Invest wisely or lose it

In psychology, they tell you that one’s behavior is influenced, to some extent, by the upbringing. Seven years of high inflation is a long time to sow stubborn habits in investors, and surely Zimbabwean stock market punters had become so much used to uneventful miracles that would see portfolios tripling or quadrupling on a daily basis in response hyperinflation that saw inflation hitting around 500 billion percent in late 2008, according to estimates. Of course Zimbabwe is now a totally different place but one thing has come to worry investors. For once stock market punters understand they can lose money on the Zimbabwe stock exchange. And many more will continue to lose money.

The phenomenon is not surprising in stable economies. In the 10 years since January 01 2000, the S&P 500 lost 2.7%, whilst the FTSE 100 has lost 2.4% before even factoring inflation. Let’s get closer to home. In the three years from 01 January 2007 to 31 December 2009, the Johannesburg Stock Exchange’s All Shares Index (ASI) gained 10.3%. Considering that cumulative inflation in South Africa was 27.4% over the same period, it is quite clear that the ASI has lost 14%. A person who invested 100 loaves of bread on the JSE in 2007 was only left with 86 loaves by end of 2009 when adjusted to inflation. Inflation eroded the other 14 loaves. The Lusaka Stock Exchange in Zambia (LuSE) has performed much better over the same period. A 100 loaves invested on 01 January 2007 on the LuSE were 109 by 31 December 2009. Although cumulative inflation was quite high at 39.5% over the three years in Zambia, investors on the LuSE emerged rare winners on the back of robust economic growth.

The dollarized trades on the Zimbabwe Stock Exchange (ZSE) since 19 February 2009 have obviously created distortions in terms of evaluating the real returns on the ZSE over a long period, but a glimpse on the year-to-date trading on the ZSE confirms that indeed investors can lose money on the stock market in Zimbabwe, which is so different from the last 4 years where the ZSE was always defying the law of gravity. Year to date, the Zimbabwe Stock Exchange has lost about 9.53%, whilst the some counters such as Fidelity Life have lost as much as 50%! Now it’s dawning on investors in Zimbabwe that a normal economy has some defined order where rewards and losses are more or less evenly distributed, and the choices that one make today will only reward them in the future more on the basis of sound judgment. And sadly, speculation will play vital role, but not usually rewarding.

Investors on the Zimbabwe Stock Exchange therefore need to sober and invest in companies with solid fundamentals. Some of the listed companies, without access to long term reasonably priced capital and strategic re-focusing will continue to reel under so much pressure for a very long time and it should not surprise anyone to realize that some companies will not declare dividends in the next 5 years. Some companies’ share prices are trading below their net asset values per share (NAV), with the likes of ZECO trading at 89% discount. In order to create and indeed crystallize value over the long term, investors should focus on the value the companies are likely to create in the future in line with various fundamental considerations. Let us consider an example. FBCH, the banking group, is trading at around 25% of its NAV. Theoretically, the fair value of FBCH would be around 14 cents per share and not the current 3.4 cents trading price and the differential would ordinarily be the ‘opportunity’ for punters to benefit on the upside. Unfortunately, as the market has come to a consensus, the share price of FBCH doesn’t need to be at 14 cents. Investors are not seeing reason, and indeed the market is collectively saying that the fundamentals associated with the future of the banking group have nothing to justify a share price of 14 cents today unless there are clearer fundamental changes on the likely future earnings of the group. Considering the need to capitalize its building society arm, and indeed the latent sustainable demand for housing, its market share and the general liquidity crunch, the banking sector is not at its best footing to convince the market to award FBCH favorable optimism today.

The same goes for the likes of NMB, ABCH and ZBFH that are trading far below their NAVs. Collectively, the Zimbabwe Stock Exchange will rise in line with general increases in the liquidity levels in the economy as what has been happening since dollarisation, and most of the share prices will gravitate towards their ‘fair’ value levels. But specifically, the returns that individual investors will get will be a function of sound judgment and investing in companies with better prospects, and to some extent, luck. I am a strong believer in luck, but luck only benefits those that are prepared. And as the law of attraction goes, luck meets those that anticipate it and indeed investors can put themselves in the path of luck through their actions and choices of companies they pick to invest in. The point remains therefore that yes, money can be lost on the stock market. Many will continue losing! Willdale share price has tumbled by about 60% since January 2010! That is so much loss in US$. I wouldn’t want to speculate and lose $60 for every $100 I would have invested in Willdale in such a short time. That’s a huge bundle, and I guess no one would want that.

And investing on the stock market in a stable economy is the much more difficult than investing during the hyper-inflation period where everyone has sure upside nominal benefits. Equally, as there would be losers, some will be benefiting and winning, and Zimplow has gone up 74% year to date! Ofcourse focusing entirely on the short term is a wrong approach to evaluating returns on the stock market considering the long term nature of stock market investments. But the figures from the S&P and FTSE over the last 10 years equally show that the short-term sometimes expounds to long term and the facts remain strong, and indeed stuck in the tradition of making losses! And therefore cutting your losses in the short term improves overall returns on the long term.

On the other side, the fixed income market, which became so active during the birth and boom of asset management companies in early 2000 on the back of rising inflation, has become so depressed largely due to the poor vision of the government in ignoring the importance of setting a risk-free rate in the economy. Generally, deposit interest rates are very low, mostly below 2% per annum and considering that inflation can close the year above 8.7%, investors on the money market are likely to lose money to inflation this year in Zimbabwe. Many Zimbabwean corporates are facing challenges in raising capital, and many right issues have been disastrous for sitting shareholders. Yet it remains mysterious why some of the seemingly ‘solid’ corporates are not interrogating the markets directly by issuing commercial paper in a market where those with excess cash feel cheated by the prevailing deposit interest rates.

Years of hyper-inflation, which should have hardened company strategists and made them more innovative seem to have, on the sad contrary, killed the real innovative genes of some company leaders in Zimbabwe. Accessing debt directly in the market will most likely reduce the current high cost of capital obtaining in the mainstream credit markets for corporates. And equally important would be the better rewards that will go directly to those with excess cash that have little choice as they are stuck in low-deposit interest rate environment. And it only needs companies with good vision to take the step of faith and attempt to change the current circumstances by interrogating the debt markets directly. What does this mean therefore? Does it suggest that we have incompetent CEOs running some of these big companies in Zimbabwe? The answer is a BIG yes, and some are not only incompetent, but are very foolish and continue to sit waiting for fortune to visit them. And its high time activist shareholders take their CEOs to task.

The stock and money markets in Zimbabwe are very tricky in 2010, and hope lies in improved economy-wide liquidity that will likely push the general asset price levels high to benefit the stock market punters, whilst the money market investors’ returns will improve due to reduced risk and predictability.

MONEY MARKETS RUNING WILD AND WIDE

Significant quantitative easing and a long dovish stance have kept interest rates in the major world markets close to zero for over a year. And since January 22 2008 when the US Fed Reserve made a significant rate cut in response to the liquidity crisis, key policy interest rates have hovered near zero for so long, much to the chagrin of bondholders in major markets such as the Euro-Zone, Japan and USA. Africa is however different place. Notwithstanding the crisis and a lull in ‘global’ interest rates, most sections of the African money markets remain uncorrelated with global events, and rightfully so.

Places such as Zambia and Zimbabwe have continued, as before, to reel under high real interests rates for the borrowers. Notwithstanding other countries such as Tanzania and Zambia slashing the policy rates from the highs of 2008 to encourage affordable flow of credit into their economies, the poor transmission mechanism of monetary has inhibited the benefits to the real economy serve for the respective governments reducing the costs of debt servicing. Zimbabwe, having run on a dollarized economy for over a year now, continues to experience one of the highest costs of credit in the world, and the absence of key policy interest rates and lender of last resort functionality has kept the market on a craze-wave in the determination of the interest rate levels.

Borrowing rates in Zimbabwe are varying from as low as 20% to as high as 40% per annum in the mainstream banking, whilst the secondary financial markets’ cost of capital range from anything above 150% per annum on annualised basis. These distortions, largely a function of the liquidity constraints and uncertainty, lend much of their roots equally to the absence of the ‘risk-free’ rate in the market to gauge the extent to which the economic players can price their various risks from the reference ‘anchor’.

Saddled with a huge debt of about $5.7 billion, thus about $100% of GDP, Zimbabwe is not in a desirable position to keep plunging into fresh debt arrangements considering fragility of government finances. That said however, it remains puzzling how Zimbabwe policy makers still remain silent on giving the financial markets pricing guidelines more than a year after adopting the multiple-currency system. The prevailing multiple currency system in Zimbabwe is creating ambiguities on the near-efficient ‘reference price’ for financial assets. Would Zimbabwe need to use the US bond yields at 0.42% for the one year risk-free rate? Since Zimbabwe is so close to SA and has so many Rands in its economy, would using SA’s repo rate at 6% be a sensible idea?

There are so many questions on the ‘risk-free’ rate in Zimbabwe as there are equally so many divergent answers. Policy makers need to understand that markets cannot be left to wonder and wander for so long because of the many distortions and economic costs this bring about in the wider economy. Zimbabwe’s inflation, unemployment, income levels and other key dynamics are so different from the countries whose currencies it has adopted, and therefore to have a reference to South Africa, US, UK or Australia’s reference pricing is not only a blind move, but a costly one too. For a country struggling with high unemployment estimated above 60% and worrying under-employment levels, the road to stabilization becomes long and costly too.

Notwithstanding its current debt challenges, the Zimbabwean government has to step in and set the ‘risk-free’ rate in line with the macro-economic dynamics of the country. The government therefore has to start issuing TBs and Bonds to give the market direction. Today municipalities, corporates and many other players in Zimbabwe wishing to interrogate the domestic debt market efficiently through issuing bonds to revamp their structural challenges are faced with the burdensome challenge of not knowing the ‘anchor’ risk-free rate. The borrowers are not willing to get into long-term debt arrangement for fear of locking themselves expensively on the long-end if consideration is given to the current high interest rates. The fear of making mistakes is compounded by that fact that no long-term reference pricing exists in the market, and considering the fresh history of the hyper-inflationary environment, the decision making process finds peace in going for short term debt arrangements, or, not at all! Yet, ironically, most corporates in Zimbabwe require reasonably-priced long-term capital to breathe life into the balance sheets that have been severely weakened by years of hyper-inflation.

The banks on the other hand are lending largely on the short-end, up to 3 months, in line with the same mentality of not knowing what the future holds. For the banks, the fear of the future is compounded more by the economy-wide liquidity constraints, the absence of lender of last resort, non-existence of liquid ‘risk-free’ assets and the dearth of a secondary market for credit securities. The secondary market is always a very vital window in generating liquidity on bank balance sheets in times of liquidity challenges. How do banks therefore effectively trade credit instruments on the secondary market without perfect knowledge of the policy risk-free rate? It would therefore be so unreasonable to trivialize the importance of the ‘risk-free rate’ in an economy that has a long history of policy uncertainty. And without the policy rate, any long-term pricing is left to speculation and as with the current case in Zimbabwe, the borrowers, and hence the wider economy, suffer from lack of reasonably priced short and long-term capital.

As companies continue to reel under serious capitalization challenges, and with banks’ loan-to deposit still below the desirable levels, the policy makers need to understand that equally the government revenue, which is itself a function of the scale of economic activities, would continue to remain depressed. Zimbabwe expects only about $1.4 billion revenue in 2010, and saddled with $1.7 billion of recurrent expenditure (117% of revenue), the helping hand of the donors has been over-estimated in the current fiscal year. This therefore requires structural and pragmatic solutions for the Zimbabwean economy, and totally missing the importance of a well-functional financial system with appropriate policy instruments to manage pricing expectations is retrogressive.

Free markets are generally thought to be efficient, but the recent global financial challenges have left huge holes on the validity of such assertions. Expecting therefore pricing efficiency on the money market in Zimbabwe without some policy benchmarks to guide expectations is putting too much faith in the power of markets to allocate resources efficiently. The effectiveness of monetary policy in some African economies continues to be debatable. As with Zimbabwe’s history, and with what has been happening in Zambia, Tanzania, Kenya etc, there definitely could be a dislocation in the efficiency of the monetary policy in influencing the real interest rates in the economy, but it is still much better to have a measure of the variance than not to have one at all. Zimbabwean policy makers should therefore never under-estimate the psychological power of the policy rate in influencing the decision making process and flow of money in the economy.

With the South Africa Rand expected to remain strong in the next 6 six months or so on the back of significant carry trade transactions on the back of very lucrative interest rate differentials between the Euro-Zone & USA, some curious eyes in Zimbabwe begin to wonder why Zimbabwe, with much higher interest rates than the 6% obtainable in SA, is not attracting so much, if at all, in terms of foreign portfolio investment inflows. SA has attracted over $2 billion of foreign portfolio investment inflows this year alone into bonds as foreign investors enjoy the ‘sunny’ interest rates. Why wouldn’t an investor in UK or Germany borrow at their current rates of around 1% per annum and invest in 20% yields obtaining on the Zimbabwean market? The key consideration for most investors would be around the sustainability of the obtaining yields in Zimbabwe. When one digs deeper to evaluate the extent of the credit spreads and realizes that in fact there is no reference risk-free rate in the economy, the conclusion that such yields are unsustainable and therefore a house of cards is difficult to argue with. On the other hand, the short-term nature of the investment assets in the market hastily confirms this fear, and as such attracting meaningful carry-trade related foreign portfolio investments into Zimbabwe becomes a pipe-dream.

The Zimbabwe policy makers therefore need to consider seriously that inasmuch as they wouldn’t want to plunge into unnecessary debt arrangements because of the current debt burden, the costs of an inefficient money market pricing system in not a better choice either. Many key fiscal requirements of capital nature require funding in Zimbabwe today to stimulate growth. Therefore raising debt in the market with the twin objectives of funding activities with larger multiplier effects on employment creation and on the other hand giving the financial markets risk-free benchmarks could be the one of the best policy option that policy makers can take in addressing an array of challenges with one stroke of action. Equally important would be the adequate capitalization of the RBZ to allow it to carry out the functions of ‘lender of last resort’ to calm the nerves on the interbank market.