Zimbabwe: Investing in deflationary times

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NOT so long ago policy makers and commentators identified what was then “disinflation” as a short term correction in prices. As the Zimbabwean economy transitioned into a US Dollar market, prices did not adjust downwards quickly enough. Since then disinflation has relapsed into deflation.
Now, unnerving most of us is the view that the US dollar may be entering a long bull market. If so, there is little doubt that deflation is here to stay. As deflation turns secular, pension funds will be hit the hardest. Incomes will suffer, asset prices will trend lower while capital returns shrink.
Is deflation is here to stay?
First, as we pointed out, our currency the US dollar is set to remain on a rally. Relatively strong GDP growth in US coupled with the Fed’s anticipated interest rate rise are two strong tailwinds for the Dollar. To aggravate the effect, our largest trading partner’s currency, the Rand, is on the receiving end of the Dollar’s rally.
As divergence in the two currencies worsens, the Zimbabwean consumer and durable goods’ prices will fall further down in dollar terms. The trend has already manifested in the retail sector where most of the products imported from SA are falling in domestic currency stoking deflation fires in the process.
Oil prices may have inched up in recent days in reaction to worsening geopolitical tensions and claims of record level US shale drillers closing shop. But on the whole, we believe oil prices will remain subdued in the medium term. As the Iran deal plays out, the country’s oilfields will soon add their output onto the world market, driving prices down.
In an environment where none of the OPEC producer nations is willing to lose market share, many share the view that oil prices will remain under $60 a barrel for some time. With low prices, most production and transport costs will remain capped, adding to deflationary pressure.
Last, Zimbabwe has defied some Economics tenets. Until two months ago, we firmly held the view that wage prices are sticky downwards. But we have since witnessed wages being slashed by as much as 30% in many companies and parastatals. It may be too early to notice the impact of wage cuts on both the Producer and Consumer price indices. Faced with weak demand, most companies will now have the flexibility to reduce their prices reinforcing the narrative we have of entrenched deflation.Advertisement

Asset class selection
If deflation is going to stay with us for as long as we think it will, investors especially pension funds ought to be concerned. For starters, up until 2015, property prices have been able to hold out. While equities’ valuation lost almost 20% last year, property was able to retain most ground.
We think a traditional flight to safety (property) is what propped up property asset prices. But now as more properties are marked to market or sold, downward price revaluations are becoming more apparent, taking a toll on property investment companies. Real Estate Institute of Zimbabwe (REIZ) estimates that property companies are negotiating current rentals at between 5% to 20% discount.
We think the property asset class may be losing its lustre as a defensive investment. As such concerns become rooted, pension funds heavily exposed to property asset class should expect precipitous drops in fund values.
Equities market has lost almost 19% so far since January 2015. Deflation has been a part contributor to weak earnings which in turn have depressed valuations and led to poor dividends. Not only are pension funds getting less income but capital growth is being challenged.
Flight to safety
In this deflationary environment where income and capital growth are both in limbo for most assets, investors need to rethink their asset selection strategy. If predictability of income and capital growth are important considerations for investors then we venture that corporate bonds should assume a bigger role in pension funds’ portfolios.
But we also caution that selectivity is critical. Thorough credit analysis is important in identifying securities to avoid. Bonds issued by cyclical businesses, heavily geared companies and highly regulated industries carry a warning tag.
Ray Chipendo is Head of Research at Emergent Research. He can be reached on: