What is the stock market telling us?

By Admire Mavolwane

In any economy, analysts are normally able to identify and interpret certain indicators that are useful and help explain events. But wide variations exist in terms of the understanding of

and relative importance assigned to these indicators.

Some hate them whilst others are always constructing and using them. In certain instances indicators are constructed with reference to a certain commodity and are to illustrate distortions arising in the economy. For example, in the past the price of a litre of fuel used to equate with that of a litre of Coca Cola. At the moment, a litre of fuel costs in excess of $50 000, whilst that of Coca Cola costs $25 000. Perhaps this tells us that we should stock up with the latter.

The indicators that tend to worry central bankers and economists are the rise in housing prices, consumer credit and the stock markets. Also included in the cocktail of indicators is the price of gold, although it is of particular importance overseas. Stock markets, in particular, are taken to represent investors’ inflationary and exchange rate movements’ expectations.

Monetary authorities do not take kindly to the exuberance of stock markets, gold or housing prices, as ‘expectations’ are an important facet of controlling inflation and stabilising the exchange rate. If investors and the general populace expect the currency to depreciate and inflation to rise, they in turn take positions in these assets that ultimately lead to the outcome becoming a self fulfilling prophecy.

The January stock market bull run, in which the industrial index gained 87,32% a record yet to be surpassed this year, can be ascribed more to investors’ inflationary expectations than to speculative exuberance and the normal January effect. The market continued to exhibit the same buoyancy such that at one time it attracted the unwanted attention of the authorities.

One school of thought suggests that the same gains attained on the bourse could also have caught the eye of the tax man, government need for funding aside. As at the close of business this Wednesday, the industrial index had gained 371,3% since the beginning of the year.

The outcome to the inflationary trend, moving 132,7% in December 2004 and accelerating steeply to 265,1% in August 2005, finally proved that investors were right in trying to remain a step ahead. On the other hand, proponents of the speculative thesis would describe it as a mere bubble and a simple case of the situation feeding upon itself. However, while the stock market rise may be a bubble, but inflation surely isn’t.

It is unfortunate that we do not have an official housing price index, which hinders a proper analysis of how property prices have behaved since January. As proxy, using prices advertised in the press, upmarket houses in the northern suburbs which used to cost between $900 million and $1 billion in January are now ranging between $6 and $8 billion. Those properties in the southern and western suburbs which were costing around $300 million are now costing upwards of a whopping $1,5 billion. The inclusion of a ‘negotiation allowance’ by sellers somehow distorts the real value of properties. It is nevertheless clear that prices have gone up by more than 500%. Those investors holding Dawn and Mash shares have seen their investments appreciate by an almost similar margin of 760% and 493% respectively. Although various reasons can be advanced to explain the rise in property prices there is no doubt that inflation has had a big role to play.

The stock market in the past week or two has provided economic analysts with an indicator whose interpretation is rather depressing. Trading which has been dominated by hectic activity in those counters perceived to be the blue chips and foreign hedge counters, could be a bad omen. On a week-on-week basis Old Mutual has appreciated by 50%, to $120 000; Meikles, 65% to $38 000, and PPC 18%, to $1,3 million. Delta, Econet and Innscor have not been left behind either. The buying frenzy in the big caps has pushed the industrial index to new highs closing this Wednesday on 2 172 503,45 points.

One explanation for the selective nature of trading on the bourse has been rapid depreciation of the local currency unit on the parallel market which has whetted investors’ appetite for the foreign currency hedge counters.

Warranting serious and sober analysis, however, is the implication of this indicator for the economy as a whole. The country’s economic health has been deteriorating fast over the last couple of months but it seems that the pace has recently accelerated. Investors have thus started categorising counters according to the extent to which they are likely able withstand the effects our own hurricane Katrina, hence the interest in the likes of Delta, Innnscor and Econet.

As alluded to above, most central bankers, especially in the western world, are uncomfortable with sustained stock market bull runs because US dollars and US dollar denominated bonds are held by investors in portfolios. When fund managers expect inflation to run, they switch from US dollars to shares and physical gold, resulting in the weakening of the US dollar which by itself feeds into inflation. The recent run on the international price of gold to an almost seventeen year high of US$470/ounce has been attributed to heightened inflationary pressures as a result of the push in oil prices. Also, according to the renowned economist Dr Marc Faber, the rise in the price of the yellow metal “is reflecting the reality that central bankers are printing money”, which has a huge bearing on inflation.

What all this seems to suggest is that if you are an analyst who sets great store by both local and foreign indicators what you have to decide is will the domestic economy slump of its accord or will it subside because of the influence of a world-wide depression?

In other words what does this all mean? The pessimists would be of the opinion that the events on the stock market are an indicator that the end is nigh. Those who are less fixated by such things are likely to feel that the whole issue is largely irrelevant now.