Happy birthday … not!

In July, the stock market welcomed its 6th birthday as stock prices continued to plummet. The VN index marked the event with a bleep on its chart: It rose 4.16% on July 20, but the small gain was quickly overwhelmed by the downward momentum.

Between July 1 and 31, the index lost another 18% and temporarily dipped to the 399.8 point on Aug. 2.
The quick fall in the VN index after months of hyper growth caught investors off guard. Many  suffered significant losses as prices tumbled at average 30% from the April peak. Demand for stock withered away as investors left the market to lick their wounds.

Such a thick air of pessimism filled the market, so that not even the good Quarter 2 performance reported by the listed companies could put the money back into the game. For example, Vinamilk’s share, one of the most sought after securities earlier in the year fell over 10% in July alone (45% since April), despite its 6- months - before -tax profit enjoyed 22% YOY growth rate.

And the large increase in the number of new companies listed in the bourse does not help either. In July alone, while prices were diving, seven new companies made their market debut, adding VND 4,000 billion worth of new stocks, which effectively doubled the market size (calculated at face value of VND 10,000 per share). As the result, prices fell at an even faster rate in the second half of the month.

All of the new shares, which were initially hoped to rival the market’s interest, joined the downward movement. Even Sacombank, the biggest private bank and the first to be listed, saw its share take a nosedive right after floating on the exchange on July 12, despite healthy earnings: 6 – months - before - tax profit recorded at VND 303 billion, equivalent to 74% of its annual target. Sacombank shares lost 20% of it value before the end of July.

The State Securities Commission (SSC), fearing excess supply will dampen prices further, has proposed that the listed companies either hold back their additional share issues until a later date (like the case of Sacombank) or buy back their shares to lessen the supply-demand gap.

There are still reasons to celebrate

The sense of crisis, however, is somewhat deceptive. When looking at the market over a longer time frame, the situation is not all that bad. In fact, there are still reasons to celebrate.

Looking back at the last 12 months, it is very clear that the market has made a big leap forward. The number of companies listed on the stock exchange increased at an unprecedented rate of over 53% in the 12 months between June 2005 and June 2006.

More importantly, big and profitable companies started to join the bourse, such as Vinamilk (with VND 1,590 billion worth of stock) and companies from the financial services sector such as Sacombank (with VND 1,890 billion).

The participation of large corporations has dramatically increased the market size, which has quadrupled from VND 1,700 in July 2005 to VND 8,000 by the end of July 2006. That means, in just 12 months, the number of new stocks made available for trading is four times larger than the amount accumulated by the previous five years – very impressive indeed.
At the same time, interest in the market also soared, especially since the beginning of 2006 when stock prices were shooting through the roof. At the moment, over 50,000 trading accounts (up from 21,000 in July 2005) are registered at the 15 securities firms.

And while the VN index traded at under 250 points on the exchange’s 5th birthday last year, on July 20, 2006, it remained above 400 points, albeit sliding from the all time peak of 632 points set in April 2006.

In general, it is clear that over the last 12 months, the market has reached new depth. The current downswing, although painful, is the necessary correction after the market has soared to un-sustainable levels during the first few months of the year.

Amid the rapid expansion of the number of shares available for trading, some investors fear that “excess supply” is keeping share prices depressed. However, it should be stressed that with approximately US$ 3 billion in capitalization (or 5% of GDP); the market is still very small, while billions of dollars of idle capital are available in the economy waiting for investment opportunities. Surveys by the General Statistics Office suggest that each year the savings that people put under their mattress (after investing and depositing at banks) amounts to something like US$ 3 billion a year, which is equivalent to the market’s capitalization today.

In other words, there is plenty of room for the market to expand and the long-term solution for boosting share prices is not to stop companies from listing, but rather to boost investors’ confidence.

In any case, during the first two weeks of August, the VN index is showing signs of recovery. It bounced back to 476 points on Aug.16 after falling below the 400 point level on Aug. 2. So far the government’s worst fear that history is repeating itself has been averted – as when the VN index fell from its historic peak of 571 points on June 25, 2001, to the all-time low of 130 points in 2003.

Analysts believe the market is bottoming out as the PE ratio is getting lower and stocks are being more reasonably priced. According to the Stock Investment Weekly, the only national paper on the stock market (run by the MPI), the average market’s PE ratio has fallen to 15 times from the 25 times record set on April 25 and there are 22 of 49 stocks that are undervalued. Investors therefore were strongly encouraged to stop selling and prepare to buy.

Observing the press reports and commentaries, it sounds as though the market’s sentiment is changing, and if the stock analysts continue beating the drums in the coming weeks, some investors might return to the market in search of bargains, which will drive the VN index to move north.

In search of the next Bull Run

Nevertheless, to return the market back to its growth trajectory, it will need more than upbeat commentaries. What is required is a significant and important development that moves the market’s psychology as well as its fundamentals. When looking back at the source of the Bull Run earlier this year, it can be seen that the whole event unfolded right after the government’s decision to increase foreign investor’s ownership from 30% to 49% in September 2005. In which case, it could be expected that if and when the government scraps the ownership cap as proposed by the Vietnam Association of Financial Investors (VAFI), a new bull rally might begin.

It is hard to overstate the importance of the foreign investors to the market’s health. Not only do foreign investors have strong financial capabilities but also experience and a long-term view on investment. In reality, they are like the anchor that keeps the market from being hurled around by waves of buying and selling caused by speculators or inexperienced local investors as they move in herds. For the market to develop and expand in a sustainable manner, it is critical to increase the participation of professional and experienced investors, most of whom concentrate in the foreign investor groups.

However, this force is weakening as the limit on foreign ownership is being approached. Currently, foreign investors are only allowed to hold a maximum of 49% equity from a listed company (30% in the case of banks) and the relevant figures on the current foreign ownership at some important companies on Aug. 8 are as follows: Sacombank (29.55%), Vinamilk (33.98%), REE (48.57%), and Sacom (40.07%). That means that soon foreign demand will no longer able to support the market in the downturn.

VAFI’s proposal to scrap the ownership cap on this group in companies operating in businesses where no conditions are required is in line with the spirit of the new Investment and Enterprise laws and will help to raise stock demand significantly. According to VAFI, of the 70 companies that have been listed and will be listing (in the HCM exchange) or register in Hanoi, there are only five companies that belong to the conditioned business activities and where the ownership cap will remain. The SSC also has said that it will consult the government about  providing foreign investors easier and deeper access to the market.

Such moves will undoubtedly improve market sentiment, especially at a time when analysts believe the cycle has reached its trough.