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The joyless rally

Equity purchases made under duress produce a joyless stock market rally, where people are desperate to preserve their wealth, rather than cheer on recovery.

Six years ago, Zimbabwean shares were enjoying one of the greatest rallies the world has ever seen.

In the year to April 2007, the local stock market was up 12,000% as investors rushed to invest.

President Robert Mugabe was leading the country towards bankruptcy, after letting his war veterans seize farms owned by white farmers. Agriculture was in a state of collapse. Roads were crumbling. The rate of unemployment was 80%. Industry was bankrupt. Yet stocks defied reality.

Why? Quite simply, Mugabe had told his central bank to print as much money as it took to pay Zimbabwe’s debts.

Putting money on deposit was a bad idea, as inflation went up. Buying government bonds was a tricky proposition. Anyone lending money to troubled companies could not be certain of getting their money back. Getting money out of the country was difficult.

So, as new money entered the system, banks used it to invest in the stock market. Or they lent it to affluent investors, who did precisely the same. As prices rose, they kept investing. Until, of course, the Zimbabwean dollar crashed, wiping out their gains in real terms.

It is way too premature to compare indebted western economies to Zimbabwe. But Mugabe was strangely fixated on winning national elections by rigging the ballot. And western politicians have become equally desperate to win voter support by rigging their economies.

They know, only too well, that opinion within their parties is becoming radicalised as austerity grinds on. Fringe parties are edging closer to power as the demagogues who run them, from whichever side of the political divide, offer “easy” solutions that will be difficult for economies to deal with.

Money printing by central banks is already taking place at an unprecedented rate. Credit rating agency Moody’s has punished the UK for its lack of growth by pushing down its credit rating from AAA to Aa1. And currencies, led by sterling, are in a race to the bottom as governments try to make their exports competitive.

Investors are noting these trends with increasing concern as cash held on deposit starts to find its way into equities and institutions become marginal sellers of bonds. This so-called “great rotation” has caught the imagination of investors for nearly six months. 

It is worth noting the stock market is an expectation machine rather than a reflection of reality. Far from believing we are heading into inflationary hell, investors are viewing equities as a hedge against the possibility of it taking place.

The hedge isn’t perfect. When inflation gets close to 10%, varying rates of inflation on raw materials, plus an escalation of pay demands, wreak havoc on corporate costs. But it’s good enough, for now.

Andrew Garthwaite, a Credit Suisse strategist, argues the sectors to back in an inflationary period are food, retail and telecoms where companies can prise cash out of individual customers before they need to pay their suppliers. High-yielding stocks and real estate aren’t bad bets either.

But equity purchases made under duress produce a joyless stock market rally, where people are desperate to preserve their wealth, rather than cheer on recovery.

In which respect, our current situation may not be so far removed from Zimbabwe, after all. 

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