HomeOpinionZim’s unorthodox business cycle

Zim’s unorthodox business cycle

By Tafara Mtutu

The economy is slowly showing signs of recovery from the pandemic, and some economies’ central banks have already begun taking measures to contain demand-driven inflation.

The recovery has capital market players ascertaining the path of the global economy’s business cycle and how best they can recalibrate their portfolios.

A healthy understanding of business cycles is key to setting capital market expectations, and this has been widely accepted by many capital market players all over the globe.

A business cycle is a perpetual cycle of growth and contraction in an economy that is often measured by the trend in the GDP growth rate.

Business cycles can span several years, or a few months. The United States, for example, experienced a 28-month business cycle that ended in November 1982 and a 128-month cycle that ended in April 2020 and its business cycles last 56 months, on average.

At each turn, the progression of business cycles often lends to strong indications of returns in several asset classes. Business cycles are especially important to investors wishing to take advantage of short-term fluctuations.

Long-term investors subscribe to the theory of reversion of asset class returns to the mean over a long investment horizon and, as such, do not feel the need to frequently fine-tune their portfolio in response to the business cycle.

In addition, institutional investors who correctly ride the waves of the business cycle can earn superior returns for their clients over time.

There are two primary phases in a typical business cycle; the contractionary and expansionary stages, which can be split into five phases, namely (i) initial recovery, (ii) early expansion, (iii) late expansion, (iv) slowdown and (v) contraction.

The initial recovery stage is often characteristic of economies bottoming out after a recession, with very low short-term interest rates and a very steep yield curve.

During this phase, monetary policy measures are mostly accommodative in a bid to “jumpstart” a struggling economy. An upswing in expenditure of consumer durables, unemployment and overall business confidence are also observed during this period.

As the monetary policy measures begin to take hold, an economy shifts to the early expansion phase, which is characterised by a gain in momentum, production, investment, and profits.

This also filters into the rising employment figures, increased consumer borrowing and spending. Tapering also begins, as central banks slow down on stimulus packages and starts controlling economic growth. As a result, short-term interest rates slowly notch upwards and yield curves slightly flatten but remain upward-sloping.

The economic train is full steam ahead in the late expansion phase, and authorities double down on containment measures at this stage. Short-term interest rates are often increased further upwards and yield curves flatten further.

Characteristics of this phase are usually similar but more pronounced compared to the early expansion phase. The continued rise in interest rates begins to curtail borrowing and the economy shifts into a slowdown.

The yield curve is flat and, in some instances, inverted. In many cases, economies are especially susceptible to shocks such as global crises and pandemics at this stage.

The tight hold on economic growth by the central banks then prompts a contraction, which is highlighted by rising unemployment figures, declining profits, reduced spending, and a decline in interest rates. Central banks implement measures to counteract the contraction and the cycle is perpetuated.

As a business cycle progresses, inflation can move above or below market expectations, and this impacts asset classes in different ways. When inflation surges above expectations, inflation hedges, such as real estate and commodities become more attractive compared to bonds and equities. In the case that there is deflation, bonds become attractive especially when interest rates cannot move below 0%.

Zimbabwe’s business cycle, on the other hand, exhibits characteristics that do not conform to theory and empirical evidence in many other markets.

Like the global economy, Zimbabwe’s GDP growth expectations of 7,8% in 2021 and 5,4% in 2022 after a 2020 growth rate of -4,1% are indicative of an economy transitioning from a recession and into an early expansion phase.

The upward trend in interest rates from 15% in June 2020 to 60% in October 2021 also supports this view. However, inflation has been on a downward trend, from a high of 838% in July 2020 when the country was still in a recession to 55% in October 2021.

Unlike developed markets whose inflation rates are mostly demand-driven, Zimbabwe’s inflation trends have been largely driven by supply-side factors and measures by the central bank to control supply-side inflation growth have been surgically implemented without weighing down the country’s economic growth prospects.

The unorthodox combination of positive economic growth, rising rates and declining inflation have mixed implications on Zimbabwe’s equities.

An increase in interest rates could curtail debt funding for many companies’ projects and working capital, but this will be offset by an agriculture-led improvement in disposable incomes and an inflation slowdown.

We opine that this will be beneficial to business that (i) are cyclical, such that a slowdown in inflation will result in a stronger increase in demand, (ii) do not need extensive debt funding to maintain solvency, and (iii) closely enjoy the benefits of a good agriculture season in the country.

We note the banking sector as one industry that will largely benefit from these unique circumstances as we head into 2022, all things unchanged.

The sector’s overall loans-to-deposits ratio has steadily increased from 31% in December 2018 to 43% in October 2021, and 30% of these loans are invested in the agriculture sector, which is poised to register yet another good season in 2021/22.

Investors should consider stocks in financial services in their portfolio with the help of their investment advisors.

  • Mtutu is a research analyst at Morgan & Co. — tafara@morganzim.com or +263 774 795 854.

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