European debt crisis shakes investors’ nerve

21:52 | 08/06/2010
Hence, what happens in June depends upon how the debt crisis is controlled, although the prospects are getting brighter

The local stock market is nervously looking on at Europe’s woes
Although the market reacted slightly more positively to the European debt crisis by the end of May, the risks from the global financial market have yet to disappear.

Since Vietnam’s macroeconomic fundamentals have stayed almost the same compared to when the VN-Index reached the peak of 550 points in May, June’s market performance will be mainly driven by the outcome of the European crisis under one of the three scenarios, short-term, medium-term or long-term impacts. When the market is directed by the external factors, behavioural and technical analysis approaches can only support the buy/sell decisions in the short-run once the fundamentals get stabilised.

In general, the domestic macroeconomic environment in May, in our view, will be maintained in June except the likelihood of lower inflation rate due to the recent adjustments in petrol prices. Monetary policies are forecasted to have minimum changes since the interest rate level has not reduced and deposit rates for some small commercial banks have even slightly climbed. This illustrates the weakness of State Bank’s attempts to pump money into the economic system through the open and interbank markets.

This includes regulations to limit the amount of short-term funds used for long-term loans and the restrictions of the usage of interbank funds for financing. As long as the global economy shows signs of stability, the indices could become highly attractive under June’s forecasted macroeconomic outlook. Inflation is predicted to be lower than 0.3 per cent in June, credit growth maintained around 2.5 per cent, the US dollar-Vietnamese dong exchange rate will be stable, monetary policies could be further expanded and become effective from the third quarter.

Hence, what happens in June depends upon how the debt crisis is controlled, although the prospects are getting brighter. There are three main scenarios and which one finally becomes reality could be seen during June.

Scenario one covers short-term impacts. The crisis could be solved within Greece, other economies such as the US, Germany, France, China and Japan will undergo proper adjustments to ensure the economies do not fall into recession.
This scenario will become reality when countries in the EU fully agree on solutions to support Greece.

At the same time, other potential ‘candidates’ such as Spain or Portugal will take stronger steps to stabilise the economy, regaining investors’ confidence. The giants will quickly adapt to the weak Euro economic environment to avoid long-term impacts on gross domestic product (GDP) growth. Consequently, the price of raw materials will bounce back, equivalent to the pre-crisis period.

Under this scenario, Vietnam’s economy will see little impact as bilateral trade with Greece or the EU is not too significant and investors’ psychology will be strongly supported. Consequently, the market will lift, at least to 550 points when investors price in the recent domestic macroeconomy good news. However, inflation threats will return similar to the first four months of the year and pressure expansionary monetary policies. If this scenario occurs, investors should focus on the cyclical sectors and stocks as we mentioned in the quarterly sector allocation strategy report issued in the second quarter.

Scenario two covers medium-term impacts. The crisis will be gradually controlled after firm actions from related countries. However, key economies need longer time to adjust the trading strategies and macroeconomic policies to minimise negative impacts.

This scenario occurs when the debt crisis is not solved in the short run, having more serious effects on other countries such as Spain or Portugal before being partially stopped under the intervention of EU and global community.

Under this scenario, the global economy will be characterised as the Euro continues its depreciation and other countries have to get used to a weak Euro for at least a few years. Global economic growth will slow, but not fall into recession. Meanwhile, raw material prices will drop due to the fears of the crisis and major indices being adjusted downwards, then fluctuating due to a combination of a global slow-down and attempts to buy undervalued stocks.

If this case happens, Vietnam’s trading activities with the EU zone will be impacted in the short run. However, over the long run, this should not be a big concern as the bilateral trade with EU is fairly balanced between imports and exports and the size is not material; the weak Euro hampers exports to EU but is beneficial for imports and local companies have ability to change their import-export structure to ensure the trade balance in the long run.

If this scenario is realised, the picture we could see is:
* The VN-Index and HNX-Index are downward adjusted on the same trend as other global indices before the fluctuations at a lower sustainable level.
* Low liquidity due to investors’ caution and the limited use of financial leveraging.
* A number of sectors and stocks would be specifically influenced under this scenario. Sectors that could have direct negative impacts, as EU is the key export market, include seafood (a 26 per cent market share) and garment and fashion exports (20 per cent). Sectors that could have indirect negative impacts, due to the adjustments of the global price of raw materials in fear of global crisis, include natural rubber and steel sectors.

Sectors that are less impacted with companies that serve domestic consumption using local inputs, include energy, banks, real estate and construction materials. Sectors that may have advantages in the short-run, which use imported raw materials for high and stable local consumption, include plastics and healthcare which import around 80 to 90 per cent raw materials.

Scenario three covers long-term impacts. The European crisis seriously impacts on the global economy and major economies fall into crisis and deterioration.

This is the worst case scenario when the situation is out of EU’s control, which causes a new global crisis although the scale could be smaller than what happened in 2008. A few signals could be observed. These include the debt market getting worse in Spain and Portugal, then impacting on Italy and Ireland, the remaining EU tightening public spending and the regional economy slowing down and falling into crisis, impacting on China, the US and Japan. As a result all the indices, including futures, deteriorates.

Under this scenario, both the underlying local economy and the stock market will be heavily impacted. Trading activities will be narrowed not only with EU partners, but also the world. Investors, especially ones who use financial leveraging, are recommended to decisively cut losses to cash out to minimise risks. Defensive sectors are likely to outperform when the market goes to trough but under-perform when the indices recover from the bottom.

Which one has the highest probability of occurrence? Examining what was happening during the last week of May, in our view, the most likelihood is the combination of 50 per cent of scenario one and 50 per cent of scenario two due to the following reasons:

Reasons for the first scenario are as follows. First, China and the US have shown positive signs of adjustments to adapt to the risk of economic slow-down. Second, key EU economic powers such as France and Germany seem not yet to be affected by the crisis. Third, global investors are still looking for opportunities to buy ‘undervalued’ stocks. The Dow Jones recovered immediately once it fell below 10,000 points. Fourth, future indices are fairly stable. Lastly, prices of raw materials have risen slightly compared to the lowest in May.

Reasons for the second scenario include Spain being downgraded on the last trading session of May; the US economic recovery yet to prove sustainable; and major indices fluctuating strongly, implying that investors are sensitive to the current outlook.

With the above analysis, we have kept our cautious optimistic view. For long-term investors, the VN-Index in the 500 point range is attractive for buying decisions. Investors should focus on large cap stocks to lower potential risks in case the debt crisis gets worse under scenarios two and three.

Unless the picture of the first scenario, under the fundamental analysis section, becomes clearer, which means the crisis is not as serious as predicted, investors should limit financial leveraging and investments in penny stocks. June’s market is forecasted to be surprising depending on the global economic and political progress. Hence, investors should closely follow the daily news to have a suitable investment strategy (buy/sell, select sectors/stocks) under each scenario we mentioned above.

(*) The detailed report can be downloaded from SME’s website:

By Nguyen Viet Hung Director of Research & Investments SME Securities JSC.

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