HomeBusiness DigestA Tuesday of carnage: Who pressed the panic button?

A Tuesday of carnage: Who pressed the panic button?

IT was almost inevitable that something momentous would happen in the local financial markets following the events of September 11.

 

The Sadc-appointed facilitator of the political talks, President Thabo Mbeki, looked highly relieved to finally announce a deal between Zanu PF and the two MDC formations. Monday saw the deal being signed amid mixed reactions of hope and suspicion both within and outside the country. Optimists trusted the deal to be a starting point in the recovery of the economy. Sceptics on the other hand doubted the sincerity of the parties.

True to market expectations, something did happen, but not exactly in the form that had been anticipated. The parallel exchange rate came off significantly. It dropped by 50% on Tuesday from about US$1: $40 000 on Friday September 12. Currency hedge stocks Old Mutual and PPC had begun retreating when it became apparent that the deal would be signed. The prospects of improved relations with donor institutions and countries implied that foreign currency would start to flow into the country. Under these circumstances, currency hedges would cease to be important as forex inflows improved or so, the argument continued. Investor interest was therefore expected to shift to local companies which might be expected to recover from years of shrinking operations.

A state of shock gripped the equities market on Tuesday as a wave of selling set in. Surprisingly the blue chips were the worst hit. Investor favourites Delta, Innscor, Econet, Seedco, Aico and Rio Zim plunged by at least 50%. Second tiers and penny stocks largely held their own. A section of investors, chiefly speculators, took flight from equities preferring to go long in Zim dollars. At the same time currency dealers reportedly had more selling orders in a seemingly panic reaction to the political agreement.

Until that Tuesday investors had been blithely content to chase positive returns whenever prospects were bright. This week they were reminded that this can sometimes be dangerous. An entire life’s saving can be wiped out overnight. Equally, profits accumulated in booms can easily be lost within a very short time.

Local companies can learn a lesson from the market squeeze which has left many financial institutions in the developed world licking their wounds. The victims in 2007 include UBS, Bear Sterns and Northern Rock. This month Lehman Brothers, which before the collapse was the fourth largest investment bank in the US, filed for bankruptcy after suffering write downs on its assets. The company was not fortunate enough to get a financial bail out after reports that a South Korean suitor baulked out on the last minute.

Fellow investment bank, Merrill Lynch, was taken over by a leading commercial bank, Bank of America, in a deal worth US$50 billion. The company had written down more than US$40 billion of its assets in the past year. The US Federal Reserve had to come to the rescue of the financial markets twice this month, first with a takeover of mortgage finance giants Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae), and second with the injection of capital into insurer AIG. This was done to avoid a systematic failure of the financial markets.

Closer to home, in South Africa, Old Mutual suffered write downs of US$135 million. This was after some Fannie Mae and Freddie Mac preferred stocks which Old Mutual was holding were downgraded. For some time now, Old Mutual had been suspected of having exposure in mortgage securities, which the company refuted. The share price on the London Stock Exchange came off by 56% from a 2007 peak of £1,87 to £0,83 on September 16. Of course, the price slump escaped unnoticed by many ZSE investors to whom Old Mutual’s core fundamental value is its currency hedge status.

The causes of the write downs were once discussed in detail on this column. Financial institutions were holding assets linked to low grade mortgages. The allure of these instruments was the high yield. This is because the mortgagees had poor credit history which resulted in them paying more than the prime rates. No investment bank wanted to be left out of the party. In fact, at the peak of profits on Wall Street, failure to participate in the collaterised debt securities was viewed as idiocy.

In the same vein, local investors are going to great length seeking a high yield. In the absence of viable investment alternatives many are turning to equities. Most of the money on the ZSE nowadays is hot. This creates serious volatility on the market and is also the source of shocks the market sometimes experiences. Traditional investors such as pension funds and insurance companies are now thin on new money to invest as premiums fall short of operating costs. This means that the market now lacks stable investors. The speculators can not be relied on as they tend to react as a herd; all buying and selling at the same time.

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