With most post-Bhumibol scenarios not being particularly depressing, Thai equities are likely placing high odds on a prolonged armed civil conflict

One Asian market that recently popped up again on my value screen is Thailand, which has trailed MSCI Emerging Markets by about 5% this year. However, Thailand was recently trading at valuations, which while fundamentally cheap, were about in line with Thailand’s historically depressed average. Then came the sell-off, driven by rumor around King Bhumibol’s health. Thailand is now trading at levels where political reform, if any, is essentially a free option in the hands of investors (and headline risk is at least partially priced in, post sell-off ). But, is the downside well understood ?– Will Thailand enter a prolonged phase of political instability, much worse than what it has been through over the last decade.

Among the markets I track, Thailand’s real equity yield of 6%+ is just behind Israel’s 6.5% and Czech Republic’s 7.3% (see Exhibit 2a). In fact, among the top 8 markets with highest real equity yields, only Chile’s 3.5% GDP growth est. for 2010 is higher than Thailand’s 3.3% consensus est. Thailand’s central bank is also well positioned to keep interest rates depressed for a while, as economic recovery picks momentum in what is arguably the most well employed economy in the region. Despite in-line 2010E GDP growth expectations and credit ratings, emerging markets collectively trade at about 1/4th the real equity yield in Thailand (see Exhibit 2b). The issue at hand is underlying political instability, which isn’t surprising for a country that has averaged a coup about once every four years. As of now, the attractiveness of an investment case for Thailand rests squarely on its political situation and there are more than a few reasons to believe that Thailand may not fully deserve its cheap valuation.

Exhibit 2a – Real Equity Yields


Exhibit 2b – Real Equity Yields vs. Credit Ratings


*Consensus credit rating score is provided by II; Real equity yields are calculated on 2009 earnings and headline consumer inflation.
Source: First Call, Economist, Institutional Investor

Historically, SET’s performance has been closely tied to Thailand’s political stability (see Exhibit 3a). In that context, not only is recent approval rating for Abhisit Vejjajiva comforting, but it is also equally comforting to see past performance of the ruling Democrat Party, whose average control duration, which is almost 4x the current time spent in power, has been twice the average control duration of all Thai governments over the past three decades.

While Thailand might look relatively attractive, that isn’t a particularly new observation. Despite what appear like cheap valuations, Thailand’s P/B is about in line with its 10-year historical depressed average (see Exhibit 3b).

Exhibit 3a – Duration (weeks) of govt. in power vs. SET performance (since 1988)


Exhibit 3b – Thailand’s historical Price/Book multiple


Exhibit 3c - Net monthly equity purchases by foreign institutional investors

Source: SET, MSCI, Misc. Sources


Is uncertainty overpriced ?. I estimate that had it not been for the political overhang, Thailand would have been trading at least 50%+ over its current multiple. There is uncertainty around Thailand’s political future, once King Bhumibol is no longer at the helm. That takes a “strongly perceived” stability factor out of the equation. That said, given Thailand’s political past, one could argue that the royal family hasn't been particularly successful in ensuring stability. What happens once King Bhumibol isn’t there is anyone’s guess. However, the range of possibilities isn’t too depressing, considering that a violent civil war is unlikely. Let’s pen down a range of scenarios, some likely and some less so:

Will Abhisit finish his term ?. On previous two occasions, Democrat Party finished more than 3/4th of it’s term. At this point, it is the party in power and is said to enjoy a good relationship with the royal family. As long as the privy council doesn’t go against future King Vajiralongkorn, Abhisit would fancy his chances of finishing his term.

Will PPP return ?. If Thaksin, the exiled ex-PM (now believed to be associated with PPP) or someone from PPP itself stages a comeback, it wouldn’t be a significantly worse option either. This is arguably the alternative that promises most significant change – Certain powerful members of PPP have previously stressed the need for reforming Thai monarchy. If that does happen, it may very likely be preceded by armed conflict, which is unlikely to sustain until there are clear divisions within the Thai army. While Thaksinomics might be nothing more than populist economics, many foreign investors cheered Thaksin’s last stint in power, which incidentally was also the longest uninterrupted rule (2001-2006) since the military rule from mid 70s to mid 80s. Between 2001 and 2006 (Thaksin’s period of rule), SET returned 100%+ over MSCI World.

Will Crown prince back a military coup ?. Despite Prince Vajiralongkorn’s military linkages, it doesn’t appear too likely that he’ll implicitly support a military coup. The royal family is well supported by Abhisit, and there isn’t an obvious motivation to compromise that relationship. Prince’s military relationships, which may not be particularly strong anymore, will likely be best used to ensure that a coup is not staged.

Will military stage a “precautionary” coup ?. Even if the military were to gain control and hold on for an indefinite period, will there really be much more than a headline impact ?. It’s worth noting that military rule by itself hasn’t hurt the Thai economy. Realize that Thailand has been hurt by constant changes, as opposed to military rules - SET went up almost 5x during the last prolonged military rule between 1976 and 1988.

Few can blame investors for only pricing downside in a market where a quasi-democratic system has failed to bring stability. Yet, a closer look at the range of options suggests that equities may be pricing high odds of an armed conflict, which may be co-incidental with PPP’s potential resurgence, and precede a “significant reform”. This effectively offers free optionality in the hands of investors, in case such a reform plays out. That being said, Thai equities of late have become short-term trading vehicles where foreign investors either rarely stick long enough (see Exhibit 3c above) or prefer to wait and watch. This is as speculative a trade as any and should only be traded for its optionality vs. its investment attractiveness.


Note - The range of scenarios outlined in this post are purely speculative, solely for the purpose of analyzing political risk, and do not constitute my opinion on the Thai royal family or various political outfits within Thailand.



DISCLAIMER: The information, opinions, estimates and projections contained in this post were prepared by me and constitute my current judgment. The information contained herein is believed to be reliable and has been obtained from sources believed to be reliable, but I make no representation or warranty, either expressed or implied, as to the accuracy, completeness or reliability of such information. I do not undertake, and have no duty, to advise you as to any information that comes to my attention after the date of this post or any changes in my opinion, estimates or projections. No part of this post can be reproduced without permission, unless reproduced with due credit provided for the source. Investment research is provided for information purposes only and does not constitute investment advice or an offer or solicitation to buy or sell any designated investments discussed herein. Please discuss with your investment advisor before investing.