Of suspicious movements and suspicious minds

By Ranganayi Makwata

AUGUST 2007 will go down in history as one of the most volatile months for global stock market investors as shares fell, recovered and subsequently

fell again due to problems in the American sub-prime mortgage market. Trouble started when homeowners who had taken mortgage at cheap introductory rates faced sharply higher payments as interest rates spiked.

The mortgages were sub-prime, or second chance lending, meaning that loans were made to borrowers who ordinarily would not qualify for the best market interest rates because of their deficient credit history. Due to increased risk to both lenders and borrowers as a result of a combination of high interest rates, poor credit history, and murky financial situations often associated with sub prime applicants, these loans were offered at a rate higher than prime lending. Lenders would then bundle these risk loans into securities which they would then sell to investors. But interest rates began to be hiked progressively as the Fed struck a pre-emptive blow on inflation, default on the mortgages rose, at the same time that the value of the collateral was dropping.

Financial sophistication had resulted into these mortgages assuming different forms included collaterised or asset backed bonds and derivatives which were based on the said bonds. As such at the onset of the crisis it became difficult to tell who had lost what. Investors could respond in the best way they could; dumping the shares of banks that facilitated these loans. Banks in turn demanded more collateral from borrowers, which the latter could not supply while at the same time they virtually stopped lending to each resulting in a liquidity crunch on the inter-bank market. Defaults had also to be covered by the sale of quality stocks depressing the market stock market further. To avert a spill over of the sub-prime crisis into the mainstream economies, central banks responded by either injecting liquidity into the overnight money market and/or cutting the interest rates.

Back home, investors shunned the local bourse for most of the month, a situation uncorrelated to the much talked about US home market crisis. While overseas markets caught a cold following the above mentioned sub prime debacle and the concern that it could precipitate a depression, local investors were caught flat footed by a policy issue, by and large beyond their control. As a result, for the better part of August, it seemed shares would record yet another decline.

In highly suspicious circumstances, however, the market started firming on August 28, with a 1,78% gain before it romped 7,77% and 12,43% in the last two days of the month. Consequently, August is showing a marginal positive return of 6,95%. The recovery of the market was suspicious because it was mainly driven by blue chip counters Old Mutual, Delta, Innscor, PPC, Meikles and Econet, which form the core of many portfolios.

The toast of the resurgence was Old Mutual which gained over 25% consecutively at the peak of the run on August 30 and a day later. The counter was merely re-rating in line with the reported devaluation of the local unit on the alternative market. The Old Mutual Implied Rate (OMIR), a widely accepted proxy for the value of US$, which was at $126 380,97 on August 24, had jumped up 84% to $232 813,09 on August 31, narrowing the ratio of the OMIR-to-the-parallel market rate from 51% to 80% during the same one week period. Having reached and surpassed the traditional OMIR-to-the-parallel rate ratio of 70%, Old Mutual started slowing down while demand for other local blue chips such as Meikles, Delta and Innscor remained strong.

But is the three day rally a mere twist of fate, or a calculated market manipulation by the moneyed? Most fund managers are collecting their portfolio management fees monthly and they have been used to fattening their pockets every month save for July since the onset of 2007. May and June, for instance, recorded returns of 108% and 262%, respectively, while months prior to that did not disappoint with growth in excess of 40%. That counters such as Old Mutual, Econet, Innscor, Delta, PPC and Meikles, the famous big five on the exchange popular with most fund managers, were in the forefront of the mini bull which started towards month end and fizzled out soon after could be sheer coincidence. But skeptics can be excused for claiming that the invisible hand of the fund manager was at play to ensure good portfolio fees this month and let the market take its course thereafter. Nothing was there to support the firm trading experienced in the six days to September 3, they would argue.

Financials released so far are breathtaking with bottom-lines growing over hundred-fold for most companies. What is disturbing however is the increasing contribution of revaluation gains as it has become difficult to make profits out of core business especially in the banking and insurance sectors.

Our focus this week is not on the said sectors but spirits/wine manufacturer African Distillers commonly known as Afdis. Although sales volumes increased marginally, aggressive pricing prior to the price slash directive saw revenue for the year to 30 June 2007 growing by 9 647% to $142,5 billion.

Margins were strong, improving by nine percentage points to 48% while $68 billion operating income was booked. The supply of raw materials, particularly bottles, remains a big challenge to the group due to the foreign currency shortages experienced in the country. The bottle shortage is compounded by the fact that the containers that find their way across the borders are not recycled.