What is the outlook for the domestic capital market?

They say that for a bull in the capital market, if it wants to earn, it is essential to be positive and live in the belief of a better tomorrow. Who knows, maybe this is one of the many reasons why we have an underdeveloped capital market. There are too many pessimists and we do not have short selling to be able to come into our own and even get the chance to be right. Although our capital market is quite young and underdeveloped compared to more developed markets where it is quite normal for younger people to plan their financial future because there is no state mother to take care of all needs in old age, there has been noticeable interest in investments lately. Despite the fact that foreign financial markets abound with everything that is lacking at home, which is a much larger selection of financial instruments for trading, ETFs (exchange-traded funds), short selling, options, and the like, stock indices have shown signs of recovery and an upward trend since the beginning of the year (Chart 2).

Many still perceive the stock exchange through the IPO (initial public offering) of HT in which many citizens participated, and the popularity of the stock exchange was at a high level. Many citizens became owners of shares, through public offerings, or before that, through the privatization of companies. Due to the rapid growth of the market that lasted until around mid-2007, many viewed investing in shares as a way to make easy and quick profits. And then came the end of the ballad and the financial crisis of 2008, which, by the way, has long ended where it started, and in the minds of ‘our’ media, it is still (unfortunately) a current topic with which they (un)intentionally entertain the public. The sudden and severe market decline led to the creation of a negative image of the capital market, which is why most characterized investing in shares as a gamble equivalent to gambling in a casino. Many realized what has long been known in foreign financial markets: ‘There is no tree that grows to the sky.’ ‘But all that was, will be again,’ wrote the Preacher long ago.

The current state of the Zagreb Stock Exchange (ZSE) is by no means cheerful. The continuous decline in turnover over the last few years (Table 1) has accompanied a tremendous drop in the index and its scraping along the bottom (Chart 1), a chronic lack of liquidity, capital outflow from equity investment funds, the disinterest of pension funds in Croatian shares (not that there are no opportunities), and the introduction of capital gains tax at the beginning of this year have stamped the current state of the stock exchange. Among positive developments, we can highlight the acquisition of the Ljubljana Stock Exchange (LJSE) at the end of last year, which can be interpreted as a positive step towards expanding the offer to investors in the domestic and regional scene.

Table 1 – Regular equity turnover of the Zagreb Stock Exchange in the period 2007-2015.

In the tables below (taken from the presentation Capital Market in Croatia, from the conference on the Croatian money market in May in Opatija), the reasons for the current state can be found. There are fewer and fewer shares on the regulated market that can be traded (Table 2). Consequently, if the number of available trading instruments is declining year by year, the turnovers will also be smaller, as is evident from Table 1. Therefore, it is necessary to increase the number of joint-stock companies (offerings of shares of state-owned enterprises on the stock exchange and/or new successful companies from the private sector) whose shares can be traded as well as the level of transparency.

Table 2 – Shares on the regulated market of the Zagreb Stock Exchange

The decline in the number of available companies whose shares can be traded has also contributed to a smaller number of investors in the domestic capital market, who have stopped investing due to incurred losses and/or poor conditions, and have largely positioned themselves in the global financial market primarily due to the wide selection of financial instruments available for trading. The question arises as to how to bring investors back to the domestic capital market? A better and higher quality offer of financial instruments that can be traded transparently may be just one of many answers to the previous question.

Table 3 – Number of small investors in the capital market in Croatia

The current state of the capital market has also been influenced by institutional investors with their (non)investments. Primarily, we think of mandatory pension funds whose portfolios are mainly adorned with government bonds (about 72% of the portfolio), which have incurred colossal losses on shares in the construction sector whose shares have lost value by over 95%, and a complete failure of investments in the tourism sector (CROBEX tourist from 21.03.2013 to today has made a return of about 200%). Table 4 shows a rather low exposure to both domestic and foreign equity markets. If it is known that, for example, the S&P 500 index (which contains the 500 largest companies in America measured by market capitalization) has an average annual return of about 9% (which is significantly higher than the returns of government bonds and also significantly safer), we can rightly question the motives of such an investment strategy (if it can even be called a strategy). It will be necessary for institutional investors to become more actively involved in the equity market in order to (re)activate the capital market and raise it to a higher quality level.

Table 4 – Institutional investors in securities in Croatia

Let’s see what awaits us in the future and what the charts say. CROBEX (the index of the Zagreb Stock Exchange) reached its peak on October 15, 2007, with a closing price of 5,392.94 points, while the highest daily value ever recorded was reached on October 16, 2007, with a price of 5,448.16 points (Chart 1). The lowest value in the 10-year period was recorded on March 9, 2009, with a price of 1,239.17 points, while on the same day the index closed with the lowest price of 1,262.58 points. In the midst of the financial crisis, in a period of just one year and five months, CROBEX experienced a colossal drop of -76.59% when observing the highest and lowest closing value of the index.

Crobex indices reached their highest levels since October 2014.

On the daily chart (Chart 1), two moving averages (MA) are set that show the strength of the trend. The faster MA of 50 periods crossed the slower MA of 200 periods at the beginning of 2008 and indicated a long-term downward trend. For those who do not know, moving averages show the strength of the current trend, and as long as the price of the index or stock is above the relevant moving averages (20, 50, 100, 200), it is said that the trend is upward, and when the price is below the MA, it is said that the trend is downward. Likewise, when the faster MA (in our case of 50 periods) crosses the slower MA (in this case of 200 periods), it is considered a trend change, and vice versa. If the crossing occurs above the 200-day MA, it can be an indicator of an upcoming downward trend, and if the crossing occurs below the 200-day MA, it can be an indicator of an upcoming upward trend. From the chart, it is evident that throughout 2007, the price was in an upward trend and above the MA. The crossing occurred at the index level of about 4,900.00 points while the index had a price of about 4,600.00 points. Moving averages lag behind the price but are a strong indicator of the trend. In this case, the signal of the crossing could lead to the conclusion of a strong downward trend as the price had already fallen from its peak by about 850 points after an unsuccessful attempt to conquer a higher peak. After that, the price remained below the 50 MA until the bottom of 1,239.17 points, after which it tested that MA and broke it, and by mid-2009, it also broke the 200-day MA at around 1,850 points. Before the crossing, a resistant horizontal line was formed, and the index moved in a horizontal channel between the values of 2,300 points, which proved to be a significant resistance level that was tested several times and the values of 1,600 points (the level at which a double bottom was formed at the beginning of the year, signaling a trend reversal). The price broke the downward trend line, and if it manages to form a higher peak (resistance level around 1,940 points), we can expect a continuation of the upward trend.

Chart 1 – Movement of the CROBEX index over a 10-year period (daily chart)

In the chart below (Chart 2), the picture is much clearer. A downward channel is visible that was broken at the end of August after which it was tested, giving it support. The breakout is significant as it occurred on a horizontal trend line that has alternated roles as support and resistance levels on the chart. The index level of 1,820 points is crucial for the further development of the movement direction. It is significant that within the larger downward channel, a smaller downward channel (marked with red dashed lines) was formed from which the price exited with confirmation of breaking the 20-day MA through the 50-day MA, which is a signal of an upward trend. It is positive that an upward trend line (marked in green on the chart) was formed on which the 20-day MA crossed the 50-day MA from below and gave the first signal of a trend change, coinciding with the lowest level of the index from 2012.

Will the indices reach new peaks or will the decline continue?

The price is at the first key level around 1,860 points, which is also the first key resistance level (R1). It is possible to break that level with the continuation of the upward trend or a return and test of the level of 1,820 points and continuation of the trend. The next key resistance levels are at 1,940 points (R2), which marks the previous higher peak recorded in 2014, 1,980 points (R3), and at the level of 2,030 points (R4), which is the peak from 2013.

In favor of the technical indicators for the continuation of the index growth are also increasingly better macroeconomic indicators, from GDP growth, lower interest rates on loans, growth in industrial production, etc.

Chart 2 – Movement of the CROBEX index over a 5-year period (daily chart)

How CROBEX will move in the upcoming period we cannot predict with certainty, but it is obvious that it has all the prerequisites for the continuation of the upward trend. For the development of the capital market in Croatia, new financial instruments as well as new joint-stock companies on the stock exchange are needed. Whether there will be an ear for all of the above remains to be seen. They say that the pain of missed opportunity and opportunity cost on the stock exchange is much greater than the loss itself.

Author: Ivan Stojanović, Head of Croatian Market at CM-Equity AG (OptimTrader)