ZSE bull run – when will the music stop?

By Ray Chipendo, HARARE, October 25 (The Source) – When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing, said Chuck Prince, former Citigroup chief executive and chairman referring to credit bubble before the 2008 financial crisis.

No better words can sum up the general mood of the current Zimbabwe stock market than the words of Prince. Well, Chuck Prince stopped dancing not many months after making that statement to FT – he was forced to retire. But that was not before he was warned that timing the end of the song was a really hard thing to do. Citi suffered huge losses from risky assets it held.

Zimbabwe’s stock market has been on a recording run ever since the government engineered bond notes. None of the local investors may be forced out when the music stops but they will be bruised when the equity markets self-correct. Notice, Mr Prince did not say “if” rather “when” – an acknowledgement that the music will stop. In the same way, money managers and investors alike marvel at how stocks are out of step with reality yet they are still on the dancing floor- holding the same assets they know are extremely over-priced.

Today ‘music’ is akin to the equities bubble that has inflamed in the recent months. Every trader and investor believes they will foresee the correction and jump off the market at its highs just in time for the correction. How that is possible – is difficult to tell.

Fundamentals vs Technicals

The dizzy heights at which the market is trading today do not suggest that money managers are not paying attention to fundamentals. The rush into equities is now beyond the pretext of ‘inflation cover.’ This is now more about fear of missing out perhaps the greatest and shortest rally in the history of the ZSE. By staying out of equities, when peers are recording double digit monthly returns, a manager can lose assets to competitors. As an advisor at a respectable brokerage firm succinctly put it “How do you give advice to your clients without looking conflicted: when your fundamentals are suggesting a value of 100 cents but the market is still buying at 180 cents.”

At a retail level, a local money manager had these few pointed words about what characterises this stage of the bubble – “when your mother calls advising you to buy shares because her friends’ children are doubling their money overnight.” To confirm, calls by Diaspora friends sounding off the idea of putting together some hard currency, trading for RTGS at premium and buying raging growth shares have all become too common today.

When liquidity dries up

Recently a local advisory firm made the insightful observation that in the last weeks of August, share prices were going up rapidly without corresponding volumes – suggesting a dearth in liquidity. But the lack of liquidity is not two way. Liquidity is dry for buyers and galore for sellers. Simply, buyers are queuing for shares that sellers are not willing to give up – hence demand has been driving prices up with very few shares changing hands.

But when the market self-corrects, suddenly everyone turns from being a buyer to a seller and liquidity for sellers evaporates as prices slide. Holders are locked in until buyers come to party – often at rock bottom prices. At that moment it is advisable to be the choosy buyer and not the desperate seller.

Therefore, one should think about who else is holding assets they are buying. You don’t want to buy assets at the same time speculators are buying. Investors with the same motives often act in unison leading to sharp price movements. Today, stock trades in the last four months have for the most part been driven by short-term holders or simply speculators driven by other factors other than fundamentals or need to fulfil portfolio allocation goals. These are traders who will dump the assets at the faintest sign of a market decline.

Potential catalysts for a correction

We may not know when and how things will pan out. Not even the policy maker knows. However, as Mark Twain puts, “history may not repeat itself but it often rhymes”. To the extent that cycles are predicted to continue, investors can be assured that the current bubble is going to burst. We cannot tell when the correction will occur, but at least we can get a sense of where we are in the cycle. In my opinion, we may have hit the top of the cycle.

Black swans are events or occurrences that deviate beyond what is normally expected of a situation and are extremely difficult to predict. Just as in the case of the 2008 financial crises, it is black swans that often trigger corrections and crashes. Below is an attempt to be as encompassing as possible in identifying potential events that could poke holes in the current bubble. The idea is not to be overwhelmed by thinking about the number of things that could go wrong but to have some balance in one’s decision making.

Liquidity withdrawals – in the last four months most pension funds and money managers have moved funds from bank balances and TBs into equities. In an event of anticipated or forced redemptions, managers will look up to the equities market for liquidity and withdrawals. If the cause of a sale is affecting a number of funds at the same time or a large pension fund, the sale may spark a domino effect as speculators rush to be the first out of the door.

Risk off event in RTGS and other assets – a major part of the rush in equities has been devaluation of RTGS against hard currency. The prevailing discount is a risk-on case, which reflects an aggregate of market participants’ fears. But we all understand that this discount is neither correct nor wrong but mostly a reflection of the market’s perspectives in this case – trust in monetary policy. This discount, is a highly fallible figure that can be drastically changed by a single political/policy event, announcement or act. Such an event would re-rate the risk attached on TBs or RTGS securities drawing funds from equities into deserted asset classes such as TBs and Bank balances.

A return to fundamentals – less likely but plausible is a possible gradual return to sensibility. Where a few courageous funds will question the current prices and trigger respect for the fundamentals.

Leverage – it is not unthinkable that seeing the stock market double in 3months some players in the market may be leveraging stock purchases. Few months back, regulators allowed investors to borrow against their listed shares. For leveraged purchases, significant drop in price could trigger a situation akin to margin calling leading to forced selling.

Negative news in a blue chip – as Nassim Taleb puts it “it is contagion that determines the fate of a theory in social science, not its validity”- yet contagion is one of the least recognised phenomenon. Negative news in the performance of a share or underlying company is good enough reason to spark a market wide crash. It can be news unrelated to fundamentals such as Econet’s share price plunge when investors protested the rights issue terms. Speculators will jump at the sound of panic setting off a negative chain reaction across the market. Bear in mind, speculators are not interested to understand what is driving the share movement more than they are interested in the movement itself. Ray Chipendo is a Director at Emergent Capital Management, an investment advisory and private management firm. 

Editors Note: In the story “undefined” sent at: 25/10/2017 10:07

This is a corrected repeat.