Tafara Mtutu Global geopolitical tension that is centred on the Russia-Ukraine crisis has given rise to several risks that have shaken global capital markets. Among these risks is global inflation, which surged beyond 9% in May 2022.
In response to the rising inflation, policymakers in developed markets hinted that there will be multiple interest rate hikes throughout 2022 to counter the rising inflation, and some central banks in developing markets have already begun increasing rates in a bid to maintain currency stability over and above the incentive to slow inflation down.
However, this comes at a time when the economy is still in need of economic stimulus after the crippling effects of the Covid-19 pandemic.
Several countries are still yet to rebound to pre-pandemic output levels and measures to stimulate growth will inadvertently fan unwanted inflation pressures created by the Russia-Ukraine conflict.
The Covid-19 pandemic, which garnered worldwide attention in March 2020, is estimated to have cost the world economy some US$16 trillion to date with an additional US$12 trillion expected to be incurred in lost output over the next four years to 2025.
The magnitude of these losses cements the mandate by global policymakers to recover lost value as swiftly as possible, and this has underpinned an extended period of low interest rates since March 2020 as well as fiscal support packages by several governments over the same period.
We note that in November 2021, the Federal Reserve had begun hinting at three interest rate hikes in 2022 to contain demand-driven inflationary effects of the fiscal and monetary policies to stimulate growth.
These pronouncements, in part, set the stage for asset allocations that favoured equities, inflation-linked bonds, and floating rate notes in 2022.
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This global economy’s Covid-19 recovery plan was abruptly marred by the Russia-Ukraine conflict which came with unforeseen supply-side inflation pressures.
The unexpected volatility in the supply of critical commodities like crude oil, natural gas, corn, and wheat at the onset of the conflict saw prices of these commodities skyrocket to record levels within two months with ripple effects on global price levels.
The additional unexpected inflationary pressures subsequently prompted a response that was juxtaposed with Covid-19 recovery efforts.
Four months after hinting of three interest rate hikes related to the recovery from the pandemic, the US Fed signalled six more hikes in March 2022 and inflation targets were also revised from 2,9% to 4,3%.
The unexpected spike in inflation and increased interest rate hikes subsequently impacted the expected returns from several asset classes.
According to economic theory on business cycles, real assets often benefit the most from unexpected inflation. In this case, commodities at the centre of the Russia-Ukraine conflict benefited the most with double-digit returns in the first five months of 2022.
Crude oil and natural gas prices gained 53,2% and 145,9% respectively, while wheat and corn prices increased by 50,3% and 31%, respectively.
Further, we opine that the protracted constraints in the supply of these commodities in the short-to-medium term could see commodity prices stabilising at current short-term equilibria until substitutes for Russia and Ukraine’s exports are established.
On the other hand, equities tend to underperform when actual inflation moves ahead of expected inflation. In the five months to May 2022, the Dow Jones Industrial, S&P 500, and Nasdaq Indices lost 8,6%, 12,8%, and 22,5%, respectively. In European markets, Germany’s DAX weakened by 8,3% while the FTSE 100 recorded marginal gains of 3%.
The poor performance in equities was also magnified by a reversal of the herding effect which manifested in technology stocks.
These stocks were hyped after the tech sector was unanimously deemed the best performing sector during the pandemic, leading to unsustainable price appreciation which is now reversing. In the year to date, Meta lost 42,4%; Alphabet, -22,5%; Apple, -17,8%; Netflix, -67,3%; and Amazon, -32,4%.
However, in Zimbabwe, most equities have recorded positive performance in the double digits, if not triple digits.
The ZSE returned 113,2% in the five months to May 2022 in nominal returns, and standout YTD performers on the bourse include Axia (+304%), Tanganda (+273%), and Innscor (+224%).
We attribute the low integration of the country with global markets to the disconnect between the global and local capital markets.
According to the Singer-Terhaar model which adjusts capital markets expectations for global integration, market returns are heavily influenced by factors that drive global market returns in extensively integrated markets. On the other hand, markets that are less integrated with the global market are likely to experience a volatility in returns that is mostly driven by country-specific factors.
We note Zimbabwe’s capital markets are one of the less integrated markets given that (i) the country’s currency is not actively traded in global markets, (ii) low capital mobility which nullifies the economic transmission effects that manifest through changes in currency rates, interest rates, and inflation rates, and (iii) declining international investor participation on the Zimbabwe Stock Exchange.
These constraints also pose further risks to existing traditional risk factors, although the ZSE’s returns somewhat compensate seasoned investors.
- Mtutu is a research analyst at Morgan & Co. — [email protected] or +263 774 795 854
