Is the ZSE an asset bubble?
DESPITE the current lull on the Zimbabwe Stock Exchange (ZSE), the year-to-date has seen an extraordinary rise in the value of both the industrial and mining i
ndex – 493% and 2 213% respectively.
“The stock market,” Keynes wrote in 1936, “is a game of musical chairs, of snap, where the winner is the one who makes his move fractionally ahead of everyone else.”
He proposed the view that the stock market was an environment in which speculators anticipate “what average opinion expects average opinion to be”, rather than focusing on factors fundamental to the market itself such as dividends and earnings.
Judging by the performances of the Zimbabwean indices in recent times, Keynes may have suggested that we’re all winners.
The question to be asked concerning the performance of the Zimbabwean bourse, is whether in fact a bubble is perpetuating itself and therefore, a crash is imminent or is the growth in the indices derived from the increasingly warped nature of the economy?
It would be relevant at this point to define an asset bubble.
This phenomenon occurs when market prices differ significantly from their long-term fundamental values. The assumption is that, in the long-run, prices will return to their fundamental value, often with a massive exaggerated correction in the form of a crash.
We will attempt to give a layman’s explanation of the forces driving the market and whether we believe a bubble exists.
There is a school of thought, which suggests that the stock exchange is simply an investment vehicle for investors attempting to beat inflation.
There are a number of investors who believe that the indices are simply rerating themselves in line with inflation. It is important to note that the current economic environment; where rampaging inflation has hit 455,5% for September, interest rates are between 90% and 120% resulting in massive negative real interest rates.
Investors putting their money on the money market are in essence seeing the value of their investment decline daily.
Many investors would also highlight the relatively low price earnings associated with many listed institutions at present and that these company earnings more than match their valuations.
Others would argue that coming up with an intrinsic valuation in US dollars would find the general index undervalued. This poses the question of which exchange rate is being used; if one were to use the rate of US$1:$55, there is no question Zimbabwean assets would look cheap.
However, this rate suggests that the Zimbabwean dollar is undervalued in the increasingly speculative driven foreign exchange market.
There are a number of factors, which we believe may suggest that both indices are inflated beyond their natural long-term trend.
If we start firstly in the way in which investors value the companies. The pervasive use of the price earnings ratio on historical accounts is a cause for concern. Companies listed on the exchange are now required to produce two sets of accounts.
Firstly the historical accounts which don’t take into consideration hyperinflation, and inflation adjusted accounts IAS29, which attempt to take into account inflation.
The inflation-adjusted accounts tend to be ignored by the majority of analysts on the market.
It is a fact, that high inflation causes historical accounts to produce a misleading picture of corporate performance such as understating depreciation charges and also don’t reflect consistently a company’s current financial position.
If the market were to use inflation adjusted earnings to calculate their price earnings ratios, a slightly more grim picture of the state of company’s earnings would be portrayed with many counters actually recording losses making their share prices look overvalued.
Secondly, the nature of market players has changed significantly in the last few years. The market is no longer dominated by large institutional investors, whose rationale for investment was always based on solid fundamental analysis and who usually pursued a passive “buy and hold” investment strategy.
The market is increasingly pervaded by “punters” interested primarily in making “a quick buck” and who tend to have little interest in the quality of their investments.
Also to be noted, is the proliferation of asset management firms, many of which we believe will ultimately perish in harsher times.
Another worrying development caused by negative interest rates, is that of individuals leveraging themselves considerably in order to invest on the market thereby perpetuating an even greater rise in the value of the market.
The role of expectations in analysing bubbles is a crucial one, as beliefs about the future are an important determinant of behaviour today.
Rational expectation theory assumes that on average, people are able to guess the future correctly.
However relating this to the Zimbabwean market would be foolhardy.
Consequently, the theory suggests only genuinely unforeseeable events cause present forecasts to go wrong. Rational expectations also fail to address a crucial aspect of any market and that is market psychology.
A more realistic approach is the use of the extrapolative expectations in which investors attempt to extrapolate past variables such as past profits or past inflation. This is no doubt a more practical way for investors to attempt to forecast the future.
The average investor may conclude that due to the nature of past inflation, inflation is likely to reach 800% by year-end therefore, this is sufficient ground for investment.
It is generally easier to recognise the existence of a bubble in theory rather than in practice.
Under the speculative bubble theory, an asset’s price can be bid up above its intrinsic value because some market participants believe that others will be willing to pay more for that asset in the future.
The theory suggests for a while, the belief is self-sustaining, encouraging the market to boom, but eventually market participants lose belief that prices will continue to rise further resulting in a crash.
One could apply this to our market particularly in the great bull-run in the middle of the year, which saw shares bid up to stratospheric levels, stocks have since rescinded slightly poised possibly for another run.
Whether or not one believes that the exchange is an asset bubble or not, we believe in the medium term, the indices should continue to sustain their current levels and who would bet against another record breaking bull run in the near future.
However, in the long run we believe that a serious correction of sorts is in the offing, which may be triggered by a number of possible extraneous events. Chief among the events being a normalisation of the current economic environment, which in turn would initially lead to punitive interest rates.
As Keynes once remarked: “In the long run, we’re all dead.”