In recent months, we have seen very strong increase in precious metal prices. Without a doubt this was due to change in central banks policy. After November panic on the stock markets, the FED withdrew from further increases of the interest rates. The ECB survived only two weeks without printing after which it returned to spoiling the currency in another form. What’s more, central banks around the world have given a clear signal that higher inflation is needed (stupidity) and that rates need to be lowered again and printing resumed to start boosting the economy (another absurd). This policy has been used in Japan for twenty years, called today as “wasted decades”. As Albert Einstein used to say “Insanity is doing the same thing over and over again and expecting different results.” In any case, we are aiming for a situation in which inflation will increase while central banks will keep interest rates on extremely low levels.
What does this mean in practice?
Well, the negative real interest rates will become even more negative. This means that interest on bonds or deposits will be lower than inflation. In such an environment gold prices rise the most. The fact that central banks would eventually return to printing was obvious due to the scale of overall debt. The only unknown question was when exactly. What we can and should do is to focus on the fundamentals so that we can anticipate certain trends and be patient.
I am writing about it in context of the Warsaw Stock Exchange, which will probably reach the bottom in a few months or so, and then enter a period of strong growth for several years. There are many reasons for such a scenario. I am writing about it today to prepare you mentally to enter the market in an extremely difficult moment, when we hear negative data from almost every economy, and there is a lot of fear among investors. For this kind of moment you should prepare yourselves today because if the market drop another 15-20% then the rebound in the first phase of growth may be as spectacular as in 2009.
Why the WSE will be the growth leader during the next bull market?
1. Enormous divergences in valuations
During the current bull market that has lasted over 10 years, capital flowed mainly to developed markets, in particular to the U.S.. As you can see below, global (World) valuations indicate a strong overvaluation, where CAPE is 23.5. U.S. shares are even more expensive.
In comparison, neutrally valued equities in emerging markets look good.
Particularly noteworthy are shares from Emerging Europe, including: Poland, Russia, Czech Republic, Slovakia, Bulgaria and Romania. Shares in this region are very cheap and if we had such valuations after a period of panic in the markets, I would have no hesitation in investing substantial capital in them. However, I think that due to the strong economic slowdown, cheap shares will become even cheaper and the Polish currency will weaken by a dozen percent giving investors a very good entry point.
2. Shares differences
Currently, we are dealing with fairly strong valuation disparities on the Polish market. Namely, the most expensive are shares of the largest companies included in WIG20 index. Medium-sized companies look much more attractive. On the other side, smallest company’s shares in the sWIG80 index are very cheap. They have P/E below 10, and still pay 3.35% dividends, which is very good considering today’s standards.
At this point, I must immediately emphasize that based on my experience, shares of large companies are growing the most in the first phase of the bull market. This is related to the flow of capital known as smart money. The largest players, seeing an attractive market, invest in it through available instruments, which in majority of cases provide exposure only to the largest companies. Over time, smaller players join the trend, focusing on smaller and usually more attractively valued companies.
3. What does Polish Smart Money do?
Very attractive valuations of Polish companies are also noticed by the biggest players. They are aware that such low valuations will not last long. Over the past two years, Michał Sołowow, Dominika Kulczyk, Roman Karkosik and Zygmunt Solorz have bought back their own shares. This means that they either buy shares in the companies they control for private money or to buy back shares completely to withdraw the company from the stock exchange. These are people who know what they are doing and I’m not talking about demonstration activities but transactions whose total value is approaching 4 billion PLN.
4. Shares valuations from the international investors perspective.
Managers who hold significant amount of assets looking for an attractive stock market take into account two things. Described above stocks valuations and exchange rate. These two variables have a huge impact on our investment results. If shares prices do not change but the exchange rate of the local currency increases, then having the dollar as a common denominator for our international investments is an advantage. In an ideal environment, we invest in cheap shares and at the same time in strongly undervalued currency.
Until recently, global players had two ETFs through which they could invest on the Polish market. I am talking about EPOL (iShares) and PLND (Vaneck). Both denominated in dollars. However, due to low interest, only EPOL has survived to this day. The problem is, however, that its history goes back to 2010, and my goal is to show you the valuation of Polish shares in dollar terms using the longest possible time frame. For this purpose, I used the WIG20 index chart expressed in U.S. dollars.
In the years 2003–2008, investment in the Polish stock market brought international players profit of 500%, it was a result of both increase in share prices and strengthening of the Polish zloty against the dollar. Profits were probably higher because the presented index does not include dividends paid over 5 years.
Currently, WIG20 valuations in dollar terms are 65% below 2007 levels. In real terms, due to dollar devaluation resulting from inflation valuations are even lower. As a curiosity, I marked levels at which I will probably make larger purchases using red frame. In order for us to achieve them, the valuation of shares should decrease. The zloty may further weaken against USD. If there is a greater panic then both scenarios will be very likely, which will make Polish stocks extremely attractive. For me it will be a perfect time to get rid of dollars or Swiss francs and buy shares bearing in mind that after the purchase, prices may fall for some time. For me, however, it is an investment for years as Gazprom used to be, instead of catching lows in order to get rid of shares with a 10% or 20% profit.
5. Global capital migration.
I have written many times about how capital migrates between developing markets and the U.S.. In context of today’s article, however, this is very important. As you can see, in the last cycle capital went mainly to the US strengthening the dollar. Current situation resembles 2000 in many respects. Some says that history does not repeat itself, but its knowledge makes predicting the future much easier. Draw your own conclusions about it.
source: own elaboration
At this point, some of you may think: good, but Poland is no longer a developing country. We were promoted to the group of developed countries. I see only positives in that. For investors, the WSE is still perceived as one of the countries belonging to, what used to be Central and Eastern Europe block, but due to the status of a developed country investment risk has decreased significantly. What’s more, the current government is trying to satisfy international finance, as a result of which the attack on Polish currency, as recently carried out on Turkey, is very unlikely.
6. Economic growth
The Polish economy, despite the sick distribution policy, is still doing well. We have a very high GDP growth of 4.7% year on year compared to 1.1% for the Eurozone. Demographic situation in comparison to Europe also looks decent after taking into account the migration of well-educated and very culturally similar Ukrainians. The country’s debt is also at a tolerable level in relation to “competition”. All that makes Poland an attractive place to invest capital.
Importantly, as one of the few countries we use our own currency, which in the environment of potential economic slowdown immediately weakens, which gives a temporary impulse to mitigate the effects of the crisis. The Polish zloty acts as a stabilizer. How important it is you can see on the graphic showing economic growth in Europe just after the last crisis.
source: Ekonomia, dr Robert Pater
7. Migration of giant capital from Israel.
In 2012, Henry Kissinger, a person who had a huge impact on global politics, said in sincerity that there would be no Israel in 10 years. A moment later, Rotschild spoke in a similar tone (I don’t remember which one). They are not people who are trying to predict the future. They create it.
Three years ago the trend of capital migration from Israel to Poland began. First, the emissaries of the respective families bought land, businesses or real estate. Migration intensified over time. Today you know what the issue of Jewish return to Poland and Act 447 look like. For my part, I just want to point out that for the economy as a whole, the migration of such gigantic capital can have a very positive impact on the economic growth and results of listed companies. Will it positively affect the quality of life for an average Pole, I leave it unanswered.
8. Changes in the NBP policy
The policy pursued by the National Bank of Poland has not been special in recent years. Over the past three months, there have been significant changes that may affect the stock market.
a) Gold purchases
Over the years, the NBP has gathered gold reserves of 112 tonnes. Purchases made in recent months have caused gold reserves rising to 228 tons. It is a very good move. The vast majority of central bank reserves are foreign currencies such as the dollar or euro. In crisis situations when the value of the local currency drops sharply, central bank should in theory sell foreign currencies and thus stabilize the exchange rate. When an attack on the Polish zloty was carried out at the end of 2016 to deactivate the currency options, the NBP did not take any action until USD exchange rate exceeded 4.25 and EUR 4.50.
On the other hand, the central bank of a peripheral country like Poland rarely has a chance to win against the global speculative capital. In other words, increasing gold reserves is a very good step that may help stabilize the exchange rate in the future or, in the event of major turmoil in the monetary system, stabilize the zloty exchange rate at a higher level.
By the way, there has been speculation that the Polish gold deposited in London is a “security” for certain claims arising from a law that has recently been widely publicized. The question is how much truth is there?
b) Announcements of central bankers
Another policy change of the NBP relates to planned share purchases. Until 2008, the only central banks tasks were to regulate currency supply and interest rates. Over the decade, major central banks have started acting like hedge funds by buying all kinds of assets and completely distorting market mechanisms. The NBP, which until recently had not engaged in such activities, intends to change this, which is signaled by members of both the bank and the Monetary Policy Council. This is sick!!! A group of bankers using currency that they can create beyond all control will buy shares by raising or lowering their price depending on what they see. NBP members will get a toy with which they will manipulate stock prices and run front-running privately (advance movements). Although I consider such actions extremely harmful, this additional buyer, which will be the NBP, will positively affect listed companies prices, which is another factor confirming good prospects for the WSE.
9. So, is now a good moment to buy Polish shares?
In my opinion no. Virtually every large economy in the world slowed down strongly and it is not clear when this trend will reverse. The economic situation and prospects for shares are very well illustrated in the graphic below.
Well, yes, but the FED has already begun the process of interest rate cuts, which is supposed to help raise stock prices to new highs. Maybe I will surprise you, but drops occurred during the period of interest rate decreases not increases, which is perfectly confirmed by the graphic below.
Blue reflects US interest rates, red the periods of decline in share prices.
Returning to the economy, however, Germany, the largest Polish trading partner fell into recession. This is not surprising, since the largest part of the economy is export, in which the automotive sector has a 20% share, ir is first to experience the effects of global slowdown. To put it simply, the slowdown in Germany will soon be felt, among others, in Poland translating into a decline in GDP and perhaps will cause a reduction in the rating awarded by major rating agencies. How will this translate into share prices and the zloty exchange rate? You probably already know.
Considering all the above factors, I have no doubt that the Polish stock exchange will probably be one of the growth leaders during the next bull market, next to Russia or Turkey.
However, it is very important to understand the current situation and the threat of declines. When they appear in the U.S. as at the end of last year, they will also have a negative impact on both share prices of companies on the WSE and the exchange rate of the Polish currency. Fear in the markets is already evident from both currency valuations known as safe haven and bond yields (the lower the greater uncertainty among investors). Over time, however, panic in the markets will be used, as at the end of the last year, to justify return to printing. It will not be 60 billion or 80 billion per month, but most likely central banks will determine the “optimal” yield on government bonds, which in plain language means printing as much as needed. In Japan or the eurozone it will probably be between 0 – 0.5% for 10-year yields. In the U.S., probably between 1 – 1.5% depending on whether they are 10-year or 30-year bonds. So far, since the beginning of the year their yields has fallen to 1.68% and 2.16%, respectively. As for the “safe” bond market, this is a horrendous change.
High inflation in such an environment will manage to devalue a significant part of the debt. At the same time, such low interest on the bonds will intensify the migration of capital to the stock market. Ultimately, shares paying dividends of 3-4% are very attractive in comparison to bonds paying a meager 1% interest.
Before this happens, however, we will have some turmoil and you should be mentally prepared for it. Observe the situation, follow share valuations and the zloty exchange rate, because at some point there will be a good moment to exchange dollars and francs for the Polish currency and buy cheap shares. However, remember that usually the best moment to buy is the moment after the panic, when everyone is announcing further declines. May you then have enough courage to take action. Courage comes with knowledge. Remember that.