There are a lot of factors that an investor takes into account when making an investment decision. Inflation is one of those factors.
Zimbabwe’s annual inflation rate for July 2021 slowed down to double-digit levels for the first time since January 2019.
According to official statistics from Zimstat, annual inflation for July 2021 stood at 56,37 percent down from 106,6 percent in June 2021.
What this means is that the rate at which prices of goods and services are increasing has significantly slowed down.
A year-on-year comparison is even more revealing as the rate of price increases has slowed down to 56,37 percent from 837,5 percent in July 2020.
The month-on-month increase in average prices in July also slowed to 2,56 percent, which is slightly lower than the 3,1 percent average monthly rate for this year so far.
The July 2021 month-on-month inflation is much lower than 35,5 percent that was recorded prior year comparative.
High levels of inflation are worrisome to investors in financial assets such as stocks because it erodes the buying power of whatever money they make on those investments.
If you make 50 percent on an investment, but inflation is also at 50 percent, your real return is zero.
Luckily for local stock market investors, the ZSE’s overall market capitalisation’s gains have been ahead of inflation 7 times in the last 12 years.
The other reason is that higher inflation usually brings higher interest rates in response, from both the central bank and banks. Increased costs of borrowing are not good for the economy in general and listed entities in particular.
Stocks also trade largely on corporate profits, and rising prices and wages increase a company’s costs, which further erodes profits.
While local inflation figures are still significantly higher than what prevails in the region, the slowdown trajectory is encouraging.
Although the Zimbabwe Stock Exchange and almost all listed entities have seen their share prices appreciate, those capital gains would count to nothing if they are below inflation.
As at Wednesday this week, the ZSE’s market capitalisation had recorded a 148,73 percent gain. This is ahead of year-to-date inflation of 23,8 percent.
Inflation developments are very important to local stock market investors as stocks can provide some hedge against inflation. And this they have done.
As at Wednesday this week, the average year-on-year return for ZSE listed stocks is a massive 1 588 percent.
This is against year on year inflation of 56,4 percent.
Although investor returns on the ZSE have been above inflation the trajectory was not good for company fundamentals.
While some companies reacted to inflation by raising their prices the result was a reduction in sales as some consumers could not afford the higher prices given the level of salaries.
Inflation thus robbed investors as they ended up paying higher share prices with no corresponding increase in value. Paying more for less.
Inflation can also be used as a guide of the expected returns.
For example, if investors expect a return of roughly 10 percent year-on-year after inflation, and inflation is 56,4 percent year-on-year, then a gain of 70 percent (after taking into account transaction costs) is very good.
Theoretically, the slowdown in inflation should see the gains on the stock market slow down.
High inflation such as 106 percent in June, would see investors expecting gains above 106 percent before factoring in their expected return, but with inflation slowing down to 56,37 percent, that expectation would be lowered in line with the new level of inflation.
In other words, when inflation declines, so do the inflated share prices.
There is however another way of looking at the slowdown in inflation developments. When inflation falls, consumers can purchase more goods, input prices go down, and revenues and profits go up.
This is good for share price appreciation and should see local investors continue to buy into the ZSE but with a bias towards quality stocks.