Caution needed amid a tricky Feb

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The market in January illustrated a fundamental difference with the VN-Index not reflecting the common trend of a majority of stocks on the market.

The index rose, while over 50 per cent of tickers lost points. Ignoring five stocks that contributed the most to the rise of VN-Index, liquidity on the two exchanges probably bottomed over the past year. The market needs strong signals to boost its recovery expectations.

From pure macroeconomic perspectives, February will not offer many opportunities.

After the Lunar New Year, over 50 per cent of firms will continue to announce quarter IV/2010 and 2010 earnings. However, what happened in 2010 might be repeated in 2011 with the market not reacting to earning announcements when the macroeconomy was under pressure.

In our view, inflation will continue to be the key for other policy adjustments, especially forex and interest rates. After the year’s end and the New Year, other basic materials such as oil, coal, electricity and water are preparing for new price adjustments. Therefore, inflation threats remain high. However, the improved excitement after the holiday together with the stronger short trading on bluechips were bright spots for February’s equity market.

Inflation continues to be the driver for monetary  policies

Just before the Lunar New Year, the State Bank hinted at the possibility of lowering interest rates if February’s inflation was controlled below 1.4 per cent. Why 1.4 per cent?

We believe, if February’s inflation drops below 1.4 per cent, the capability of holding the year’s inflation under 10 per cent is still feasible. On the other hand, the pressure on interest rates and the exchange rates might even cause adverse consequences on inflation control and it becomes harder to keep the consumer price index (CPI) at a single digit rate.

However, during the holiday, the Ministry of Finance’s price management bureau forecasted February’s inflation at 1.8- 2.0 per cent - implying that the ability to use interest rate and credit growth policies in the short term is much more restricted. At the same time, risks from fiscal policies on inflation are still high, especially three months after the Lunar New Year when the ministries of Finance, and Industry and Trade recently signaled the possibilities of loosening prices of necessities such as petroleum, electricity, water and coal to match the global market and demand-supply balance.

The pressure on the monetary policy is still very high even after the New Year. We recommend investors to be cautious about the macroeconomic risks in quarters I and II since the conflicts between monetary and fiscal policies are hard to be balanced in the short run. At least one of the two must be scarified in a few months.

Interest rates less likely to cool down in the short term

Besides the role of reflecting inflation risks, high interest rates could be interpreted as a part of a contracted monetary policy. High rates are causing many equity market problems:

- High interest rates go with increasing opportunity costs of holding cash and other investment choices, one of which is the equity market. It also boosts up the leverage financing costs particularly under low liquidity market conditions.

- High rates negatively affect the operations of listed firms, especially highly geared firms such as those in the steel, cement, real estate and seafood sectors.

- High rates mean more contraction in credit growth – a negative factor to the psychology of investors and cash inflows to the financial market.

- High rates mean high input costs and could cause indirect inflation.

With the inflation of February forecasted to be 1.8-2.0 per cent, interest rates have fewer chances to go down in the short run. The State Bank might have to wait one or two months longer before any action.

Investment alternatives rather than credit growth

In December, 2010, the equity market picked up strongly despite the slow-down of the credit growth in the economy. What happened shows that the correlation between credit growth and equity performance is not always very tight. Cash in the economy is very abundant, so the key is how they are allocated between asset alternatives such as deposits, foreign currencies, gold, shares and real estate.

- Cash deposits: With the short-term cash rate of 14 per cent at the moment, deposits are fairly attractive when the equity and real estate markets are dampened. From our observations, cash outflows from the equity market are retained in the money market mostly, so they can come back anytime as long as the signals become clearer.

 - Gold: Although there are optimistic forecasts on the medium and long term gold prices, the attractions of gold seem to reduce when the price remains stable. If the global economy and political environment are stable then there would be lower volatility in this market compared to 2010.

- Foreign currencies: The concerns over the devaluation of the VND has enhanced the demand for foreign currencies. Together with the increase in the US dollar deposit rates recently, this is a fairly safe choice for longer term. Therefore, we do not expect a frequent transfer between the equity and this market in the short run.

- Real estate: It is forecasted that 2011 continues to be a challenging year for real estate market in both Hanoi and Ho Chi Minh City. Since the relationship between the real estate and equity market is very tight, the allocation of funds between the two tends to be stable over time.

- Equity: To reach the profit level of 14 per cent like the bank deposit interest rate, the VN-Index must rise to 550 points from the end of 2010. In the short-run, this is challenging under the current macroeconomic risks. However, the target is feasible for the whole year. The equity market hence is still very attractive for medium and longer term investors.

2010 earnings not the key focus of short traders

In January, approximately 50 per cent of listed companies announced quarter IV earnings and estimates for 2010, many of which are positive. What is worth noticing is that investors did not react to the good news except for some rare bluechips. It proves that earnings is now not an important supporting factor to the market – a similar scenario as for 2010 when the macroeconomic environment was under stress. We, hence, do not expect surprises when the rest of firms report quarter IV/2010 earnings in February and March.

In combination with the new trend of investments in bluechips instead of pennychips and mid caps as in 2010, we recommend an investment strategy in February to focus on large caps with good fundamental base and prices not having  gone up in January. Earnings in quarter IV and 2010 is a good reference for the selection criteria.

Bluechips or pennychips?

Recently, the market had various comments on the misleading VN-Index when the indices rose only due to the support of a few bluechips. In fact, over 50 per cent of the stocks still dropped. On the other hand, in 2010, many small and mid caps went up significantly while VN-Index stayed almost the same due to the stagnancy of bluechips. The two trends are very similar by nature. However, investors tend to react more vigorously this time. What are the reasons for this?

Firstly, it implies that portfolios of local retail investors still have a significant portion of penny and mid caps, so when the index rose and their position went down, more attention would be paid to the unusual trend.

Secondly, when bluechips are attracted and become a clear preference trend for 2011, retail investors will have to restructure their portfolio to have new cash for disbursements on bluechips. The pressure on penny and mid caps is predicted to go up in the coming time.

Thirdly, when most of bluechips underperformed in 2010 to 20-30 per cent compared to penny and mid caps, the recovery is necessary to create balance in valuation. Many bluechips currently have lower P/E and P/B than small stocks in the same industry.

Ignoring factors that affect the calculation of the index and reasons for the potential misleading, the preference towards bluechips in 2011 is reasonable and totally explainable. However, bluechips that overreact for a long period, exceeding true value sooner or later will be adjusted.

Overall, under challenges of the existing macroeconomic conditions, market liquidity likely continues to be under stress. Short trading cash flows, therefore, still dominate the market. The trend of switching from pennychips to bluechips in 2011 is getting clearer and clearer. However, since the supply of bluechips is large and the concentration is lower than small caps, the excessive ups and downs are less intense. We recommend investors focus on bluechips whose prices were not heated in January such as PVS, PVD, VNM, SJS and CII.