The General Market Index of the Cyprus Stock Exchange (CSE) is up almost 40% in 2014, making it far and away the best performing frontier stock market this year. Furthermore, since Cyprus is part of the EU and stocks are priced in Euros, this is not a situation where the stock market has rallied to compensate for massive currency devaluation, such as in Argentina or Kazakhstan this year. This island nation of 1 million people is now home to the hottest stock market in the world, with the General Market Index closing above 142 on Friday, Feb 21, a level unseen since November 2012:
So what’s going on? It’s worth putting the whole rally in context first. While the performance this year has been great, the base level is very low with the index closing at about 103 in December 2013. The Cyprus Stock Exchange has been hammered since the financial crisis in 2008, dropping from a peak of 5500 in the index in late 2007. That translates into a 98% drop from the high even after the 40% rally this year. You can see the dismal performance in this chart of the past 10 years:
Yikes. As bad as the index’s performance was, volume was at least steady until 2012. So what happened in early 2013 that reduced volumes to all-time lows?
That would be a looming national bankruptcy, causing banks to close for two weeks in March 2013 with scares that a bank run would further accelerate Cyprus’ descent into financial disaster. Their credit was downgraded to junk status and a bailout was soon arranged by the EU, with bank deposits over 100,000 all taxed. For a quick overview of all the events check out this link, but it would suffice to say that money was flowing out of Cyprus as quickly as possible.
Despite the rally in the stock market, Cyprus’ economy is still in dire straits. Growth is still expected to contract and debt is expected to continue growing until 2015. Unemployment remains a big issue with about one fifth of the country out of work. And thanks to the extremely severe stipulations of the bailout, bank deposits are still receding.
But there are signs of optimism now. Last week it was announced that capital controls implemented during the bailout last year would begin to be relaxed. Preventing bank runs have been a priority of the central bank but those fears seem to have abated with the governor stating he was “cautiously optimistic” in a conference last week.
Nowhere has this change in sentiment been more apparent than in the performance of Hellenic Bank Limited (HB), one of the most actively traded stocks in the General Index. Since trading at about €6.00 in 2007, the stock had fallen to a low of just €0.047 in October 2013, and an online game maker now owns 30% of the company. HB is now up about 36% YTD but still only trading at just above €0.11, a penny stock of a company that reported net losses last quarter and are still on the verge of bankruptcy.
However, trading volumes are up and money genuinely seems to be returning to Cyprus, especially to firms less related to the financial sector. The bargain hunting has spread to the rest of the 12 members of the index, with Logicom (LOG), a local IT company, up almost 95% on the year. Vassilico Cement Works (VCW), a cement production company, is up almost 70% on the year.
While the dangers to Cyprus’ economy remain very real, the forward looking stock market is clearly pricing in that the worst is over. For those who look to enter markets while everyone is exiting, Cyprus provides a compelling situation to pick up bargains with the index still 98% off its highs despite the rally this year. We do not currently have a position in this stock exchange, but it is a market we will be following more closely given the valuations. The relative lack of currency risk to investing in Cyprus makes for a unique situation when compared to other frontier markets.