Turbulence on the world’s main stock exchanges is keeping local equity analysts in Ukraine on their toes, even as the country drifts off into the holiday season.
The fear is that investors may well pull the plug on emerging markets, which could wipe the impressive gains made by the Ukrainian PFTS this year.
July 31 saw the first signs of an imminent correction with utility, metals and machine building stocks being the main losers. According to Dragon Capital, one of Ukraine’s leading brokerage companies, the market lost some 2.1% in a single day’s trading. The sell-off was however not too dramatic, with losses taking place against the background of lower trading volumes. The majority of Ukrainian stock market investors adopted a defensive wait-and-see posture rather than succumb to worldwide flight from risky stocks. By the beginning of the week it started to climb again, and on Tuesday the market was up by 0.5%.
Adomas Navickas, a partner at Baltic Investment Company (BIC) says: “Although markets have proven to be quite resilient so far, we have much to fear from a global correction which could hurt budding bourses such as the PFTS, which still suffers from low liquidity.”
In the past, however, the Ukrainian stock exchange has proven to be somewhat isolated from the wider reality of global volatility. Relative market immaturity, low liquidity and high expectations of future gains have all helped to insulate the Ukrainian markets from outside shocks.
Only twice – in February this year and in May last year – did the local market see a serious correction linked to external turbulence. Both times the market recovered quite comfortably and continued its inexorable rise to new heights.
Ukraine buoyant despite US woes
It is therefore quite tempting for local investors to ignore the sea of trouble outside the country and continue betting on Ukrainian stocks. Local stockbrokers are also fairly upbeat about future prospects - on July 25, the KP-Dragon index, established by Dragon Capital to track most tradable stocks, broke the 10,000 barrier, a level ten times higher than two and a half years ago.
Most analysts believe growth will continue, unless trouble in the US and other stock exchanges becomes more severe, but so far the problems faced by world markets still seem to be a long way from Ukraine.
The main reason why stocks in the US took their recent tumble was because of a feared credit crunch linked to a troubled housing market. For years cheap housing credit fuelled an explosion of risky loan products for people with low incomes who borrowed excessively on the back of a buoyant housing market. As predicted, the bonanza didn’t last and the housing market peaked last year and borrowers in the riskiest low-income categories started experiencing repayment problems.
The latest corrections on the New York, London and Tokyo stock exchanges were triggered by recent news of difficulties in the so-called sub-prime mortgage loan sector, which is now beginning to creep into other less risky loan categories. As a result, global financial institutions are re-evaluating the price of risk, and raising the overall cost of debt. This could spell trouble for companies with major debts, which could come up against a credit crunch.
Oleksandr Klimanchuk, an analyst at Concorde Capital in Kyiv, says that Ukrainian companies are fortunately still underleveraged and therefore there is no imminent risk of a credit crunch in Ukraine.
Lending slowdown imminent?
Nonetheless, the cost of borrowing could go up on the world markets, which in turn could slow down lending to the real economy and thus overall economic growth. According to Klimanchuk, however, the cost of local lending is actually declining even as external resources get more expensive.
The biggest fear however for local capital market players is foreign funds finding themselves forced to close down their emerging market activities due to investor wariness. Klimanchuk says that foreign funds are the dominant force on the local stock exchange and a sudden sell-off could therefore lead to a sharp decline in stock prices.
Some analysts argue the opposite. A retreat from risky US sub-prime loans could free up a lot of liquidity which could then be channeled into emerging markets. The only difference will be that investors will look for more diversified and liquid stock exchanges to minimise the risk. “While the readjustment in financial markets was painful for some, it was a necessary return to a more appropriate assessment of credit risk by investors,” says John Lipsky, first deputy managing director of the International Monetary Fund (IMF).
Re-evaluation rather than retreat may explain why the leading emerging market bourses in China, Russia and south-east Asia have fared reasonably well during recent crises. The Shanghai stock exchange, which was the instigator of a sell-off earlier this year, is once again posting solid gains.
The main weakness of the Ukrainian stock exchange in this context is that it is considered too marginal and illiquid to be of much importance to institutional investors. The behaviour of local players is therefore hard to correlate to a wider global context, even if there is a link.
Fast decline but quick rebound
The weather forecast for Ukrainian stocks in the next few months is a mixed one, but local analysts believe the prospect of fresh gains still outweighs the risks. “Ukrainian stocks tend to decline quickly, but they also recover quickly as investors still fundamentally believe the stock exchange will outperform other markets,” says Klimanchuk at Concorde Capital.
However, if shares in London and New York take a nosedive the local stock exchange is unlikely to carry on regardless. Despite its resilience, the Ukrainian market does not operate in a vacuum and external woes could yet exert a discernable influence.
For now, the storm clouds gathering in the US are still contained to riskier asset classes. The IMF believes the prospects for the global economy and emerging markets are bright, despite market volatility and rising energy prices, so there is a good chance that Ukraine will weather the storm. But it will be a restless summer for local traders.
