Dominic Scriven, chief executive officer of Dragon Capital, explains why now is the time to add to the emerging Asian economy despite its recent dismal equity market performance.
Vietnam is not the first country that comes to mind when considering international investment opportunities.
This is not only due to the fact that Vietnam is still considered a frontier market, but also because of its dismal equity market performance and macro volatility over the past four years.
However, investors who are willing to add Vietnamese equity market exposure are set to be rewarded, especially if their investments are made before the economic reforms firmly take root.
A frontier market such as Vietnam has a low correlation with developed markets, which provides good portfolio diversification. The story of Vietnam is as much about fundamentals and economic reforms as about diversification.
When Vietnam joined the WTO in 2007 there was a popular belief it would evolve into the next Asian export powerhouse. The country’s mix of favourable demographics, a sound macroeconomic footing and a stable political system presented an ideal platform for expanding manufactured exports.
But what was expected to be a swift evolution from fish to computer chips stalled on the back of bad macroeconomic policy decisions that resulted in an unhealthy cycle of boom and bust.
Easy fiscal and monetary policies during 2009 and 2010 were one of the main reasons for the soaring inflation in 2011, while subsidies for water, fuel, power, and other key components also played their part. However, in late 2010 the government recognised the seriousness of the situation and started vigorously pursuing economic reforms.
Results thus far have been quite impressive. Loan and money supply growth, as well as the fiscal deficit, were curbed. Foreign exchange reserves doubled over eight months and for the first time in five years the currency remained stable for more than one year, suggesting that the devaluation cycle may finally have been broken.
Economies go through different cycles of recovery, overheating and stagflation. Each period is uniquely defined by the direction of GDP growth relative to trend, and the direction of inflation. Each of these periods is linked to the outperformance of a specific asset class.
During reflation, bonds are expected to be the best asset class while during recovery investors tend to turn to stocks. The challenge is to identify at which moment the economy moves on to the next period in order to make the best possible management decisions for your portfolio.
From Q2 2010 until Q2 2011, Vietnam experienced a period of stagflation, which was characterised by rapidly rising inflation, slower GDP growth and a poorly performing equity market. In Q3 2011, Vietnam entered a time of reflation where growth was sluggish, profits were weak and real yields dropped as inflation slowed.
The key question is ‘When will Vietnam move to the recovery phase?’ To successfully answer this, we need to take a view on inflation and when GDP growth will bottom out.
CPI year-on-year peaked at 23.1 percent in August 2011, and has followed a downward trend since. May 2012 CPI came in at 0.18 percent month-on-month, resulting in inflation of 8.3 percent year-on-year and 2.7 percent year-to-date.
Furthermore, we expect headline inflation to reach 6 percent year-on-year in September and stay around 7 percent toward the year end which is below the average 9 percent in the last decade.
Vietnam is similar to the West in that its real estate sector is saddled with leverage in the corporate sector. However, it is different from the West in terms of household leverage.
The exposure of Vietnamese households to credit cards and mortgages, relative to GDP, accounted for only 12 percent in 2010 while total credit amounted to 136 percent. Since then, Vietnam started deleveraging, reducing total credit to GDP to 117 percent by the end of 2011.
According to a McKinsey study covering 45 historical cases on the impact of deleveraging on GDP growth following a recession, GDP growth is expected to bottom out within two to three years from the commencement of deleveraging. Vietnam started its deleveraging process in 2011.
Hence GDP growth may be expected to bottom out in early 2013 or 2014. However, given its low household debt, we believe that Vietnam will bottom out sooner and reach its bottom in Q3/Q4 2012 or early 2013, which will represent an optimal time to make equity investments (see chart below).
This view is further supported by the expected strengthening of 2012 corporate earnings. Based on conversations with numerous companies, there appears to be more upside than downside to 2012 corporate earning forecasts which are forecasted at 9x PER 2012 with the VN Index at 450 percent and 18 percent of EPS growth vs – 9 percent in 2011.
Vietnam’s 12 percent-14 percent deposit rates are by far the highest in Asia, indeed most other countries’ are below 4 percent. Given its declining inflation, Vietnam is the only country that actually has plenty of room to manoeuvre on its monetary policy.
We therefore expect the State Bank of Vietnam to accelerate the easing of its fiscal and monetary policies. In addition, we anticipate deposit rates will drop by 400bps to 8 percent, which bodes well for Vietnam’s stock market performance.