Is the spectacular market crash in Vietnam (and indeed that in China) a cautionary tale for bullish emerging market investors? The country raised its benchmark interest rate to 12 percent from 8.75 percent on May 19, in the latest effort to tame surging inflation by tightening credit; consumer prices surged 21.4 percent yoy in April, reflecting a widespread trend across emerging markets from China (almost 10%) to Russia (12%). Real interest rates had been negative before the move, as they are currently in China despite a series of rate hikes. Vietnam's bank lending rose by almost half the 30 percent annual limit set by the central bank to reduce credit growth in just the first 4 months, while S&P this month cut its outlook on Vietnam's credit rating to negative from stable, citing ``rising risks to macroeconomic stability from an overheating economy.'' Last month the government reduced the 2008 economic growth target to 7 percent from a previous forecast of as much as 9 percent, a sign of things to come elsewhere in Asia perhaps. Gross domestic product growth slowed to 7.4 percent yoy in the first quarter, having expanded at 8.5 percent in 2007, the fastest rate since 1996. This is a common story across the emerging market universe; India, for example, is facing a similar policy dilemma with an infrastructure boom and commodity imports driving inflation and forcing tighter monetary policy and a slowing growth outlook; Russia is postponing many large projects because of their inflationary impact given a tight labour and raw materials market. The net effect of tighter lending restrictions and rising interest rates to manage inflation will be surprisingly weak growth in 2009 in the developing world; the current 'de-coupling' consensus is dangerously complacent. Ironically, the current rally in emerging markets to erase YTD losses is being driven by heavily weighted commodity plays, which will prove to be the most cyclically exposed to a synchronous global growth downturn. Vietnam has been one of the most impressive economic success stories of recent years, having grown GDP by an average 7.5% over the last decade, yet the benchmark VN-Index closed Friday at a fresh 52 week low of 428, after falling for three straight weeks. Total market capitalisation is down to less than a third of GDP. The index has fallen almost 60 percent this year to become the world’s worst performing market, after a spectacular retail investor driven bubble burst. The market had tripled between end 2005 and end 2007, preceding similar excesses in China's Shanghai market. Although some would claim that Vietnam lacks the same scale advantages as China with a population of only 85m, this misses the fact that Vietnam is increasingly being drawn into China's economic orbit as a base for outsourced manufacturing. Anecdotally, many domestic Chinese companies in labour intensive textile and electronic assembly operations are switching production out of southern China to Vietnam as they face intense margin pressures, with local unemployment sub 4% and wages rising at 20-30% a year. Vietnam's demographics are also far better, with half the population under 30. For my money Vietnam, which joined the WTO last year, is the last Asian Tiger that hasn't been tamed by foreign investors.
The question is: where will stocks bottom after a traumatic collapse? Valuations are attractive, at 11.5x 2008 earnings; 70 of the 150 stocks on the Vietnam market are on sub 10x prospective earnings. Cheap, but probably not nearly cheap enough yet given the macro risks. Monetary policy has been dangerously loose in Vietnam until recently, and added to an infrastructure led investment boom and soaring current account deficit has fuelled the inflation spike. Like China, authorities in Vietnam must face up to the destabilising impact of an undervalued currency, which they are now allowing to appreciate slowly. The government is worrying that its huge privatisation programme is at risk. On April 3rd, it was announced that the stock market trading band would be widened to two points, but one result has been a slide in activity; I think this move has artificially lengthened the cathartic phase of the local bear market, but for foreign investors the risk of a currency crisis similar to that suffered by Thailand in 1998 is high until inflation is brought clearly under control. There is a silver lining to this kind of shake-out in an immature market like Vietnam's; until the crash, companies were issuing shares like confetti and were under little pressure to improve standards of corporate governance. The constant stream of rights issues diluted EPS, contributing to the market's slump. Non-financial firms were being distracted from their core businesses by the temptations of dabbling in the market (very like China). The quality of earnings and corporate governance will come through this crash much enhanced. Vietnam is going through the teething pains of most emerging markets as they grow to economic maturity, and the progress made over the last decade is probably even more impressive than that of China at a similar stage of it's development. Although local market performance and GDP growth correlate only very crudely for emerging markets, the spectacular potential of Vietnam, both as an offshore manufacturing base for China and a tourist/investment destination, augurs well for longer term performance. While the Vietnamese market has begun discounting a tight credit squeeze and lower GDP growth (although not a potential currency crisis), many other emerging markets such as India and Brazil are still in denial as to the painful trade off between growth and inflation they now face, and downside risks are substantial.
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