SOON after the monetary policy was announced, there seemed to be an increase in the level of volatility in almost all the financial markets.
The stock market took
quite a huge knock while inter-bank rates went berserk. There appears to be an increase in the number of economic agents wanting to sell their properties and one wonders how the parallel market for foreign currency is behaving in light of the new “whistle blower” policy introduced by the new monetary policy. This week we take a macro approach in looking at the stock and money market.
Worth noting is the fact that at the present moment, an investor cannot get any asset from the stock and property market that would give him any yield that matches that being obtained on the money market.
If one looks at the property market, one would notice that most of the property prices are pegged to the parallel market exchange rates. Thus, the property market can be viewed as a derivative of the parallel market rate. Worth noting too is the fact that the estimated increase in the parallel market rate was around 300% for 2003.
The industrial index grew by 288% in 2003 and worth noting again is the fact that no company reported an earnings growth in excess of 3 000% during the year. On the other hand, the effective annual yields being obtained on most money market investments exceed 5 000%.
There is a very interesting relationship between simple interest rate and effective annual yield: most, if not all, of the interest rates quoted in the money market happen to be nominal (or simple) interest rates. For a given nominal interest rate, the higher the frequency of capitalising (or compounding) the higher the effective annual yield. As such, it can be seen that the growth of the effective annual yield actually increases exponentially as the nominal rate increases.
Another interesting issue to look at is the level of inter-bank overnight rates that can be considered to be more in line with the current levels of inflation. Given the fact that the quoted interest rate is a forward-looking figure, and year-on-year inflation is a backward looking (historical) figure, it becomes less relevant to compare the two rates. Thus, a more reflective estimate would be to compound the current month-on-month inflation rate of 33,6% for 12 months so as to arrive at a figure, which we can then meaningfully compare with the interest rates.
Compounding 33,6% for 12 months gives an annual inflation figure of 2 964%. The equivalent quoted overnight rate that gives such an annualised inflation figure would be an overnight rate of 349%.
Please note that the overnight rate quoted in the market is a nominal rate and not the effective annual yield. Allowing for a relatively high level of volatility, it can be estimated that overnight rates between 300% to 400% can be considered to be more in line with the current levels of inflation.
The 91-day Treasury Bill rate remained unchanged at 79,71% as economic agents have not been submitting bids for Treasury Bills since commercial paper was actually trading at far higher yields compared to the yields of government paper. This is likely to increase the chances of the government resorting to seignorage as a source of financing its activities.
Another interesting scenario in the money market is the fact that the market position is actually in surplus, with the surplus being held by a few banks. The majority of the banks are however short and are having to look for overnight accommodation from inter-bank trading, which happens to be acutely short, thus explaining why rates remain high despite a surplus market position.
The stock market
Currently, the stock market is experiencing a bearish trend and this is arguably due to the relatively more superior returns being offered in the money market. This appears reasonable since all the financial markets compete for money from the same “animal” called “the investor”.
One theoretical argument is that investors prefer to invest their money in assets that will give them the highest expected return for a given level of risk. Generally, the stock market is traditionally perceived to be more risky than the money market. With this in mind, the money market is actually very attractive compared to the stock market since it is relatively less risky while at the same time offering higher expected returns.
Hence, as a short-term strategy, it appears very prudent to actually significantly reduce exposure in stocks.
The stock market can however be considered to be quite cheap from a historical point of view. The market PE at the end of 2002 stood at 18x, but it has drastically gone down to around 6x as of the end of December 2003.
This shows that, despite the impressive bull run experienced for the better part of 2003, the rate at which the earnings reported by listed counters in 2003 was actually higher than the rate at which the share prices went up.
Hence, from a historical point of view, we perceive the stock market to be relatively cheap at its present levels and thus a good investment vehicle in the medium to long term.
Going forward, stock picks in the stock market should shift from attaching more weight to income statement linked ratios such as PE and Operating margin and start putting more attention to analysing the gearing, cashflow and liquidity position of the stock. It is recommended to shy away from stocks that have high levels of gearing, low levels of free cash flow and low liquidity levels.
Counters to consider taking exposure in during this time of turbulence would be those that have a low level of gearing and relatively high levels of free cash flows such as Dairibord Zimbabwe Ltd and Pelhams Ltd.
Due to high level of volatility in most of the financial markets, it is very difficult to make meaningful projections of future performance in the long run.
Consequently, it appears prudent to prefer those markets that are relatively liquid in nature whilst simultaneously attaching more weight to short term investments.
The stock market, though cheap, is still likely to continue failing to get an impetus for a bull run as long as the current situation in the money market prevails.