Is Vietnam Another China?
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Interest in Vietnam exploded in 2006 when the Ho Chi Minh stock index (Bloomberg: VNINDEX:IND) grew 144% in one year, forcing global and emerging-market investors to sit up and take notice. Those fortunate enough to catch the “sweet spot” of that growth—from January 31, 2006, to February 28, 2007—saw a 264% capital gain in just 13 months. Vietnam realized the highest gains of any emerging market in a year when emerging markets were one of the strongest asset classes around, prompting investors and emerging-markets strategists to wonder if Vietnam might be “the next China.”
Vietnam exhibits many characteristics of a new “Asian Tiger.” However, a comparison with China, a look at Vietnam’s evolving equity market, and contextualization of Vietnam’s near-term economic issues all point to a key constraint: Vietnam lacks China’s scale. Its capacity to absorb large-scale investments is very small in comparison to China’s, and its liquidity risk is greater. But for smaller investors, Vietnam offers diversification benefits that could balance out some of the political risk of Chinese investments.
China’s rise to economic, political, and cultural prominence is one of the dominant stories of the 21st century. Investors justifiably ask whether Vietnam is now playing out the same dynamic, and if the lessons learned from China can be applied to investment opportunities in Vietnam.
The most obvious similarity between China and Vietnam is their transition from socialist to market-oriented economies. Unlike the Soviet Union, which initiated political reform before economic reform, China and Vietnam assertively retain one-party state control, while allowing their citizens increasing liberties in the economic sphere.
Both China and Vietnam began their reforms with agriculture, permitting small producers to keep a portion of their production quotas and 100% of any surplus created beyond that. This gave cultivators the incentive to maximize productivity at the margin, where it matters most. The government encouraged innovation and efficiency without completely dismantling the preexisting quota system.
In both countries, agricultural liberalization increased productivity and freed rural populations to migrate to cities, where market reforms allowed the creation of small businesses that could take advantage of a rising labor supply. Once this dynamic was seen to address local needs without threatening political authorities, the governments began to introduce additional market reforms, gradually reducing the role of SOEs (state-owned enterprise) in the economy. In 2005, a second stock exchange was created in Hanoi to facilitate the partial privatization of SOEs by allowing up to 49% of SOE equity to float.
Vietnam also boasts a young and highly literate (over 90%) population that is available for industries that are both intellectually demanding and labor intensive, as well as a demographic that will be younger than China’s for some time to come. The fact that most of Vietnam lies close to the sea facilitates growing industries’ access to shipping and participation in global trade. In November 2006, Vietnam joined the World Trade Organization, opening doors to new markets for the country’s growing industries.
Figure 2 provides a view of Vietnam’s fairly steady GDP (gross domestic product) growth, which has averaged 7.5% annually since 1990. That falls short of China’s formidable growth rates of 10% and above, but consistently beats the growth rates of developed countries and many emerging markets. Given the relatively recent development of public-equity markets in Vietnam, a large portion of that growth probably remains as private equity.
The most obvious difference between the two countries is size. Table 1 shows that China has approximately 15 times Vietnam’s population, 30 times its land area, 30 times its GDP (2007 figures at PPP [purchasing power parity]), 215 times its level of market capitalization, and 4.1 times its level of FDI (foreign direct investment). FDI in Vietnam is 9.17% of GDP, compared to 1.18% in China. Those numbers raise serious questions about whether Vietnam can absorb that much capital productively without fueling inflation.
There are important historical differences, too. For centuries, Vietnam resisted Chinese political domination, and often even Chinese influence. During the Cold War, Vietnam took Moscow’s lead, not Beijing’s. Today, Vietnamese policy makers may look at China for lessons on market reform, but they determine their own political path. Although the economies of Vietnam and China are intertwined, their politics are not, suggesting that exposure to Vietnam may provide limited diversification of political risk.
A third key difference is the duration of communism, particularly in the south of Vietnam. In China, more than 30 years elapsed between the implementation of communism and the introduction of the first market reforms. In former South Vietnam, full communism lasted only about 10 years. As a result, when market reforms were introduced, Vietnam still had a working-age population with experience running businesses in a market economy. China not only underwent a significantly longer period without a private-business culture, but famine, purges, and the Cultural Revolution silenced or eliminated many of those who could have retained business knowledge.
The impact of the duration of communism can be seen in Vietnam today. The vibrancy of Ho Chi Minh City (formerly Saigon), socialist from 1976, contrasts sharply with the more sedate Hanoi, running under socialism since 1954.
Figure 1 shows the Ho Chi Minh stock index, capturing its stunning rise in 2006 and the equally dramatic decline after November 2007, which must have disappointed momentum investors and burned any hot money chasing past returns. A long-term investor who entered the market in January 2006 would still be up 75% (about 20.5% annualized) on September 1, 2008. On the other hand, investors unlucky enough to have entered in February 2007 would have experienced a frightening 65% drawdown between then and June 2008, losing just over 50% of their investments by September 2008.
Thus, an index investor in Vietnam since January 2006 could have gained 265%, lost 65%, or remained invested over the entire period (to September 1, 2008) for a 75% gain. Annualized over the key trading periods, these figures come to +244%, -49%, and +20.5%, respectively. Clearly, Vietnamese equities have the potential to add considerable value, but they also entail substantial risk. These factors alone demonstrate the value of understanding the local market.
An analysis of nearly four years of weekly Ho Chi Minh stock-index returns reveals an average annual return of 22.7% and annualized volatility of 33.1%. Assuming a risk-free rate of 4.5% gives a Sharpe ratio of about 0.551, approximately in line with other emerging-market ratios over the period, as shown in Table 2.
Table 2: Vietnam Returns vs. China and Emerging-Market Indexes and ETFs Analysis of weekly returns data from October 15, 2004, to August 29, 2008 (range chosen for data completeness). Sources: Bloomberg’s Vietnam Stock Index (December 12, 2008), and Yahoo! daily close data (September 14, 2008) via XLQ, for EEM, FXI (iShares FTSE [Financial Times and London Stock Exchange]/Xinhua China 25 Index), and SSE (Shanghai Stock Exchange) Composite.
Vietnam’s returns have a low correlation with both emerging-market indexes (shown by EEM, the iShares ETF [exchange-traded fund] that tracks the MSCI emerging-markets index), and with Chinese index returns, suggesting that Vietnam can bring major diversification benefits to emerging-market and Asia-oriented portfolios. But taking full advantage of diversification requires substantial rebalancing, and Vietnam’s low liquidity figures may make this difficult for large portfolios. Liquidity constraints caused by low daily volumes probably account for the high weekly autocorrelation (0.268), indicating a strong short-term momentum effect. While sources differ on the index’s average trading volume—citing figures from $10 to $100 million (VietNam Net Bridge 2008)—they all agree that the volume has risen rapidly from less than $1 million per day in 2005 (Balfour 2006).
A technical analyst looking at Figure 1 would note that the index appears to have tested and rebounded from a support level set in 2006 at the 400 mark. From a technical perspective, the next key test is whether the index rises above a potential resistance point somewhere between 595 and 600. Crossing this level would indicate persistent bullishness on Vietnam, whereas continued resistance at 600 would suggest that investors are still waiting for some fundamental trigger to click before reentering the market in force.
Figure 2 presents selected economic fundamentals, and shows that the dramatic decline in Vietnamese public equities coincides with the resurgence of inflation as a macroeconomic concern in late 2007. Vietnam’s inflation has been driven by global increases in food prices, a mounting trade deficit, and monetary expansion through the introduction of new credit systems (Qiao, April 17, 2008). Vietnam’s informal central-bank policy of keeping the dong roughly pegged to the dollar has exacerbated these factors by importing inflation from the United States.
Figure 2: Vietnam Equity Index, GDP Growth, and Inflation by Quarter, January 2001 to June 2008. Note: Index levels scaled by 1/50 to facilitate same-chart comparison. Sources: EIU (Economist Intelligence Unit) for annual CPI data (September 14, 2008); Bloomberg (September 12, 2008) for remainder.
Monthly data show that the steep slide in the Ho Chi Minh index began in November 2007 as the CPI (Consumer Price Index) reached double-digit YOY (year-on-year) increases and continued rising. As of August 31, 2008, CPI inflation has continued rising each month to over 28% YOY, dangerously close to hyperinflationary levels.
Given inflation worries, the declines in Vietnam’s equity market are reasonable. On one hand, fiscal and central-bank policies traditionally advocate reigning in economic growth to combat inflationary overheating. On the other hand, out-of-control hyperinflation greatly unsettles political and economic life, creating the potential for riots, capital flight, and extreme public policies to combat economic disorder, particularly as an authoritarian government asserts control over an increasingly unhappy population. Alarming inflation levels can produce either scenario, and both are bad for equities.
The recent uptick in Vietnam’s index approximately coincides with a 2% reduction in real YOY GDP growth from 8.5% in December 2007 to 6.5% in June 2008. This suggests that Vietnamese efforts to cool the economy may have reassured some investors that the scarier hyperinflation scenario is unlikely. Still, it remains to be seen whether the economic contraction will be enough to contain inflation, which continued to rise in July and August 2008, despite precautions. If so, the recent uptrend may be more technical and speculative than based on fundamentals.
Vietnam has the classic qualities of emerging and frontier markets: boom-and-bust risks, relatively low liquidity, and government that is somewhat less than transparent. But there is a basis for solid long-term performance: a young and relatively educated population, links to global trade networks, a technocratic government interested in reproducing the China dynamic at home, reasonable Sharpe ratios, and a low correlation with other emerging-market indexes. In the short term, the key issue is whether Vietnam can stave off hyperinflation and return to predictable growth rates. If the governing authorities can meet that challenge, then investors with Asia-oriented and emerging-market portfolios may want to take a serious look into small long-term allocations to Vietnam.
—Bruce P. Chadwick, PhD, CFA, is principal at Chadwick Consulting, an independent consulting firm specializing in quantitative, emerging-market, and SRI research and strategy.
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