Tsvetoslav Tsachev, Head of Analysis Department, ELANA Trading

Recently, I heard a story about a passenger ship that escaped Hurricane Katrina in 2005 while its passengers had been watching the blockbuster Titanic. To watch this movie while escaping the category five hurricane was very similar to the Bulgarian stock market in January. Investors, both foreign and domestic, were frightened by the global financial storm but did not have many options other than stay in the market and hope to escape the worst. The severe drop in world markets was also reflected in Bulgarian stocks. The shares of most blue chips companies were 30 per cent below their October peaks and looked susceptible to additional losses. Moreover, the global economy is heading into a very rough period and many economists are predicting not only recession in the US but in Europe and Asia too.

Signs of economic weaknesses can be sought everywhere except in Bulgaria, but here is beyond the glimpse of foreign portfolio investors. In fact, nothing changed during the fourth quarter – the Bulgarian economy grew faster; construction and the real estate market were sound; companies invested in new equipment and were working at full capacity; rising domestic demand and prices supported the growth of sales and profits. The reasons that attracted decent interest from abroad to stocks were valid and will remain intact during the second year after Bulgaria joined the European Union.

The problems concern the market itself. Trading with stocks became popular only recently and attracted many unprepared speculators. Their capital helped the last rally of prices in August and September. As a result, prices accelerated faster than corporate fundamentals and created a dangerous gap. The commonly used indicator for valuation, the price-to-earnings multiple, jumped above the level of 30-40 for many industrial companies. Most of them have already shown solid growth in sales and improved profitability and will remain on the watch list of investors. However, the mortgage crisis and the following credit crunch changed the appetite for risk. It is unreasonable to expect that Bulgarian stocks will remain at higher multiples than other East European markets.

Foreign investors prefer to exit emerging markets in time of turbulence and risk. Domestic speculators faced other problems that were relatively new for the market – the liquidity issues of repo-operations and the excessive leverage of the volatile market that accelerated not only gains but also losses in January. Small players were forced to close their positions in the thin market which resulted to sharp losses for indices. Any selling activity from foreign investors was multiplied by domestic speculators, pushing down the Sofix index, of the 16 most liquid shares, to the levels of January 2007.

Bulgarian institutional investors were the main force behind the market growth in 2007. Mutual and pension funds attracted considerable capital last year and invested in stocks. The mutual fund industry tripled in terms of assets under management and was close to a billion leva at the end of 2007. However, mutual funds were subject to capital withdrawals during the correction and were unable to support the market. Funds with a higher risk profile fell between 10 and 20 per cent from the beginning of the year and managers preferred to maintain enough cash. Some of them were forced to sell their holdings as a large institutional investor announced the exit from several mutual funds during the last trading week of 2007.

The Bulgarian stock market has entered a new phase of its development – more liquidity and volatility lie ahead, even without the turbulence of world markets. Investors will be focused on the corporate news and perspectives for future growth. Prices will depend on the fundamental picture for Bulgarian companies. A period of change is expected in the portfolio structure and stabilisation of the blue chips that proved to be attractive investments during 2007.