Executive summary:
- A coup is increasingly likely.
- Record high earnings, dividends, and price multiples for the Thai stock index (SET) suggest lackluster returns over the next decade.
- A nascent breakdown in the correlation between the Thai index and profits suggests low returns over the next five years.
- Historically, the best time to buy Thai stocks is when politics is stable, earnings are low and volatile, the baht is weak, energy prices are peaking, and P/E is low.
- The Thai stock market is also vulnerable to severe short-term, open conflicts on structural issues regarding the monarchy and cohesion of the Thai state.
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Three weeks ago, during the weekend of the botched parliamentary elections in Thailand, a coup did not seem at all imminent, despite the killing of a protest leader at a polling station the week before or the "Laksi gunfight" on the eve of the election. Over the last few days, however, a coup now seems palpable.
In this article, I will explain why I think both the growing conflict and the markets are signaling weak returns over the next five to ten years in the kingdom. There are some bullish indicators, to be sure, but the majority of the evidence is not positive.
First, the politics. What has changed in recent weeks is not so much the rise in violence in the last few days but the sense that the competition for the narrative of the violence is spinning out of control. Take the talk about the "men in black," the mysterious gunmen that seem to pop up at critical times on either side of the political divide to cause mayhem and bloodshed. It is the debate about the identity and motives of these sorts of characters that have become the focus of the argument on both sides rather than the underlying conflict that inevitably spawns them. Increasingly wild claims and counter-claims are bandied about, and emotions run ever higher.
Although the talk about these gunmen often leads back to comparisons to 2010 and arguments about who killed who and why, the current situation reminds me more of August 2006, when one could read stories about a car bomb in front of Prime Minister Thaksin's house big enough to blow away a section of the city, along with claims that the bomb was not that powerful; was crude; was sophisticated; was fake and planted by friends of Thaksin; that it was real but planted by friends of Thaksin, who was never in danger of being killed; that it was planted by the military; that it was planted by rogue elements in the military, etc. The most basic facts were so swept up in the maelstrom of events and speculation that it was all but obvious that a coup was imminent. In such a situation, there is little alternative but for states of emergency, martial law, and the elimination of all overt political competition. A month later, the army, festooned in royal yellow, pushed Thaksin out.
The present situation has not yet reached that particular pitch of farce and tragedy. The "popcorn shooter," the children who were killed over the last few days, and the claims that the perpetrators were Cambodians is certainly pushing events to that point. More importantly, I think patience on all sides appears to have worn very thin. There has been, after all, zero progress in resolving this crisis.
The rhetoric has become hotter among pro-government Reds, PDRC protesters, moderates, almost everybody. At the same time, figures from the formal opposition, who had receded into the shadows up until now, have stepped up their calls for the prime minister to go while presenting themselves as moderate, almost nonpartisan alternatives. More ominously, General Prayuth has quietly changed tack since his efforts to downplay the possibility of a coup two months ago.
The government is now hamstrung. The Constitutional Court has forbidden the government from trying to restore order to the streets of Bangkok. The Election Commission has threatened to charge the prime minister with corruption in the failed rice subsidy program (which may eventually provide the military with the cover it needs to legitimize its takeover). And, the prime minister, much like former prime minister and opposition leader Abhisit Vejjajiva and protest leader Suthep Thaugsuban, may be charged with murder in connection with the political violence under her watch.
The conflict has been a battle of attrition but it now seems to be transitioning to the next stage: a coup. What is still needed on the part of those who would remove the government is a more plausible case in the eyes of the Thai people to push that agenda forward. Prime Minister Yingluck and the Red Shirts have, at least up until recently, been very careful not to provoke a coup although that caution has also demonstrated their lack of power. I suspect that we need at least one more grand event, something on the scale of the 2006 car bomb, to create the sense that the very nation is unraveling and to legitimize what seems increasingly inevitable now. Certainly the rhetoric on the part of those presumably opposed to the government is designed to create that impression.
But, does any of this matter to markets? Nobody who has any considerable sum of money in the Thai market can be oblivious to the frequency of political disturbances in Thailand. Since the beginning of the Stock Exchange of Thailand (SET) records in 1975, there have been something like twenty prime ministers, four successful coups, three unsuccessful coups, five massacres, five constitutions, one monarch, and even elections.
With respect to how political volatility relates to returns in the Thai market (TF, THD, TTF), I think a few tentative observations can be made based on the limited historical data we have:
1. Successful coups are bearish.
2. Unsuccessful coups are bullish.
3. Frequency of changes in government coincide with falling markets.
4. Civilian bloodshed in Bangkok is bearish. (It is also possible that massacres or heavy, political violence on the periphery, such as in the Far South, during Thaksin's drug war, or the battles with Vietnam in the 1980s and early 1990s coincide with bull markets).
5. Constitutional change seems to be correlated with changes in the direction of the market.
Unsurprisingly, with so much political volatility in such a short amount of time, many of these events overlap one another. Generally, however, I think we can summarize all of this by saying that political conflict does appear to make a difference. In other words, "Sell when there's blood on the streets of Bangkok."
In the tables and charts below, I compare returns with episodes of political instability. Again, we hardly have copious amounts of evidence, but I think this should cause some to doubt the claim that markets in Thailand are immune to political instability. Because these events often occur on specific dates or are stretched out over months, the returns are approximate, but I think they are fair approximations. Returns are stated in real dollars.
| Successful coups | 10yr ann returns |
| Oct 1976 | 4% |
| Oct 1977 | 0% |
| Feb 1991 | -14% |
| Sept 2006 | ??? |
(Source: calculations from Nicholas Farrelly, New Mandala and the SET).
| Failed coups / no coup in prev 5yrs | 10yr ann returns |
| Mar 1977 | 5% |
| Apr 1981 | 18% |
| Sept 1985 | 23% |
| Feb 1996 (no coup) | -11% |
| Feb 2001 (no coup) | 14% |
(Source: SET and New Mandala).
| Bangkok massacres | 10yr ann returns |
| Oct 1976 | 4% |
| May 1992 | -11% |
| Spring 2010 | ??? |
(Sources: Wikipedia and SET).
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(Sources: SET and Thailex).
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Based on these patterns, I tend to think that political unrest is bearish, although this says nothing about the direction of causality or whether there is any causal relationship at all.
It also has to be said that none of this speaks to types of events that are, within the span of the last forty years, unprecedented, particularly royal successions and changes in the cohesiveness of the Thai state. In the last few months, domestic and foreign observers seem to be grappling with the increased possibility that the kingdom could break up along regional lines. I will say a little more about those two points in the conclusion.
For now, I want to focus on the historical behavior of the market apart from political considerations. Virtually all of the indicators I have examined are bearish.
Before reviewing those indicators, I would like to acknowledge the importance of an obvious generalization about the Thai market, namely that Thai stock returns, especially up until a decade ago, have been far more volatile than US returns, although there has not been a huge difference in returns over the course of the last 38 years.
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(Sources: SET and Robert Shiller).
In nominal dollars, the Thai stock index went from 5 to nearly 45 between the second quarter of 1986 and the third quarter of 1990. That was a feat that the S&P 500 needed twenty years (1937-1957) to accomplish. Between August 1994 and August 1998, the Thai market went from 60 back to 5. As of April 2013, the SET was back to 55.
My point is really simple and obvious: one should not enter the Thai market without a phalanx of bullish indicators. Those indicators would include a financial collapse and political stability. That is precisely the opposite of what we have now.
In the following table, I have listed five measures that seem to have been useful in indicating medium-term (five- to ten-year) dollar returns.
| Indicator | correlation (w/5yr return) | correlation (w/10yr return) |
| CAPE | -0.57 | -0.88 |
| P/E | -0.55 | -0.76 |
| Nat gas | 0.37 | -0.76 |
| Baht/MA60 | 0.16 | 0.4 |
| Earnings beta | 0.69 | 0.49 |
(Sources: SET, St Louis Fed, Bank of Thailand, and World Bank)
Let me begin with the weakest correlation (changes in the exchange rate) and then work my way up that table, saving the fifth, idiosyncratic indicator (earnings beta) for last.
The question is, is a strong baht (or, a weak dollar) good or bad for the market? And, the answer is, Yes. It is great for the stock market but bad for future returns. The baht tends to rise with (actually, slightly lag) the stock index but the best time to buy into the market is shortly after a major devaluation. Although the baht has come down somewhat since last year, it remains (as of this writing), like the stock market and profits, near record post-1996/1997 levels.
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Ten-year Thai stock returns are also strongly correlated with real dollar prices for energy, especially the world price for natural gas. According to Platts, 67% of power generation is derived from natural gas, and although Thailand is relatively well-endowed with natural gas reserves, it has been increasingly dependent on imports since 1998. Although the relationship between energy prices and Thai equities is complicated, one might simplify it by saying that the Thai equity market responds best to dramatic declines in global natural gas prices, and those declines tend to occur after energy prices hit historic highs. Sixty-seven percent declines in gas prices in 1983-1988, 2001, and 2008-2009 were each followed by stock market booms (1986-1990, 2001-2004, 2009-2013??). Rising or flat gas prices seem to be associated with reduced stock market growth performance, if not outright collapse, but the relationship is not as clear-cut on that side.
Although for reasons I have outlined elsewhere (and which I hope to write about again in more detail in the next few weeks), I believe we are in a secular bear market in commodities, it has to be noted that the biggest declines in commodity prices seem to occur in the earliest stages of the bear market, and perhaps again near the end of bear markets. Although it is not unreasonable to expect another dramatic decline in commodity prices at some point, the last big drop in energy was five years ago, and at this point, it would seem better, as with exchange rates, to wait for the next crash before pursuing Thai equities aggressively.
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More conventionally, P/E ratios, especially CAPE, are at levels that suggest poor future returns. As noted above, equities and profits have eased off their 2013 highs, but they remain at levels last seen during the boom two decades ago. Considering how cyclical and correlated Thai valuations, stock prices, earnings, and dividends are, it is very hard to justify buying into this market at these levels.
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I would like to expand a little, however, on this topic of the relationship between valuations, stocks, earnings, and dividends in Thailand, and for two reasons. First, I have attacked the use of CAPE as a metric in the American market in previous articles, so I have to provide at least some justification for referencing it here. Second, delving into these relationships is a good way of understanding both the Thai and US markets somewhat better. And, that will take us back to the "earnings beta" metric I referred to earlier.
Quite simply, the Thai market by almost any measure perfectly mirrors the US market. I am not referring to the low correlation that emerging markets reputedly have with US markets as much as I am the internal dynamics of the markets. In most respects, the Thai market resembles the US market prior to the Great Depression, perhaps because both of those markets are/were geared towards manufacturing and export.
With regards to the US market prior to the Great Depression, and especially before World War I, stock prices tended to be highly correlated with earnings (and dividends) over the short run but were less volatile over the long run--the end result being that the P/E ratio tended to be inversely correlated with earnings and dividends and relatively indifferent to stocks.
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In Thailand, we could say much the same but with some key differences. Stocks tend to be positively correlated with earnings (and dividends) over the long run, but are also more volatile over the long run, with the result being that the P/E ratio is mildly correlated with earnings and strongly correlated with dividends.
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In contrast to the US, where earnings growth has been constant since the Depression, or more volatile than stocks prior to the Depression, a market in which P/E ratios tend to be correlated with earnings and to be highly cyclical makes employment of CAPE less problematic, assuming that behavior remains constant. Unfortunately, although there is a lot of data on Thailand out there, as an emerging market, it only goes back a few decades. In other words, we have to make do with what we have.
That brings me back to the "earnings beta" metric. I explored this somewhat last summer with regards to the US market, and I will elaborate on it again in the near future, but in brief, since the Great Depression, the rolling, five-year beta of earnings to stocks has been negatively correlated with future returns. This is precisely the opposite of pre-Depression behavior, where beta was positively correlated with returns.
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In Thailand, like pre-Depression America, returns are positively correlated with the beta of earnings. In other words, high stock-earnings correlations combined with relatively low stock market volatility, which is what we have been seeing over the last decade and a half, is bullish in Thailand but bearish in the United States. And, in both markets, this measure is at very high levels (using the most recent data available). In the US, this measure is simply off the charts (particularly with year-on-year changes). I think, however, that this is a statistical fluke in the US and in Thailand, as well. Correlations between stocks and earnings have been driven up in recent years by the dramatic rebound in earnings from the crisis-lows of five years ago. In 2013, that dynamic appeared to change in both markets. In the US, stocks surged on the slowdown in earnings growth, as did the SET, at first. But, if history is any guide, that bodes well for the US and ill for Thailand.
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I think that we will find that as time moves on and the extreme levels of five years ago are eliminated from rolling correlations, a sudden shift in these measures will occur. Therefore, although I believe that the measure is objectively bearish for the US and bullish for Thailand, I have taken the liberty of focusing on the last two years to interpret the signal in precisely the opposite fashion.
In conclusion, virtually all the signs from the market point to poor returns over the next five to ten years. If the Thai market experiences a sharp sell-off in the not too distant future, there may be an opportunity to make money in its wake, but bar that, there is no justification that I can see to brave this historically volatile market at this point.
And, there is nothing promising that I can see in the current political dynamics. A low-intensity civil war has been dragging on and intensifying for nearly a decade now without unduly depressing returns and economic performance in the country, but I do not believe that state of affairs can continue for much longer. This crisis must come to a head, and the coup that seems to be on the cards now will not solve it, because the crisis is ultimately rooted in interlocking tectonic changes in Thai society.
I have nothing intelligent or insightful to say about the speculation that swirls around what may or may not happen when the time for the succession comes. What matters is the instability that the inevitable speculation must inevitably nourish. The most recent edition of The Economist has a good synopsis of how uncertainty about where the Crown Prince's sympathies lie amplifies the tension, but others have speculated, not implausibly, that some "royalists" are not trying to position themselves for the Crown Prince's accession to the throne but are rather trying to influence the succession itself. Generally, I have little patience for Kremlinology, but in relatively authoritarian societies, this sort of speculation can serve to make some events less opaque.
Over the very long term, I am bullish about Thailand's prospects, despite the hordes of reasons to be pessimistic. Bangkok is the anchor of mainland Southeast Asia. Stability and continuity of aristocratic privilege in old Siam has permitted Thailand to avoid both European colonization and the wave of post-colonial totalitarianism and genocide that swept over Vietnam, the Mekong Basin, and Burma.
It is easy to dismiss the shenanigans and deplore the outrages of Thai politics on both sides. When I walked around the anti-government protest sites in Bangkok three weeks ago, I was troubled by much of what I saw. Not many people will accuse me of being a sanctimonious democrat, but on the eve of the election, I was shocked by how callously buoyant the protesters seemed to be about both the violence that had occurred only hours before (despite Suthep's rhetoric about an almost Gandhi-like disavowal of violence) and, more importantly, I think, their willful obstruction of the election.
The obstruction of the election was not so shocking in terms of the violation of what many (particularly in the West) would regard as an inalienable right to vote but rather because it denies to the rural regions of the North and Northeast their one lawful path to having a say in the country's affairs. In other words, it seemed like nothing less than an invitation to civil war, a brazen alteration of Thailand's unwritten constitution.
The problem is that Bangkok, which has historically been at the core of the Thai state and identity, as well as the commercial, political, and cultural link between Thailand and the rest of the world, has simply never come to terms with the full import of the idea of "Thainess." On the one hand, this idea can be used to explain to foreigners why their understanding of Thailand will always be superficial, but it also legitimates the idea of a nation of equals, an idea that many Thais are, unjustly or not, not prepared to accept.
Ultimately, I think the facts on the ground will force Bangkok to find a way to accommodate the aspirations of the North and Northeast and force the North and Northeast to accommodate Bangkok's pretensions. Neither the North nor the Northeast individually or combined could constitute viable independent states. They are still dependent on Bangkok economically, and the alternative would be to move towards a situation more reminiscent of Laos than Siam.
The relationship between the center and periphery will probably take decades to work out, as will the role "Thai-style" constitutional monarchy will play in that order, and the question is just how much violence and upheaval that process will entail. No matter what occurs, it is likely that Bangkok, which has been the most stable, prosperous, democratic, cosmopolitan, and liberal spot in mainland Southeast Asia for the last century will be at the center of growth for the foreseeable future. There are simply no other contenders.
The next few years may not be especially pretty, however. Until a viable political settlement arises and the market is less richly priced, there is too much risk in the Land of Smiles.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. (More...)
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