In the past week, many analysts have warned of a possible bubble in the Colombian stock market. The IGBC has hit record highs this year growing approximately 37% approaching the 16,000 mark.
Those who are sounding the alarm bells cite this year’s rapid growth as well as a 2009 growth rate of nearly 53% and claim that this kind of expansion is not sustainable and a significant correction might be just around the corner.
On the other side of the argument stands the president of the Bolsa de Valores de Colombia (BVC), Juan Pablo Códroba, alongside a number of brokers and analysts who all claim that the sharp rise in the value of the IGBC is backed by fundamentals, not bubble-causing speculation or large inflows of foreign capital.
Speaking of the sharp rise in 2009 and 2010, Mr. Córdoba said to a La Republica reporter that, “We forget that there was a 30% decline the previous year due to the international financial crisis of 2008. So a large part of what we are seeing is recuperation and the rest is the rise in the market.”
Following the logic of Mr. Córdoba, a 30% drop in 2008 followed by a 90% rise in the following two years amounts to a 60% increase from 2008 – 2010, or 20% per year. When put in those terms, a 20% per year increase over three years does not sound nearly as alarming as an almost doubling in value over a two-year period.
But is this a valid analysis?
Part of the large increase over the past two years is certainly due to recuperation from the global financial crisis of 2008 and Mr. Córdoba also pointed out that “interest rates in the United States, Japan and England are at 0%, which increases the appetite for investments in stocks and anything that’s not bank deposits.”
Mr. Córdoba is exactly right in this analysis but he failed to go further and look into the future. Investors have moved capital away from developed markets which have traditionally provided reasonable, safe returns and have decided to move their capital into emerging markets where risk might be higher but so are the rewards.
However, the story doesn’t end there. What happens when the economies of the United States, Japan and England begin to show signs of full recovery and central banks begin to raise interest rates?
Certainly Colombia will remain an attractive investment for those who are interested in emerging markets but one must think that many who have sent their money south will begin to pull that money out when they can once again get reasonable, safe returns in the U.S., Japan and Europe. The effect that that will have on the Colombian stock market is debatable and it is by no means enough evidence to forecast the bursting of a possible bubble.
Many analysts have pointed to the fact that a large portion of the BVC is made up of energy companies and that this is part of why the large increase in overall BVC value has been driven by fundamentals. Oil production is expected to increase in Colombia as are oil prices as well as coal and other natural resources meaning that companies like Ecopetrol (with a market value of more than 5 times its book value) and Pacific Rubiales are justifiably increasing in value due to future expectations.
Also, it has been noted that the market is comfortable with President Juan Manuel Santos and his cabinet and it does not expect his administration to implement any policies that could be bad for business. This trust of the current administration also leads to increased investment in Colombian firms.
On the other hand, besides unprecedented growth rates and the possible outflow of capital as developed economies continue to recover, many are worried about the possible implementation of capital controls in order to stem the rise in the value of the peso. Any capital controls could send a negative message to the international community and this could cause liquidity to dry up as foreigners might decide to move their cash elsewhere.
Many are also pointing to P/E ratios. The P/E ratio is simply calculated by dividing price per share by earnings per share. This allows an investor to see how much others are paying for a company’s earnings. For example, if a company has a P/E of 20 that means that investors are paying $20 for every $1 of that company’s earnings while if another company has a P/E of 15, investors are paying just $15 for every $1 of earnings.
P/E can be interpreted several ways. If a company has a relatively high P/E it might be that investors are expecting high future growth or it could also be seen as a company being overvalued if others in the same industry have lower P/E ratios.
P/E ratios can also be calculated for entire stock indexes. According to Bloomberg, the COLCAP, an index which includes the 20 most liquid stocks listed on the BVC, has a P/E of 25.3 while the MSCI Latin America Index has a P/E of 15. Again, this could mean that the COLCAP will have a much higher growth rate than the MSCI Latin America Index or it could mean that the COLCAP is overvalued.
Many international analysts have indeed forecast profits of Colombian companies to grow at a faster rate than those of the region as a whole, so the highest P/E in the region could be justified. Only time will tell.
The bottom line is that, historically, we have not been good at predicting bubbles as proven by the most recent case that led to a near global financial meltdown and a collapse in real estate prices in the U.S. and other parts of the world.
Both sides can debate about the BVC and whether or not such large gains in value are valid or not.
President Córdoba makes a very good point when asked about the effects of the bursting of a possible bubble. “In Colombia the participation of families that invest in the stock market is still very small.”
Speaking of those who have pension money in the market Mr. Córdoba said that these are “long-term savings.” He went on to say that, “Since 2006 we have had various episodes of sudden drops in stock prices that have recuperated in six or twelve months.”
He also notes that, “Fortunately, the large majority of the population is still of a young age. Half are less than 30 years old.”
Bubble or boom, what is reassuring about the current situation of the BVC is that if a collapse does occur, the speculators and not the Colombian people are the most likely to suffer.