It is true that since the TSE index broke the mark of 5,000 points on June 5, 1988—itself representing a five-fold increase from a year earlier—the economy has in fact continued performing at a fairly vigorous pace, despite a continuously appreciating currency and rising labor costs. But the economy's average annual growth rate of more than 7 percent in the period was far from strong enough to support the sort of bull market found at the TSE.
Nor were corporate earnings strong enough to bolster the local bourse's meteoric rise. As a matter of fact, the surges in Taiwan's share prices have seldom had a strong relationship to the actual earnings of listed companies. For example, 14 of the companies that had pre-tax balances of revenue positions in the red during the first five months of this year all enjoyed sharp share price increases, ranging from 60 percent to nearly 400 percent since the first of the year. Moreover, many of the 20 listed companies that had long been on the brink of becoming insolvent saw their share prices performing much stronger this year than many of the blue-chip corporations. Rationality is not greatly in evidence in such situations.
This assessment is substantiated further by a look at price-earnings ratios, the price of a share divided by per-share earnings for a 12-month period. The P-E tells investors how expensive shares are relative to the earnings they produce. By May of this year, the average P-E level of Taiwan stocks had risen to an incredibly high 49; this compares with the average P-E ratio of 20 for the New York Stock Exchange. In short, Taiwan's abnormally strong stock price performances have rendered useless many traditional methods for determining stock values. Lamenting the situation, one top executive with a leading local brokerage house recently said, "Stock prices here have long ago left behind their basic rationality. "
While many factors have caused the Taiwan bourse to lose its rationality, the fundamental one is a lengthy disequilibrium in supply and demand. Demand for stocks has grown phenomenally over the years with the huge inflow of investment funds. There is a telling statistic that illustrates how rapidly capital has flowed into the bourse: at the end of 1985 the total market value of TSE listed stocks was NT$416 billion; by May of this year, the total market value had multiplied to NT$6.24 trillion—almost twice the amount of Taiwan's GNP for 1988.
There is in fact logic underlying the huge amounts of capital finding its way into the stock market. Since 1985, Taiwan's trade surplus has been expanding at a rate of more than US$10 billion per year. At first, such massive foreign exchange earnings, after they were exchanged for New Taiwan dollars, were usually deposited in local banks to earn interest, the most traditional Chinese way of managing savings. But as more and more people put their export earnings in banks, a serious problem arose. The banks quickly found themselves flooded with funds for which they could find no borrowers. As a result, they repeatedly lowered interest rates to discourage depositors. Some banks even turned down large deposits.
Frustrated depositors, faced with limited alternative investment opportunities, turned to the stock market with their funds. As investors in growing numbers followed suit, the demand for stock shares became increasingly strong. But the supply of shares has failed to expand as quickly as demand. During the past five years, only about 40 new companies have listed their shares on the market. The number of corporations currently listed on the TSE now totals no more than 170, in contrast with the 745,000 registered companies throughout Taiwan.
Despite the apparent advantage that the continuously soaring share prices seem to offer companies, most Taiwan firms are still reluctant to go public. One major reason is that company owners do not want outsiders to participate in management, as they do in publicly held firms. Moreover, going public would require considerably more accurate reporting of earnings (and taxation), a tack not enthusiastically embraced. Finally, the existing incentives still fail to outweigh all the trouble involved in listing a company on the exchange.
With the supply of stocks falling seriously behind demand, people who buy shares, be they blue-chip stocks or ordinary performers, can surely expect to make money. One market analyst recently described the situation: "The stock market now is so bullish that share prices usually undergo more increases than decreases. When prices do decline, caused by unfavorable news such as government intervention, they quickly rally to new highs. In view of this, many investors often take advantage of market downturns to buy as many shares as they can, because they need not to worry about getting stuck with those shares."
So attractive is stock buying that it has now become a part of daily life for a wide range of local people, from corporate workers and government employees to retired senior citizens, housewives, and even college students. In almost any public and private gathering, a common topic of conversation is market trading strategies.
Beyond the problem of stock supply falling seriously behind demand, wide-spread speculation by players has had much to do with the continuing steep rise of the bourse. While speculation is perhaps inherent in the nature of any stock market, that nature seems to be especially serious in the Taiwan exchange. About 50 percent of the stocks listed on the TSE are reportedly being played by big manipulators, who use various means to jack prices higher to their advantage. One of the most common practices is for the player to keep buying a target stock until he holds an influential position, then he lets a short supply drive the stock's price all the way up before finally choosing an opportune moment to unload his holdings.
This process can be seen in the change of value in stocks with a capitalization lower than NT$500 million. These all jumped by more than two times in value during the first five months of this year, while those with a capitalization over NT$5 billion rose only 8 percent. This came about because those stocks with small capitalization were financially easier for the big players to manipulate than those issued in large volumes.
Big players also work together to manipulate the market in other ways. For example, they may jointly step in to make heavy purchases to bolster prices when the market plunges. They also have been known to use various means to disseminate favorable news of stocks to encourage buying, especially when the exchange index has difficulty breaking a new mark that is psychologically important to the investing public.
The big players, who can so easily manipulate the market, are aided further by the TSE's high ratio of individual investors. These now exceed institutional investors, accounting for more than 50 percent of the total. This is far higher than the 30 percent in both Japan and the United States. A high ratio of individual investors contributes to manipulation, because individuals in general lack professional investment knowledge. Therefore, they often blindly follow the big players going into and leaving the market.
The high ratio of individual investors also makes the TSE vulnerable to sharp fluctuations, for such investors usually engage in short-term transactions and often scurry to buy or sell for sensitive reasons. Examples of this are the recent market setbacks caused by government investigations of traders using nominee accounts to evade the capital gains tax, and by government plans to crack down on illegal investment companies, many of which are among the stock market's biggest players. The market fell nearly 20 percent in a matter of two weeks after June 19, when it broke the 10,000 mark, as many investors rushed to unload their holdings in response to these investigations and the planned crackdown. But such responses were apparently too sensitive, because those disciplinary actions were not intended to intervene in the market. Rather they were aimed at helping improve the health of the market, and in fact should prove beneficial to investors in the long run.
Increasingly popular pastime—housewives, taxi drivers, and even students rub shoulders daily with the big players on the wild and bullish TSE.
Despite the sharp decline, many analysts see the setback as a temporary phenomenon and believe the market will rebound strongly in the near future. The optimistic view is based not only on the generally favorable economic outlook for the balance of the year, but also on the point that society's idle capital, the single most important factor that has long been supporting the bullish market, will remain available in huge amounts. Of no less importance, the stock buying frenzy throughout the island shows no signs of fading.
For government authorities and many members of the general public, however, the immediate concern is not whether the stock market will soon experience a strong upturn. Instead, the primary worry is the speculative way the market is performing and related economic and social implications. For example, when speaking about the TSE in May of this year, former Central Bank Governor Chang Chi-cheng called the market a "casino."
"But a legal casino has strict rules that the house and gambler alike must observe," says Pai Chun-nan, president of Pacific Securities Co. Not so with the Taiwan bourse. Pai points out that the TSE's lack of management often puts bona fide brokerage firms and investors in a disadvantaged competitive position. Although the lack of management at present tends to benefit all market players, it is still the big ones who gain the most. This is simply because big manipulators invest much more and thus earn significantly more than others. This is one reason why Taiwan has seen the rise of multi-billionnaires in recent years.
The unhealthy condition of the market is raising major concerns among government authorities and many private economists, who worry that the stock market manipulators' way to accumulate wealth is seriously distorting the distribution of income and is working to widen the gap between rich and poor. Many observers are also concerned that the nation's wide participation in stock buying tends to encourage people to engage in speculative activities, seek short-term profits, and damage the traditional Chinese virtue of hard work. Yet another major concern is that if the market continues rising at a rapid pace, it may eventually become unsustainable and fall into a disastrous collapse that could cause serious economic and social problems throughout Taiwan.
Prompted by these worries, government authorities are taking measures to improve the health of the stock market. They include the recent moves to investigate alleged trading abuses and the planned crackdown on illegal investment houses. The latter actions are expected to be launched soon in line with the enforcement of the revised Banking Law, which promises severe punishments of those running illegal investment houses.
A more fundamental step, announced recently by Finance Minister Shirley Kuo, is to seek ways to overcome the disequilibrium in the supply and demand of stocks on the market. This plan calls for listing more government enterprises on the TSE, as well as inviting foreign securities firms to Taiwan.
Regarding this latter plan, the Securities and Exchange Commission (SEC) announced in late June that it would allow three foreign brokers to open branches in Taiwan. These firms would be permitted to buy and sell securities in Tokyo, New York, and London on behalf of clients in the Republic of China. According to the SEC, only firms with capital exceeding US$2 billion, and with total assets topping US$20 billion, are eligible to apply. Candidates must be members of the New York, Tokyo, and London stock exchanges. They must also rank among the top 10 in their own countries and have at least two years of experience in managing foreign exchange transactions. The application deadline is October 31.
While the purpose of the move is to introduce foreign securities to local investors in order to channel some of Taiwan's excess liquidity outward, many observers have reservations about the efficacy of the move. They say, for instance, that the qualifications set by the SEC are so strict that they will deter interested foreign securities firms from establishing operations locally. And even if some leading foreign securities firms qualify to operate in Taiwan, that does not necessarily mean they will have enough business. "Since investing in the local stock market is sure to make quick profits these days, few investors will bother to make investments in overseas securities," observes one market analyst.
Furthermore, any qualified foreign brokerages that set up business in Taiwan could prove to be more interested in selling local stocks, which is also allowable, than in promoting foreign securities. This is partly because management fees for selling local stocks are much lower than for foreign financial products. In addition, the leading foreign firms, blessed with profound experience and expertise, will have a competitive advantage over their host counterparts in selling Taiwan stocks. As a result, the introduction of foreign brokerages may not be as effective in expanding securities supplies as now expected.