HomeOpinionAre we in a bubble?

Are we in a bubble?

By Tatenda Makoni

FOR the past 19 months, investors have enjoyed a historic rally on the Zimbabwe Stock Exchange (ZSE).

Since bottoming out in real terms in December 2019, the market capitalisation has quadrupled in value, from US$1,76 billion in December 2019 to the current US$9,61 billion using the interbank rate.

But such rapid gains for an economy still finding its footing raises the question: Is a stock market crash coming?

Although no one knows with any certainty, we can turn to an abundance of data to get a better idea of what might lie ahead for the ZSE.

A confluence of data suggests a crash:

For most seasoned investors on the stock market, the year 2016 is a psychological benchmark for the stock market’s performance. That year is generally considered the eve of the currency crush.

Market capitalisation closed at US$4,01 billion in 2016 and is currently trending above US$9,6 billion.

Perhaps the most concerning indicator that a significant price correction might await the stock market is the price-to-earnings ratio, the seven year historical average is circa 8,74x while the market is currently trading at a price-to-earnings of circa 11,88x.

Taking a closer look at the fundamentals that drove the market to this point: Investment activity for most of 2020 was driven by inflation hedging as opposed to critical fundamental valuation.

Year-on-year inflation peaked at 837,58% in July 2020 and closed 2020 at 348,59% after a slow-down in month-on-month inflation.

During that year, there was a marked devaluation in both formal and informal rates, with the interbank rate devaluing from its peg of 1:25 to the auction rate of 1:82. The parallel market which began the year at circa 1:22, ended the year at circa 1:113.

Foreign investors were net sellers throughout 2020 with purchases just over ZW$645,13 million (US$7,5 million) and sales just over ZW$5,40 billion (US$63 million).

They have remained net sellers throughout the current year with purchases of just over ZW$1,13 billion (US$13,2 million) and sales over ZW$5,84 billion (US$68,2 million).

Appetite from institutional investors and corporates has tapered off; generally current weightings in equities are high and with asset classes like fixed income becoming attractive against moderating inflation, there have been re-allocations of funding (year-on-year inflation closed July 2021 at 102,56%).

In other words, corporations and institutional investors were allocating to equities earlier in the year due to a better return profile but are beginning to unwind.

Interestingly, average daily value traded has remained resilient from circa US$500 000 from January to May 2020, to the current average of over US$1,5 million thanks to retail investors.

They are, however, not driven by fundamentals as much as they are driven by their personal ability to afford a given stock.

With stock prices that have risen rapidly and, often out of proportion to their companies’ current earnings, coupled with the reduction in activity from larger, more knowledgeable investors, the ZSE seems to be displaying the characteristics of a bubble.

But wait!

There is another side to this story; the stock market often acts as a leading indicator for economic recovery. Perhaps the current share prices have factored in investor sentiment with regards to a rebound over the next 12 months.

It is also possible that 2016 is no longer a relevant benchmark when tracking stock market performance. The underlying economy may be poised for growth beyond 2016 levels.

Other leading indicators of economic growth include increasing production, consumption, employment, and increasing activity in areas like construction and transportation.

We can have a look at a few.

Business Indicators: Industry capacity utilisation stood at 47,4% in 2016. The Confederation of Zimbabwe Industries (CZI) recently said manufacturing sector capacity utilisation rose to 56% in the second quarter of 2021, with companies injecting about US$25 million in fresh capital to sustain operations.

Bank Lending: While companies are not entirely dependent on banks to grow their businesses, an increase in lending activity has a strong correlation with business expansion. According to The Reserve Bank of Zimbabwe (RBZ), bank loans and advances closed 2016 at US$3,69 billion.

Loans and advances declined to US$751 000 in December 2019, that being the hight of the currency crush. As at March 2021, loans and advances had climbed 60% from the December 2020 figure of US$1,01 billion to US$1,66 billion in June 2021. The Central Bank indicated that about 80,89% of loans were channelled towards productive sectors.

Construction: The number of projects gaining momentum can be used as a gauge for increased investment in infrastructure. Some examples are government’s road rehabilitation programme, progress on the Hwange Power Project and modernisation of the Beitbridge Border Post.

We note that recent trading updates from listed companies servicing the construction industry reflect a growth in sales volumes especially from individual housing projects.

Cement production for the full year 2017 was 1,11mn tonnes, 1,19mn tonnes were produced in the first six months of 2021 alone.

Consumer spending: Trading updates and recently released financial results from listed consumer facing stocks reflect a general recovery in sales volumes driven by recovery in demand. Some notable examples are Delta’s Lager volumes that closed 2021 ahead of 2016 by 3,6%, Hippo Valley’s 2021 sugar sales were above 2016 volumes by 7,4%, while Dairibord’s 2020 milk volumes were bellow 2016 levels by just 3,8%.

Together these indicators seem to suggest a recovery to an economy larger than that of the psychological base year 2016. Downside risk does, however, exist given challenges presented by the Covid-19 pandemic, the need to support the fragile local currency and possible social unrest from the upcoming elections.

What are we saying?

Despite the bubble-like appearance, the stock market is in fact reflecting expected economic recovery over the next 12 months. Real organic growth in the underlying companies will soon justify the current market capitalisation.

Of course, this is a comment on the market as a whole; at an individual level there are a few stocks that are still trading at a discount to their historical averages and there are stocks whose share prices are punching far above their expected earnings. Now is not the time to disinvest from the stock market in fear of a sharp correction in prices, rather reallocate investments to those shares that still have upside potential.

  • Makoni is an Equities Sales Trader at IH Securities. She can be reached on tmakoni@ihsecurities.

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