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How will the Fed rate rise affect Vietnamese stocks?
We, like many people, believe that the US Federal Reserve Bank (the Fed) will increase its benchmark interest rate by 25 basis points (0.25 percentage points) at its Federal Open Market Committee meeting on December 15 and 16.
The Fed targets two policy objectives in deciding whether to raise rates: employment and inflation. The two objectives are linked based on the idea that when the economy reaches full employment, then companies will be forced to pay higher salaries, which will create inflationary pressures. The Fed has therefore quantified these objectives to say that it is seeking to maximise employment growth until it achieves a 2 per cent inflation rate.
Recent economic data show that the targets have been met. The October US jobs report recorded 271,000 new jobs added (the highest amount in five years). Also, the unemployment rate has dropped to 5 per cent. The Labour Department’s gauge of average hourly earnings is also starting to show signs of increased earning with a 2.5 per cent year-over-year increase in October. Inflation, however, is slightly below the Fed’s 2 per cent target. Fed chairwoman Janet Yellen claimed inflation was increasing by about 1.5-1.75 per cent. There are some concerns that falling commodity prices and slow global economic growth could impact the US labour market, but Yellen seemed to brush off these concerns. In her remarks this week she focused instead on the dangers of waiting too long to tighten monetary policy. Doing so, she claimed, could force the Fed to take sudden drastic moves instead of its planned gradual programme of four 25 basis point increases over the next year.
If we take it as given that the Fed will raise rates then the question becomes, “What is the impact on Vietnam?” The first impact is a long-term positive. As the US is Vietnam’s largest export market, if US employment is strengthening and salaries are rising, then that is good news for Vietnamese exporters in industries such as electronics, garments and agriculture. Granted, many of these exporters are FDI companies, but their gains still benefit our economy.
The second long-term impact is negative. As US rates rise, global investors may move their money out of emerging markets like Vietnam and back to the US. While there is certainly some truth to this, I question the magnitude of the impact. The planned Fed increase is a total of four 25 basis point increases. This does not seem like enough to dramatically affect capital flows. Even adding 100 basis points to the cost of equity in our valuation models does not have a dramatic effect. So, in the long-term, we think the effect is net positive from the increased exports.
The short-term impact on Vietnamese stocks could be different. Vietnam’s stock market is dominated by retail investors. Investor sentiment reacts strongly to headline news. If we look at what happened in August when China devalued the yuan and Vietnam responded by devaluing the dong, the VN-Index fell more than 9 per cent in three days. Many people will argue that this case is different because the yuan devaluation was a surprise, whereas the Fed rate increase has been expected for quite some time. Rationally, that could be true, but we still expect to see some sell-off following the announcement. In our view, this will create a buying opportunity. Looking back at the example of the yuan devaluation in August, the VN-Index recovered from its low of 527 on August 24, to reach 571 on August 28. The same thing could happen again. During November, the VN-Index was dragged down by oil and gas stocks due to lower crude oil prices, and by bank stocks due to speculations of divestitures relating to cross-ownership rules.
However, the overall macro news has been largely positive: GDP growth is up, consumer confidence is up, inflation is down, and interest rates are down. Additionally, the VN-Index is trading at a trailing price earnings multiple just above 11x, which is a good value. As such, we have every reason to expect a market rebound, especially as we move into the first quarter of 2016.
Therefore, we recommend that investors wait on the sidelines until the Fed makes its announcement on December 16. Assuming that they do raise rates, and that the Vietnam stock market reacts negatively, investors should be prepared with a list of blue-chip companies that have good earnings growth and are trading at low multiples. This will be a good chance to buy those stocks at attractive prices and achieve strong gains going into the New Year… maybe even boost your Chuc mung nam moi.
vir
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