Fundamental Analysis II


Following on the article about supply and demand, Piggy believes that it is critical to have an appreciation of several economic indicators when analysing markets. This includes understanding economic and industry growth rates, trade balances and inflation trends.

Growth Rates

Generally, countries that grow faster are often good places to invest. The Zimbabwean economy for example has experienced recessions in 2019 and 2020, with GDP estimated to have contracted by 6% and 4.1%, respectively (Ministry of Finance). The economic contraction has been a result of output losses in key sectors such as agriculture, mining, manufacturing, and tourism. The recession has largely been a result of shocks such as (i) prolonged drought episodes, (ii) Cyclone Idai and (iii) the Covid-19 pandemic. The Government of Zimbabwe estimates that the economy will rebound by 7.4% in 2021 on the back of recovery in agriculture which is expected to grow by 11.3%.  Some of the implications of high GDP growth rates are as follows;

  • More opportunities for expansion;
  • Rising incomes create demand;
  • Overseas companies want to set up operations in these countries; and
  • Foreign investors want to buy stocks of companies operating in these countries.

Overall, the above factors (normally) boost demand for the currency and cause it to appreciate.

Trade Balance

Trade balance = Exports – Imports

The trade balance is the amount a country receives for the export of goods and services minus the amount it pays for its import of goods and services. Broadly speaking, countries that run persistent trade surpluses tend to have strong currencies. Conversely, nations with consistent trade deficits tend to have weaker currencies.

For example, if Zimbabwe exports more goods to Zambia, than Zambia exports to Zimbabwe, then the demand for the Zimbabwean dollar (ZWL) from Zambia increases and therefore the ZWL may strengthen against the Zambian Kwacha (ZMW).

Inflation

This is the rate at which the general level of prices for goods and services is rising. It is typically measured as an annual percentage change. Another way to think of it is as a measurement of the loss in the purchasing power of every unit of currency per year. For example, if inflation is 5% annually, then theoretically a pen that costs 1 USD in 2021 will cost 1.05 USD in 2022. That means that your one USD will buy you less things in 2022 compared to 2021. That is why you may have heard your parents or grandparents say: things were so much cheaper in our time! It is true, things were a lot cheaper. That pen may have only cost 5 cents in 1980 for example. However, salaries were much lower as well.

Inflation affects different groups of people in vastly different ways. In general, high inflation hurts savers and investors. If you have USD 100,000 in the bank and inflation unexpectedly spikes to 10%, your money now buys roughly 10% fewer things.

But it also helps borrowers. Imagine you just got a loan of USD100,000 to buy a house worth as much. If next year inflation spikes to 10%, the same house will be worth USD110,000, but you will still have to pay only USD100,000.

The biggest threat to the economy, however, may be when inflation moves sharply and unpredictably from year to year. The uncertainty over what happens next makes consumers less likely to spend as their real income may fall, corporations more hesitant to invest, and so on. One of the worst instances of hyperinflation was recorded in Zimbabwe. In 2008, inflation was estimated at 231,000,000% y-o-y. That means that a loaf of bread that cost 1 Zimbabwean dollar in 2007 was worth 231 million just one year later. Imagine trying to plan your personal expenses, business investment, or savings, in such an environment?

An illustration of the loss of value associated with inflation

Chapter 2 of the Investment 101 handbook provides a thorough overview of inflation and other economic indicators. Download a Copy of the Investor 101 Handbook below;

https://www.dropbox.com/s/x3j4wvxdedb6eoc/investor%20handbook%20101.pdf?dl=0

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