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INVESTORS EYE STOCK MARKET REBOUND
BY GEOFFREY CRAIG
It felt like the good times would never end. The Egyptian stock market was riding a wave of popularity earlier this year, reaching a historic peak of 11935.67 points on May 5. But any premonition that the stock market would defy gravity quickly vanished. What began as a tumble one afternoon seemed to snowball as one piece of bad news followed the next causing a substantial nosedive. By the end of August, the main CASE 30 index hovered around 8000 points, a 12-month low. Egypt, erstwhile darling of emerging market investors, had transformed from bull to bear.
The initial spark, analysts say, came on May 5, when the People’s Assembly approved various measures to help pay for a spending package announced a week earlier that totaled LE 18.4 billion. The changes included abolishing tax exemptions on income from treasury bonds and removing the tax-exempt status of energy-intensive industries located in free zones.
What rubbed investors the wrong way, analysts say, was the element of surprise. “They [the measures] weren’t discussed beforehand,” notes Wafik Dawood, a senior account executive at Naeem Brokerage. “One day there’s nothing wrong, and the next there were these changes, which weren’t discussed before. It was an outdated way of making a decision. It scared investors because tomorrow they might find new decisions made, such as the imposition of taxes on stock market profits. It wasn’t the magnitude of the decisions, but the way they were announced.”
Others argued that these new measures were not such a departure from government policy. In a research note, EFG-Hermes analysts wrote: “The government has been trying to phase out new free zone incentives for FDI for several years, believing that low taxes and a favorable overall investment environment are more attractive than project-specific incentives.”
Removing the tax-exempt status for energy-intensive companies in free zones also had a direct impact on the performance of some blue-chip stocks. For example, two subsidiaries of heavyweight Orascom Construction Industries (OCI) – Egyptian Fertilizer Company (EFC) and Egyptian Basic Industries Corporation (EBIC) – are located in the Ain Sokhna free zone. The announcement that they would now be subject to a 20-percent corporate tax affected the performance of OCI greatly. The stock shed 25 percent from May 5 to 15.
Other bad corporate news followed. In July, investment bank Morgan Stanley downgraded the shares of Orascom Telecom (OT), another blue chip, from “over-weight” to “equal-weight,” dropping its price target from $97 per share to $67 due to high inflation in emerging markets, where OT has the bulk of its business.
Investors also responded negatively when the telecom company won a license as part of a consortium for a wireless spectrum in Canada. The move was considered a departure from its strategy of working in countries with large populations and low penetration rates.
The banking sector, recently one of the country’s most resilient and profit-generating, also suffered a serious blow, after ratings agency Fitch downgraded the stock of Commercial International Bank (CIB), Egypt’s largest listed bank. Earlier this summer, CIB canceled merger talks with Arab African International Bank, with which it had been in talks since October 2007.
These top three stocks – CIB, OCI and OT – make up over 50 percent of the Case 30 index by market capitalization. And investors watch them closely for indications about the market’s direction, says Amr Elalfy, director of CI Capital Research. “Retail and local investors invest mostly in small caps, but they look at the Case 30 for sentiment. Once selling began in the blue chips, the rest of the market was impacted,” he notes.
The previous downturn lasted nearly five months, from early February 2006 until late June. The market lost about 40 percent of its original value, with the CASE 30 dropping from 8000 points to 4600. The drop hasn’t been as severe this time, with the index down about 30 percent through the end of August.
But this one could be worse, analysts fear, because the economic outlook is more dour in light of double-digit inflation. “High inflation could affect private consumption and companies because of higher costs,” says Mohamed Abu Basha, an economist at EFG-Hermes. “If we see inflation come down, then that would definitely be positive news.”
However, that seems unlikely to many credit ratings agencies. In June, Moody’s changed its outlook on Egypt’s foreign currency government bonds from stable to negative, and downgraded the government’s local currency bond rating. The negative rating was “primarily motivated [by] soaring consumer price inflation,” Moody’s said in a press release. The government must reduce the level of inflation to “more manageable levels in order for the outlook to stabilize.”
Angus Blair, head of research at Beltone Financial, disagrees with Moody’s decision. “Inflation is a global problem right now, which central banks are dealing with all over the world,” he notes.
The Central Bank of Egypt has hiked interest rates five times this year, most recently at the beginning of August. The official deposit rate now stands at 11 percent. High interest rates are usually bad for investment because they divert funds away from the stock exchange. But this scenario hasn’t played out here because real interest rates are negative.
Nor should high interest rates hurt consumers, says Elalfy. “Our market doesn’t depend on credit. Most Egyptians are not very indebted, so higher interest rates don’t impact consumer spending. It could hurt corporate earnings, and lower spending, which eventually cycles through to consumers.”
Still, the government’s impotence in the face of inflation has deepened analysts’ concerns. In August, Fitch cut Egypt’s ratings outlook to stable from positive and downgraded the local currency rating to BBB- from BBB, saying the “power of Egypt’s monetary tools to curb inflation is still quite weak, raising the prospect of double-digit inflation continuing well into next year.”
Analysts agree that the central bank still lacks the ability to influence inflation through interest rate changes. But they are more optimistic that inflation will ease nonetheless. This is because the main driver behind high inflation – international food price increases – has decelerated recently. The impact of a hike in fuel prices last spring on inflation has already cycled through. And when calculating year-on-year inflation, current prices will soon be compared to a higher base.
Lower inflation would lure back foreign investors, who lost confidence in the Egyptian government’s commitment to fostering a business-friendly environment after the abrupt decisions of May 5 along with other missteps, including the decision to halt construction of a major fertilizer plant being built by Agrium, a Canadian company. Agrium had already sunk $280 million into the factory, which was more than 40 percent complete. Matters were made worse when state-owned Banque du Caire’s privatization, which had been slated for June 25, fell through after the bids offered failed to meet the private valuation.
“There hasn’t been a lot of positive news,” says Abu Basha. “We’ve heard more about Agrium, inflation and May 5 measures, for example. There hasn’t been any positive counterbalancing news. Investors are waiting for the good news to come.”
This wait-and-see approach is odd, considering that the fundamentals are still strong, says Blair. “I’m still bullish on the Egyptian market. The dynamics and valuations are good. The level of transparency is also very high – much better than the Gulf.”
The downturn has become self-fulfilling, he believes. This is fueled by analysis that relies heavily on “support levels.” These are concocted by technical analysts, who study historical data and show the points at which the market tends to rebound. Investors therefore become concerned when the market falls through one of these support levels because it suggests further decline.
During the current downturn, analysts pinpointed a market index of 9900 points as the first inflection point. But the market breached that level in early July. Analysts then picked a level of 7500 points, which has held thus far.
Regardless of support levels, analysts agree that investors will soon return and the market will rebound. In the meantime, they say the best case scenario would be for the market to at least stop its losing streak.
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Black Tuesday
Stock market lore is full of stories about single-day crashes. The most famous dates are October 24, 1929 and October 19, 1987, better known as Black Thursday and Black Monday, respectively. Closer to home, Tuesday March 14, 2006 is a day ingrained in the collective memory of investors.
On that day, a wave of selling sent shares on the Egyptian bourse plummeting. Stock exchange regulators stopped trading at 11am in an attempt to halt losses, with some success. By the end of the day, the benchmark CASE 30 index had lost 6.4 percent of its value, closing at 5892.73 points. This day has since been known as Black Tuesday.
Over the last four months, the Egyptian bourse has declined steadily. But however persistent this decline, there hasn’t been a single-day blow similar to that of Black Tuesday.
Afterwards, the sell-off was largely blamed on Gulf investors trying to recoup losses following a burst on their domestic stock markets, which had been overvalued. At the time, the Egyptian economic and corporate landscape seemed healthy enough, so the flight of Gulf investors became a widely-held explanation for Black Tuesday.
In hindsight, it is clearer that Egyptian retail investors played a larger role than originally thought. In the months before, the market saw several hugely popular initial public offerings (IPOs), and a fresh injection of capital, mainly from inexperienced local traders. In addition, there was a lack of transparency regarding company insider trading under the exchange’s rules.
The cumulative effect was to create a perfect environment for emotion to trump fundamentals. Afterwards, stock market officials rolled out a market literacy campaign for retail investors in an effort to prevent another panic. The exchange has also tightened its own rules regarding corporate governance and trading procedures.
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