Sunday, 13 December 2015

Market update

Customarily, December on financial markets is hardly ever a season of bloodshed. Either everyone is celebrating, trading volumes are thin and markets are placid or fund managers are make use of shallow market to boost portfolio valuations before year-end. This year Santa Claus rally, if it is witnessed at all, will be at best considered a revival after the recent turbulent weeks.

The most frequently benchmark used for the Polish stock market its is large-cap index, WIG20, composed of twenty biggest, in terms of the market value, publicly traded companies in Poland. The index, with its historical high of more than 3,900 points recorded in October 2007 and this decade’s high of more than 2,900 in April 2011, has seen a few months of dreadful performance. In early May this year WIG20 peaked at 2,558 points, while on F11 December’s market close it dropped to mere 1,757 points, so it declined by 31% over 7 months. Raw numbers in theory should not bear a false testimony, yet what underlies the numbers might be biased enough to prompt market data recipients to jump to conclusions.

So before we do this, three facts:
- as of 11 December 2015’s close, WIG20 components accounted for 27.6% of the whole stock market in Poland, in terms of market capitalisation,
- the index is dominated by two industries: financial sector (Alior Bank, Bank Zachodni WBK, mBank, Pekao S.A., PKO BP, PZU) and energy (Enea, Energa, PGE, Tauron),
- the index is a price index, i.e. takes into account only price movements, but fails to account for return from dividends, while the yield of the index in the long-run is close to risk-free return or slightly higher.

The first arguments persuades you to think of another, more representative benchmark for the Polish stock market, the second should tell you performance of two industries might substantially affect performance of the index.

And indeed, the shares of banks and the insurer have been falling for the recent months, as valuations discounted imposition of financial sector tax, higher bank guarantee fund contributions as well as anticipated, yet for a while put back, conversion of FX-denominated loans unfavourable for banks.

Shares of energy producers plummeted because of their planned involvement in the bail-out of coal mining, extensive CAPEX needs, both factors trimming down their dividend payout capacity.

Shares of banks dropped by 30% since May 2015, shares of utilities declined by 40% since May 2015. Besides, two vital components of the index are KGHM, punched by falling copper and silver prices (not well offset by stronger USD) and Bogdanka, thumped by falling hard coal prices. No wonder then even if other 8 companies perform decently (difficult, if the market is perceived as homogenous by foreign investors), the index could not fare well…

The better representative of the broader market is WIG. While WIG20 retracted to levels last seen in April 2009, during post-crisis rally, WIG, a total-return index (takes into account dividend income), is two times higher than in February 2009, but fell by 23% from its peak in May 2015, meaning the Warsaw Stock Exchange has officially entered the bear market.

A justified question is whether the factors depressing Polish equities are of local or global nature. If you look at performance of S&P 500, no pattern similar to what has observed in Poland can be discerned.

The same if you peek at DAX30. Both Wall Street and Frankfurt contracted at the news of faltering Chinese economy, but both are still in bull market.

If the stock exchange predicts troubles in the future, it begins to do when the troubles emerge on the horizon and they did so in May 2015, when lots of market participants realised PO was bound to lose the parliamentary election and PiS, as they got hold of power, would tamper with the economy. Policies pursued by PO were also to blame, as they also had put forward a draft of FX-denominated mortgages conversion and they set off to exploit energy companies to rescue insolvent coal mines.

With hindsight I am grateful to the New Factory for imposing stringent trading restrictions on me which have put me off trading and prompted to terminate my brokerage account. Had the limitations not been in place, I would have several times attempted to catch the falling knife. With hindsight, I see I would have been worse off.

Moving away from Poland… Prices of Brent Oil (traded in London), after bottoming out early this year, have been falling since early summer, but recently they tumbled, best evidenced by the 9% drop within the last week. Excess of oil supply is likely to persist, extraction is unlikely to be cut down by OPEC members, while macroeconomic environment remains shaky. All these factors combined ward off the scenario of crude oil prices drifting to where they were before November 2014.

And a quick glance at the copper. Quotations of the commodity have been in the downward trend for nearly five years and had a tremendous impact on market price of KGHM shares (in early 2013 it trade above 190 PLN per share, today mere 61 PLN would buy such security). Now the Polish copper behemoth is nearing the verge of breaking even, while the promises of lifting the copper tax, made by PiS ahead of the election, are up in the air.

The Polish currency, at least in comparison with our stock market, is holding up relatively well. EUR/PLN pair, as dull as ditchwater over the last three years, has climbed towards 4.40 and forges ahead to break out from the range within which it stayed for too long.

USD/PLN, far more volatile than EUR/PLN, began its ascent in 3Q2014 and in early December 2015 crossed the level of 4.00. It deserves to be stressed however, that the driver of the incline is on the USD side of the pair. The American currency is sent up by buoyant US economy, dwindling commodity prices (negative correlation) and expected interest rate hike (FED meeting due in the coming week).

Unfortunately, I am not a future-teller and even if I were, I would not dare to advise you how to reap profits from what is happening on the markets. Given high expenditures in the offing, I am keeping all my savings at banks. But even with longer investment horizon, I would not bet on stock market recovery. Fundamentally the Polish economy is holding strong, but the extent to which it can be spoilt by zipperheads behind the wheel is unknown. By analogy, in first half of 2008 everyone thought given good economic situation, the bear market should have drawn to a close and stock valuations were bound for correction. Over the next months they fell by some 50%. What I am rather confident is that if WIG slides into 30,000 points (I doubt this is probable), equity valuations will be attractive in long-term perspective.

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