The seven weeks of correction on the Bulgarian Stock Exchange (BSE) opened a brand new chapter in its modern history. It should be mentioned that many experts had already cautiously warned about an overheating market. Moreover, signs of market weakness were visible in early October but were easily ignored and indices finished the month on strong note.

Since the beginning of November, liquid stocks have already fallen between 10 and 20 per cent. November is looking like it could become one of the most unpleasant months in the history of the Bulgarian market. While prices are close to their low levels in August they are still more than 30 per cent higher than the previous low, which occurred in mid-May. In the long term, however, there are no doubts about the positive outlook for the Bulgarian economy and stock market.

The reasons for the optimistic view have been well documented and emphasised time and again: among them, European Union membership, a favourable business climate, business tax reforms, rising consumer demand, the expansion of loans.

Before assessing the short-term market opportunities and threats, it is important to understand the origin of the market correction. Bulgarian stocks showed remarkable resilience to previous weaknesses on the world markets. This time, however, it was different; the correlation with developed and regional markets was significant. The main reason could have been the growing role of short-term foreign investors, who bailed out during the aftermath of the mortgage crisis in US and the credit crunch in the international money markets.

Investors managed to enter the market through the liquid stocks, mainly those with initial or secondary public offering this year. During the past year, the main index on the BSE, the Sofix, jumped 70 per cent to its peak in early October. The activity on the international markets may have just triggered a reasonable profit-taking. Domestic institutional investors also stepped outside of the market and although they did not sell, no major support for prices was seen.

The period coincided with large number of capital increases and several initial public offerings (IPO). The capital outflows were comparable to the three largest IPOs in the second quarter of the year. Small speculators used every pull-back to open new long positions but the strength of the correction quickly pushed their cash to insignificant levels and was unable to provide additional support.

Bulgarian stocks are far from being cheap anymore. The average price to earnings ratio of the Sofix constituents is close to 30 and many industrial companies are trading at even higher multiples. This level is at the high end for Eastern European markets.

Growth rates of profits and sales have supported the market as liquid companies announced a 30 per cent increase in their revenues and improved profit margins. The improved results were visible even on quarterly basis.

It will take several quarters to bring down the multiples to the average for Eastern European markets. However, the Bulgarian market is still experiencing strong demand from institutional and individual investors, which will support the prices in short term and will be behind solid market gains in long term. Multiples will remain high in the near future and cannot be considered as signs of an overvalued market independently. The BSE cannot be compared with the performance of the markets in Greece and Cyprus during the internet bubble in 1999-2002. On one hand, the fundamental support is strong, both in terms of future profit growth and reasonable multiples when comparing to fast developing emerging markets and, on the other, the increase in share prices is less steep than the movements that are usually associated with any market bubble.

The right investment strategy is stock picking with a long-term horizon. The correction affected all liquid companies, despite their perspectives and current valuation. The sectors that usually attract the attention of large domestic and foreign investors include banks and insurers, industrial companies with rising sales – mainly in manufacturing and basic materials and infrastructure and construction companies.