The risks of overvaluation

The Athens Stock Exchange continued its upward course last week with the general stock index closing above the 2,300-point mark amid intense speculation about an upcoming, unexpected merger-and-acquisition (M&A) deal in the banking sector and alleged buying by state-controlled portfolios ahead of Prime Minister Costas Simitis’s keynote speech at the Thessaloniki International Fair. Although everybody seems to be pleased with the bourse’s steep advance since early April, few analysts warn that Greek equities could under-perform their European peers next year if this year’s spectacular rise gets out of sync with fundamentals. The Athens composite stock index gained 1.5 percent on Friday to close at 2310.5 points, posting a weekly gain of 5.5 percent and a year-to-date gain of 32.1 percent. The composite index is up 58 percent from its year-low of 1462.19 points on March 31. Although everybody agrees that the Athens stock market was oversold and therefore prone to a technical upward reaction once the overall geopolitical and economic conditions improved after the end of the Iraq war, it is the prospect of general elections, the improvement of the earnings profile of large listed companies, mainly banks, and the rally in foreign equities which have made the difference. Optimistic valuations Following the out-performance of the Athens bourse so far this month and this quarter, however, few analysts have started talking about demanding valuations in some heavyweight Greek stocks that may not be supported by even the most optimistic earnings forecasts. «It is a bit of a concern to see heavyweight stocks gain a lot of ground in a few sessions amid rumors of M&A deals. If this upward trend continues independent of the course of foreign bourses and there are no important deals in the pipeline, the risk of the Greek bourse under-performing next year rises and this is something we take seriously into account,» says the London-based analyst of a European investment bank. Foreign investment banks hungry for fees in a still-difficult market environment spotted Greece as a promising market for M&A and part-flotation deals in the first few months of 2003 when pessimism was at its highest. Realizing how essential it was to cover Greek companies seeking to take part in deals, at least one well-known European investment bank is said to have brought back its analyst to do research on local companies. «The promise of M&A and other deals, mainly part-flotations of state-controlled companies such as OPAP (the state lottery OPAP) and PPC (the Public Power Corporation) has attracted our and other foreign investment banks’ interest this year,» says the same analyst. He admits that the prospect of elections played a role in that decision because it was understood that the government had to push ahead with its privatization agenda to finance its social program in order to win over more votes. So, upon these investment banks’ recommendations, a few of their clients, mainly European funds, started buying into selective Greek stocks, such as banks, mostly unnoticed. Some of these stocks have doubled in price since then, bringing joy to their holders along with a dilemma: «Shall we liquidate our positions, take the profit and get out or not?,» says another source familiar with their thinking. With some heavyweight company valuations already stretched, the only factor other than raising the valuations of their European peers, which could have supported their stock prices at current levels or justify even higher ones, was some kind of M&A deal like the ones rumored in the market. Even so, these analysts appear quite skeptical. To them, it is not the hoopla surrounding the deal which is important but the bottom line, that is, earnings of the new company. They know very well, like many in the industry, that a successful M&A deal between overstaffed entities usually requires plenty of layoffs, which is quite unpopular in the Greek society. Even among the conservatives leading in opinion polls at this point and who appear more willing to relax regulations so as to make the labor market more flexible and facilitate M&As among large Greek firms, there is genuine reluctance to bear the blame of massive layoffs. When this issue is raised, senior conservatives appear willing either to pass the ball to somebody else or just forget all about it and go to another subject. This reality is known to the few analysts who appear concerned about the potential downfall from what may be an excessive rise of stock prices this year. They say they fully understand the role the stock market plays in creating the right economic conditions and in shaping positive expectations ahead of general elections. They are also aware of the stock buying by state-controlled portfolios in the months leading to the general elections in April 2000, which some believe will be repeated in a different way this year. These analysts, who do not appear to be politically motivated or choosing sides, say market talk of the general stock index climbing over the 3,000-points mark in the next few months may help attract fresh money and indeed push the Athens bourse higher, but warn «the higher it goes, the bigger the splash» if stock prices get divorced from fundamentals. «For a rise to be sustainable, it has to be gradual and be supported by economic fundamentals and not just the political will of the government, any government,» says the London-based analyst. «You may get a good performance, perhaps a very good performance this year with some help from the 2004 Olympics, but this will not get you far next year.» Some believe that asset prices revert to their mean after a period of excessive returns on the upside or the downside. If this year’s stock market rally turns out to be excessive and out of sync with fundamentals, then «reversion-to-the mean» implies under-performance in 2004.