Buying to the sound of cannons

The Beirut Stock Exchange closed during the war, but the future augurs well for all kinds of Lebanese paper

Perhaps the most crucial elements of any capital market, especially an emerging market, are confidence and liquidity. During the devastating days of the conflict between Hizbullah and Israel, both took direct hits. Shortly after the start of the conflict, the Beirut Stock Exchange decided to close. This closure, though guided by pure reasoning was a mistake or at least the length of the closure was unwarranted

Despite the gravity of the situation, it ought to have been the BSE’s priority to maintain a semblance of normalcy and, more importantly, allow buyers and sellers to transact. This is especially true given that the largest stocks continued to trade in London as GDRs and sent a dangerous signal about the depth and liquidity of the Beirut market.

Sell to violins, buy to cannons

There is an adage in markets: sell to the sounds of violins, and buy to the sound of cannons. In this case, if the market had reopened, none of the expected panic feared by BSE decision makers would have occurred. Simply, the market would have adjusted and many international investors who had been on the sidelines during the early 2006 euphoria would have stepped in.

When the bourse did reopen, there were several days of virtually no transactions. Bids had accumulated but no sellers were present since the mood swung to optimism after the adoption of UN Security Council Resolution 1701. The openness and liquidity necessary to any bourse in search of investors, was lost.

Some may argue that the need to avoid panic was paramount. Perhaps. After 9/11, the NYSE was closed for only three days, and there was certainly more need to contain panic in a multi-trillion dollar market than in the small but burgeoning Beirut bourse.

But from a mechanical or technical perspective, the bourse was resilient, and though we have our qualms over the decision to close for so long, leading stocks were resilient. This is due to the fact that many view Lebanese stocks as fairly in balance, or near equilibrium. A closer look actually confirms this view. The banks for instance, have seen their shares plunge by 30-40% from peak to trough. Solidere saw a fall of 40% as well. This fall in valuations, to be fair, had started well before the July 12 onslaught.

As Gulf markets corrected and investors retrenched, Beirut lost much of its luster. This regional mood, coupled with the inability of the National Dialogue to produce results, had a lot to do with the falls. Now, after the dust has settled and the guns are silent, it is time to look at value, or at least perceived value.

For Solidere, the math is quite simple. With nearly 2 million m2 of unsold real estate, and even adjusting downward the price benchmarks, the now- resurgent shares are worth, on a valuation basis, close to $40/share. This does not mean you should mortgage the house and buy, it is simply a look at how much of a compression, or discount, this successful company has suffered during the crisis.

In essence, the market is underrating Solidere’s ability to sell and rent space. This may prove to be an anomaly, if the situation clears up. Until then, we have to assume that the market is worried about the future.

Banks recover

Banks have also seen a significant fall in the shares and multiples. This is particularly interesting since many banks are not directly exposed – they lend very little in unsecured funds, and are regionally diversified. The holdings of banks in Lebanese Republic bonds did suffer a sharp blow, but have since recovered. Here, the fall in confidence is also quite sharp and has driven the shares to below 10 times earnings. This contraction in the price-to- earnings ratio belies a major shift in confidence – one of exuberance to near despair – and bank shares will soon represent exceptional value as long as Lebanon does not implode.

The arena that most reflected confidence, as the stock market closed, was bond yields. Taking the January 2016 as a benchmark and using the comparable "risk-free" 10-year US Treasury note yields as another benchmark, one can clearly see the fear reflected in the yield movement. The yield on the Lebanese Republic bond went from 7.75% to near 10% during the peak of the crisis.

Prior to the conflict and despite the political shenanigans, spreads between the Republic of Lebanon and US Treasury Notes had been relatively tight, as Lebanon bonds were trading at a 2.5% spread to US. During the crisis, this figure went to nearly 5% and even now, after UNSCR 1701, remains at 3.8%. So the war has taken its toll on the perception of the quality of Lebanese fixed income paper, and this will not likely redress itself for quite some time. The price of bonds and the yields are reflecting anxiety in the markets; anxiety not only over the aftermath of the war but also the ensuing collapse of most sectors of the economy and thus government receipts.

There had always been a sizable contradiction in the dynamics of the capital markets: On the one hand, there were roadshows by highly profitable entities, such as Solidere and the leading banks, while on the other we had a vulnerable, uneven and unstable political situation. As Lebanon made its entry into the emerging markets club, albeit on a small scale, this dynamic – that of a financial and banking center, a destination for large Gulf real estate cash, and the presence of a non-governmental militia (lets call a spade a spade) – was always going to be too much to bear in terms of risk. We had often reiterated that without a strong government, without a genuine reform of the ugly sectarian and tribal methods, a purge of the public sector and normalized relations with Syria, all this financial house of cards would collapse.

Now is not a time for pessimism, however tough the challenges may be. Lebanon still has the attention of the world, and this represents a clear opportunity. The country was never going to make it through without international intervention. We have previously argued that “the autumn will be a tough one for Lebanon, and the hope is that more international involvement in the economic process, coupled with ongoing great expatriate remittances, will help us, once again, dodge a full blown economic depression.”

Lebanon cannot survive without international involvement, not only to help its central government gain territorial control but to court international confidence.

It must also ensure that the decision to wage war and maintain peace is firmly in the hands of the government. Only then can confidence, a cornerstone of capital markets, be restored.

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