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The momentum effect on ZSE

Tafara Mtutu Research analyst
Many novice investors have been contemplating adding best performing stocks in 2021 in their portfolio in 2022. Getting to the bottom of this requires one to understand the momentum effect on stock markets.

The momentum effect is the tendency of stocks to show persistence in performance. Stocks that have done well in recent periods tend to outperform in subsequent periods, and the opposite holds true for underperforming stocks.

This effect is among technical analysis strategies employed by short-term speculative investors and its popularity in developed markets disproves the Efficient Market Hypothesis in several equity markets.

Empirical evidence in the US markets shows that the momentum effect is especially profitable among stocks that have outperformed for periods ranging between three and 12 months.

However, strategies that use momentum-based strategies experience volatile returns. The momentum effect was shown to be profitable during the economic boom after the dotcom bubble of 2000 and under-performed during crises like the global financial crisis of 2008.

Recent studies also show that the anomaly’s prevalence has waned since 2008 in developed markets. However, the effect remains instrumental in generating excess returns in developing markets. A study by La Grange and Krige (2015) revealed that, even after the global financial crisis of 2008, the momentum-based strategies earned up to 8,7% abnormal annualised returns on JSE between 1998 and 2013.

When combined with financial ratios, the abnormal annualised returns improved to 14,1%.

In Zimbabwe, a similar analysis would provide spurious results given that the Zimbabwe Stock Exchange has been experiencing sustained price increases driven by inflation and local currency depreciation since 2017. However, momentum can be measured by subtracting the price of a stock 10 days ago from the latest price and plotting the trend.

Results based on this formula and blue chips on the ZSE show the existence of the momentum anomaly on the bourse, with several stocks exhibiting momentum at various stages.

Using data up to January 11, 2021, momentum on Innscor Africa’s share price was positive and on a strong upward trajectory. This is an example of a stock that momentum investors would overweigh in their portfolio solely based on this measure of momentum given the implied prediction that points to continued price growth over the short-term.

Momentum on the share prices of Axia Corporation and Simbisa Brands as at January 11, 2021 shows that these stocks’ momentum was also positive but flattening.

Based solely on this observation, this suggests that these stocks’ prices are at the tail end of their momentum and are likely to stagnate in the coming weeks.

Delta Corporation and CBZ Holdings’ momentum was also positive in the same period but already on a downward trajectory. Momentum investors are likely to under-weigh these stocks in the portfolio in fear of earning negative returns in the coming weeks.

Strategies based on momentum are not without their limitations. Firstly, this strategy works best with blue-chip stocks. Blue chip stocks, or simply blue chips, are usually stocks that

  •  are large cap stocks,
  •  fundamentally solid, and
  •  are very liquid.

Zimbabwe’s capital markets have less than 10 stocks that meet these criteria and this limits the options available to momentum investors. In comparison, the JSE has at least 30 blue chips, while the UK and United States have over 100 and 500 blue chips in their capital markets, respectively.

Another constraint with this strategy is the trading cost involved. In order to successfully execute this strategy on the ZSE, one needs to constantly sell at the tail end of a stock’s momentum and buy at the trough.

These costs will mean taking a haircut on the profit from the strategy, and this could be a challenge given the recent increase in trading costs.

In the most recent budget statement by the finance minister, capital gains tax on the sale of equities was increased from 1% to 1,5% on shares held for over six months and 2% for shares held for less than six months. As a result, the momentum strategy that trades over short periods needs to earn 1% more than before in order to remain profitable, over and above existing costs of 1,6884% (brokerage commission, investor protection levy, platform levy, SecZim levy, settlement levy, stamp duty, and VAT).

Momentum-based strategies are also susceptible to corporate announcements that have a material effect on the share price of the stock in question.

These include, but not limited to, dividend announcements, share buybacks, M&A activity, and profit-warning statements.

The limitations are further compounded by the costs incurred in accessing tools and data that is used to calculate momentum. Currently, there are no technical analysis tools that are available to the public for free, and investors willing to purchase the data from the ZSE must be ready to part with at least US$15 every month, which adds to the costs of the strategy.

After considering these costs, implementing this strategy could end up being unattractive especially given that successfully executing momentum-based strategies can be quite difficult.

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

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