Thursday 28th April 2005

 

Investing in climate of economic uncertainty

 
 
 
 
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Four months into 2005 and the investment landscape is no clearer than it was at the start of the year. At the beginning of 2005, most local analysts had predicted annual returns in the range of 15 to 20 per cent in T&T, while in the US the market was expected to return in the region of seven to 11 per cent.

The T&T Composite Index started the year at 1,074.63 and so far is up ten per cent to 1,188.08. That’s a fairly healthy return in less than four months. However if the market were to continue at this rate we would be well ahead of most analysts expectations by the end of the year.

On the other hand, the Dow Jones, the S&P and the Nasdaq are all down for the year giving up all of the gains from the early part of 2005.

The same pattern is emerging in Jamaica where after strong gains in January (the All Jamaica Index was up 14.55 per cent) the market has turned to reflect a year to date decline of 9.34 per cent.

There are a number of factors at play here, some of them are global in that they transcend the different markets albeit affecting some markets differently to others, and some are specific to the respective markets just discussed.

Before getting into these factors, I would like to make a point regarding risk and return.

Ignoring short-term volatility

It is important to grasp the concept that, generally speaking, investing in the stock markets carries more risk than investing in a mutual fund or placing your monies in a bank deposit. The risk comes from the fact that share prices rise and fall over time.

There may be a distinct upward trend in a stock, but within the period of the trend there will be instances when the share price may rise excessively and then correct itself.

Take the example of Trinidad Cement Ltd (TCL). The company’s share price began to appreciate during the last quarter of 2004. This trend continued into 2005 where the share moved from $8.05 to $13 before falling to $11.90 and then rebounding to its current position of $12.03. (see table on Page 17)

While the example of TCL covers a span of days and weeks, such volatility can be spread out over months even years.

It is because of this volatility that investors are often advised to only put money that you would not need for the next three to five years into stocks.

This is an important point to note since while the local market is currently quite buoyant, a short term correction is not beyond the realm of possibility.

This is exactly what has happened in Jamaica so far this year and with the advent of electronic trading in T&T the market is expected to react a lot quicker than in the past.

Once you allocate long-term funds to seek out long-term returns, the issue of volatility goes away and the only real issue becomes that of the economic risk associated with the investment.

When I speak of economic risk I am referring to how well a company manages and reacts to its environment in order to generate returns to its shareholders.

If, therefore, you select stocks based in a haphazard manner without consideration as to the performance of the company, its standing within the sector that it operates and the markets or geographical location(s) that it operates from, then volatility could very well translate into absolute losses where no matter how long you wait there is no recovery.

This is why there were many instances in the past where I have advocated that investors study the annual report of companies prior to investing as well as keep updated on the changing conditions of its operating environment.

The global economy

This brings us right back to the comments made at the beginning of this article where the changing and uncertain economic environment poses a challenge for investment decision making.

On a global scale many at the start of 2005 expected that China would experience a slow down in economic growth this year.

However first quarter results are now available which suggest that this emerging global powerhouse grew its economy by approximately nine per cent over the first three months of the year. This level of growth maintained the global demand for commodities and the expectation is that it will continue to put a strain on the availability of commodity items, oil being just one example.

Increased commodity prices tend to have an inflationary effect on an economy possibly leading to a tighter monetary stance on the part of the regulators. However in much of the world, the US and Europe included, economic growth is still fairly fragile meaning that if the policy becomes too restrictive then the economy might stagnate or in a worse case go into a recession.

Finding the right balance is the key.

The rate and frequency of interest rate adjustments must be right and in the case of the US they must also sort out their trade and budget deficits. No less a person than Alan Greenspan last week commented that the US economy risks stagnation “or worse” unless these deficits are addressed. The consequences for the US dollar are also dependent on how this plays out.

Some home truths

Here at home there are also areas of concern.

Yes oil and gas prices continue to be high and significantly above budget and yes there are also higher levels of gas production and foreign direct investment all leading to increases in government revenues and economic growth.

However, the fact that it is the capital intensive energy sector that is generating growth as opposed to the more labour intensive manufacturing and agricultural sectors suggests that job creation is being fuelled more by government programmes than true market forces.

We have seen in the past that the absence of meaningful long-term job creation coupled with a rising cost of living can create a volatile situation.

Recent Central Bank statistics indicate that food prices have risen by 23.3 per cent over the 12 months to 2005.

The rise for the 12 months ending January 2005 was 18.3 per cent so we experienced a full five per cent increase in this benchmark from January to February.

The year-on-year increase of 23.3 per cent is the largest such increase in 16 years.

The last time we experienced these types of food price increases (1989), T&T was in a recession and the following year, 1990 there was the infamous attempted coup.

Capital market the key

Fast forward to today and we are witnessing another era of lawlessness in our society. As Dr Rolph Balgobin (executive director, UWI IOB) in an article in last week’s BG puts it, “T&T needs to be thinking about wealth creation when it thinks its biggest problem is wealth redistribution.”

The capital markets, especially the stock market, offers one of the key mechanisms for wealth creation in a developing economy such as ours.

As a result, it is important for the regulatory and economic authorities to send the appropriate signals at the appropriate times in order to ensure that confidence and stability is maintained in the market over the long term.

The higher food prices have contributed to headline inflation of 6.9 per cent for the 12 months to February 2005. This represents a full one per cent increase over the position in January 2005. High levels of inflation generally have a negative effect on the equity market.

The Central Bank is on record as targeting an inflation rate of 4-5 per cent. In an attempt to stem the inflationary trend the bank adjusted its repo rate by 25 basis points to 5.25 per cent.

This was done in March when the inflation trends for January were published, in April the repo rate remained unchanged.

Where do we go from here is the million dollar question. There is surplus liquidity in the economy. This coupled with increased levels of expenditure by the Government on capital projects over the next two years if not managed properly can further fuel an inflationary trend. Will inflation erode consumer spending and affect corporate earnings?

The high levels of TT dollar liquidity will seek out TT assets. Stocks and property are the two most obvious examples of this. Does this mean that property and stock market valuations will rise further?

Increasing interest rates beyond what is required to maintain exchange rate stability may have a negative impact on the non-oil sector. Does this mean that job growth will remain further dependent on government programmes along with the social implications that goes with this phenomenon?

The answers to these questions will unfold over the coming months.

As an investor you can’t control the market. What you can do is take a long term view of your equity investments and then invest in strong companies capable of generating consistent returns over your investment horizon.

Ian Narine can be contacted at [email protected] or at http://www.wiseequities.com

The contents of this article is not to be used or considered as an offer to sell or a solicitation of an offer to buy. The information contained above has been obtained from, and any opinions therein are based upon, sources believed to be reliable.

WISE makes no representation as to its accuracy or completeness and it should not be relied upon as such. All opinions and estimates therein reflect the judgement of the author and are subject to change without notice.

WISE is a subsidiary of RBTT.

 

 

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