Market learns to take bad news on the chin

Investors will need to keep a calm head as they wait for the dust to settle from a range of bold government macroeconomic moves

It included electricity prices going up by 15 per cent, upward adjustments of petrol prices, a high consumer price index (CPI) in February (up 2.09 per cent against January) and official announcements of monetary policy tightening.

Overall, the current domestic macroeconomy is worse than expected and will even underperform 2010. Recent government and State Bank action implies that March might be the focus of policy interventions to stabilise the forex and inflation areas.

These are two important drivers for other areas such as interest rates, gold, credit growth, the budget deficit and foreign currency.

The macroeconomic environment is forecasted to be challenging in the short-term, looser in the medium-term and brighter in the long-term. Therefore, any early recovery in March is less likely to happen. Tough credit tightening together with abnormal high lending rates is pulling down liquidity. Once the outcome of the macroeconomic adjustments is revealed, March may truly decide the equity outlook for 2011.

February’s equity market was a big shock, not simply due to the aggressive adjustments, but also from the fact that the interventions happened much earlier and sharper than expected. A majority of investors expected that the electricity and petrol price rises and the devaluation of the dong would gradually happen during the course of the first six months to minimise interactive impacts. However, once all the decisions were made in February, investors are now waiting to see what the outcomes will be.

February’s CPI simply reflected the price adjustments during the Lunar New Year, not including the effectiveness of the changes in electricity, petrol and foreign exchange rates. In our observation, many firms have chosen March 1 as the starting date for the new price policy. It is hard to expect March’s CPI to be lower than February’s when many goods and services prices have risen at least 10-15 per cent.

Foreign exchange scene

After the USD/VND rate was adjusted by 9.3 per cent, the unofficial market saw huge psychological pressures, which pushed up the rate to over VND22,500. However, the black market has cooled down with a narrowed gap between bids and offers. Probably, VND22,000 will be a sustainable rate for the rest of 2011.

Generally, March’s risks are no longer about what the State Bank and the government do, but what the outcomes will be. The risks will not be as shocking as in the past month, but they are longer-term. Once the signals get clearer, March may determine the outlook of the remaining months of 2011.

As usual, aggressive macroeconomic action is always accompanied with strict controls and stabilisation approaches. Immediately after a series of adjustments, the State Bank decided to further tighten the money supply. Also at the end of February, Prime Minister Nguyen Tan Dung requested all the state-owned corporations to sell forex reserves to ease the US dollar pressure. In our view, this is just the beginning of a series of interventions to regulate the economy in March:

Further tightening the monetary policy

The first action in February from the State Bank was to increase the effective base rate to 11 per cent. To control inflation, the money supply will continue to be withdrawn out of the market especially from the real estate and equity. Therefore, if investors are looking for opportunities in 2011 through the loosening monetary cycle, they need to wait at least until end of the third quarter, since it normal takes six to 10 months for the contraction to become effective.

Reduce the national budget and trade deficit

When forex reserves are at a record low, this is a ‘must do’ strategy. It means that the money supply will be reduced and the equity market will be adversely impacted.

In the last two weeks of February, foreigners suddenly became strong net sellers after many months. That sent a negative message to the market, at least in the short run.

Outlook for local investors

We believe that the cash floating in the market is still abundant after many years of strong credit growth. However, there are still sound factors that prevent the cash flows into the equity market at present:

 - Interest rates over 20 per cent for leverage trading, this tends to last until inflation and forex rates are controlled.

- Credit tightening for the equity and real estate markets, creating real and psychological impacts on short trading cash flows.

The stock market has performed very badly for almost one year, falling behind other investment channels, so it is harder and harder to persuade investors on the return potentials.

For foreign investors, short-term macroeconomic risks rank top among emerging markets, especially for the forex market even after the dong was revalued by 9.3 per cent. The one-year futures market is still trading at approximately VND23,000 per US dollar. Hence, this is not a proper time for aggressive long-term foreign cash flow disbursement. In order to attract good cash flows, the macroeconomy needs to improve, or the equity market needs to drop enough to become deeply ‘undervalued’.

In our view, liquidity remains the main concern. The best scenario is that the market needs to ‘wash out’ to attract a new circle of cash flows to buy in at healthier supporting levels. In 2010, the market pulled back to nearly 420 points to reflect concerns over the macroeconomic risks. If we agree that the first two months of 2011 were a bit worse than the past year, a VN-Index equivalent level should be 400-420 points.

The market dropped deeply enough to price in economic risks?

As commented above, the market needs to get back to 400-420 points to be in an equivalent position to 2010 taken into account the macroeconomic risks. The current level of index between 460-470 points seems too high.

If we ignore shares BVH, VIC and MSN and some banking stocks such as CTG or VCB (going in the opposite market directions), the VN-Index should be below 420 points. In fact, over 50 per cent of the tickers are now trading at less than VND20,000 per share, many have fallen below the bottom of 2010.

Based on the projected 2010 dividend, many companies are capable of paying over 10 per cent dividend yield, which is very high on the global average. However, since the deposit is presently abnormally high, cash seems to be a safer choice even when the yield is around 10-14 per cent. There are not many firms capable of delivering the dividend yield over 15 per cent, so the current share price seems not safe enough for short-term retail investors.

Recently, shares lost liquidity when the VN-Index dropped and the liquidity stayed the same when VN-Index increased. It means that equity market has not become really ‘cheap’ and attractive. If the market does not wash out in March, there is little hope for liquidity improvement. With a higher probability of going down than going up, March is not a good time for active profit seekers.

Any expectations from the AGM season?

If January and February are months of corporate earnings announcements, March and April are months for annual general meetings (AGM). Most expected news is about business plans for 2011. The plans are the basis of evaluation for the comparison between sectors and stocks’ performance under the current and forecasted economic condition. We have a number of comments.

Overall, earnings growth in 2011 should be unsurprising under the environment of high interest rates, tightening credit growth except from a small sample of firms with abundant cash, producing necessities and real estate enterprises with large inventories in the segment of high demand.

Because investors were ignorant to 2010 earnings in January and February, they are going to pay little attention to the results of the AGMs. Therefore, we do not expect any market momentum from the business plan announcements in March.

Investors may pay more attention to first quarter, 2011 earnings announcements to test  plans under economic stress. Therefore, April might contain more opportunities than March from a corporate perspective.

Overall, the focus of all investors at the moment is on the macroeconomic outlook. February has completed the first stage of these expectations, which is the realisation of government actions. Therefore, March will be a critical month for the evaluation of policy effectiveness and the complementary tools for regulations.

Though many options have been discussed, there are gaps between plans and actual outcomes. The narrower the gap, the more opportunities will appear. Investors should wait until the second half of March for a clear macroeconomic outlook before taking any investment decisions.