatever the case, people have been burned. Fortunately, the stock market does not always reflect actual economic conditions. But a prolonged plunge is worrying. Does this "market correction" herald another global recession along the lines of that triggered by the 1997 Asian financial crisis? It remains to be seen.