Is there a bubble in the Mongolian Stock market?

MSETOP is the main index of the Mongolian Stock Exchange and is composed of the 20 largest capitalizations of the exchange. Between 2019 and 2020 more than 1M trading accounts have been set up in Mongolia (representing ? of the population).? According to the founder and chairman of investment bank Mongolia International Capital, this increase in the number of trading accounts is mostly explained by government subsidies provided during the covid lockdowns which offered more disposable income in Mongolian households and pushed many people to start investing in stocks.

This resulted in an entry of more than 500 billion tugrik in the stock market (~15% of the 2020 Market cap.) and pushed Mongolia's equity capitalization from 3 trillion tugrik to 6 trillion from Q1 2020 to Q4 2021 (graph2). In 2021, the index showed the largest increase among stock indices with a 133% increase.?

I estimate the PE of the index at 86.88 in Q4 2021 and think that the rise of the index does not result from a sustainable growth of the companies composing the index but is rather a bubble due to a strong inflow of retail investor money. I am therefore strongly bearish on the MSETOP index.

Economy Overview

Mongolia is a country of 3.218 million people landlocked between China and Russia, here are some key facts about the country and its economy:

The Mongolian government's main development plan ("New Recovery Policy", déc. 2021) focuses on six priority areas: energy, border ports, industrialization, urban and rural recovery, green development and public sector efficiency. At the last Mongolian economic forum, held on April 7-8, 2022, the government called on local businesses, foreign partners and international organizations to cooperate in an investment target of 150 trillion tugriks to support the policy with the goal of doubling the GDP by 2025. Among the measures proposed in the policy, we can notice the development of connectivity between regions in the country but also with China and Russia, the diversification of Mongolia's export market, the development of green energy or the obligation for state-owned enterprises to become public. This last point can further increase the inflow of capital into the domestic stock market, which could support index prices over the year 2022.

In order to combat inflation due to rising oil prices, and shortages of products imported from Russia, the government has promised to implement a price-capping mechanism to stabilize the prices of basic supplies, such as meat, flour, and petroleum.

Another short-term issue is the decrease in foreign trade due to the pandemic (China-Mongolia border trade ports are still closed due to COVID-19). However, the Chinese and Mongolian foreign ministers reaffirmed during the last economic forum their willingness to reopen the borders as soon as possible.

Moreover, the conflict between Ukraine and Russia is also impacting the country, which finds itself in a difficult position between a historical economic ally and "the third neighbors" (USA, Japan, ...) with whom Mongolia is trying to increase its trade in order to counterbalance the influence of China and Russia. The Central Bank of Mongolia has warned that a large amount of the country's trade is conducted through Russian banks and that the latter is the source of almost all oil consumed in Mongolia. Moreover the central bank warned of the risk of default of payment from Russia and of disruption in the import of consumer goods from Europe.

To conclude on the economical overview, Mongolia has strong long-term growth potential with a clear strategy based on increasing exports and transforming the economy from a commodity-based to an industrialized state.?In the short term, the economy and the stock market is under positive pressure due to the increase in commodities (representing 23% of Mongolia's GDP) and state-owned upcoming IPOs but Mongolia also faces strong short term downward pressure from Ukraine war and covid in China.?

Index analysis

Biggest members of the index (weight >2%) :

In 2007 and 2010-2011, the Mongolian index was already behaving in a similar way to what we are seeing today: 3 to 4 digit increases within 1 to 3 years. These strong increases were both followed by a double-digit correction in the 1-3 years following the price peak. The magnitude of the increase we are seeing today appears to be even greater than the previous two times.

Source : Bloomberg

In Q4 2021, I estimate the PE of the index to be over 86x, and the median around 14x. The average is driven by three stocks: UID, MNP, and AARD with PEs of 903x, 336x, and 210x respectively.?

Top 10 PEs in the index in Q4 2021:

Source : Mongolian Stock Exchange

Conclusion

Following a massive influx of capital into the Mongolian equity market, MSETOP has grown by more than 130% over the past two years. However, the growth in corporate earnings has not followed the same dynamic, causing an average PE increase of 160%. Among the companies in the index, three stocks appear to be particularly overvalued: UID, MNP, and AARD. The analysis of these companies and the valuation of their stocks will be the subject of my next article. The index is currently stuck between a strong outlook driven by economic growth and ambitious policies and the negative consequences of covid and the war in Ukraine. With an economy largely based on commodity exports, the index price is also supported by its high price levels. A decrease in those prices could push the index to break the 32,000 MNT support, triggering a potential downward trend.

[ All investment strategies and investments involve risk of loss. Nothing contained in this paper should be construed as investment advice. Any reference to an investment’s past or potential performance is not, and should not be construed as, a recommendation or as a guarantee of any specific outcome or profit.]

Sources?

https://www.mse.mn/en/mse_top_20/266

https://www.mongolbank.mn/eng/listpublications.aspx

https://data.worldbank.org/country/mongolia

https://globaledge.msu.edu/countries/mongolia/tradestats

https://asia.nikkei.com/Spotlight/Market-Spotlight/Mongolia-stock-market-turns-heads-with-133-gain

https://thediplomat.com/2022/04/mongolia-highlights-new-recovery-policy-at-economic-forum/

https://eias.org/publications/op-ed/mongolias-new-revival-policy-what-opportunities-does-it-present-for-the-eu/

Bloomberg