Market volatility is likely to characterise the next six to nine months. As varying economic and political factors come into effect, investors will scurry around to get a sense of where markets are headed. Not that investors will not be able to appreciate key head and tailwinds, but instead, understanding the net effect of these varying forces will be the hardest thing to do.
In our understanding, three developments/factors will stoke volatility in the markets namely: the economic agenda for the next 200 days leading to elections; the election season and the inflation direction. As we all attempt to determine the ultimate impact of these forces, shifting investor sentiments will set off turbulence.
Economic Agenda – First 200 days
As elections are scheduled to take place in approximately 200days, the interim period is expected to chart a direction for the economy and investor sentiment. Of great interest will be: fiscal reforms, monetary reforms and measures to curb corruption. With effective fiscal reforms, as we have seen thus far, investor sentiment is expected to continue to improve. If risk perception has driven funds out of other assets and into equities then a reduction in the risk premium overlaying the equities market will push prices down.
However, all things equal, an improvement in the economy and a return of confidence will draw foreign investors back onto the stock market. This second dynamic will certainly push up prices. To what extent will these two counter dynamics balance each other?
To sum up this dichotomy; good news in the market has been depressing stock prices, but prolonged good news may start to push up prices.
Inflation has been key in driving investor asset allocation. In the last few months, equities have reached sky high levels thanks to inflation expectations. Now that the inflation proxy – RTGS exchange rate is at all-time low since first quarter, will the trend reverse? The market has lost approximately $5billion but is still 100% higher than it was beginning of the year. The main question is- if inflation flattens will the markets still trade at the same levels as today?
While opportunistic capital inflows are at their peak in a long time, patient and real funds are waiting for the dust to settle. Most of the investors and sovereign and private funds, particularly in the developed markets will wait for the election season and outcome.
As markets attempt to anticipate outcomes and position for capital flows, speculation will plunge stocks prices in a state of varying optimism and pessimism. The difference between a well-accepted election process and outright disapproval will be vast and consequential. A smooth and internationally accepted election process will create conditions for credit boom which will inflate asset prices benefitting asset-owners across property, money market products, real assets and equities. Whereas, a contentious process and outcome may throw us back into a pariah state withdrawing capital and deflating asset prices.
History has over and over again showed that bursts do happen quicker than booms. The stock market is certainly where it does not belong. High profits and revenues mostly created by inflation expectations and RTGS devaluation among retailers and exporters respectively are unlikely to repeat themselves should the environment stabilise. As markets attempt to anticipate outcomes and position for capital movements, the equities market will be thrown in a state of constant unrest.
Though it is said that volatility is the friend of a value investor, this may not be the season to stack one’s bets on fundamentals. Until post-election period, the markets will continue to defy fundamentals while heeding sentiment and technicals.