Creating Wealth- In a era of Recession

“This is a very, very challenging time, an exhilarating time… Assuming you survive, we’ll all look back at this as one of the great, great times to be an investor.”
(Mark Patterson, Co-founder & Chairman of Matlin Patterson Global Advisors, USA, Reuters Report, cited in Daily Graphic 18 September Edition, p57 2008)

Recent reports quoted by BBC show that even the world’s richest and investment gurus like Warrent Buffet and Bill Gates have suffered significant losses in their investments, following the stock market meltdown on the Wall Street. The ICT magnate, Bill Gates’ has had his fortunes declined by $18bn to $ 40bn while Mr. Buffet, who until this year was the world’s richest person, lost over $25bn to $37bn! Consequently, he has slipped to the second position on the Global Billionaires’ Rich List.

The IMF Director, Dominique Strauss Khan was also reported in the same report cited above as saying that “The worst of the financial crisis may still lie ahead and more major financial institutions may face trouble in coming months.”

In the midst of the gloom, lull and losses in financial markets, it seems to go against the grain of logic to suggest that there could be any attractive opportunities for individuals to create wealth. Indeed, for many readers of this article, it may even sound paradoxical, if not absurd, to propose that the world will look back at the current global recession, sometime in the future and confess that it was “one of the great, great times to be an investor” as implied in the above quotation.

Global Markets Recession Since the middle of 2008, financial markets all over the world have seen a precipitous decline for reasons which are, perhaps, no longer a secret: Poor lending by banks (sub-prime mortgage lending crisis) to non-credit worthy individuals, leading to colossal bad debts on the books of many banks. This eventually translated into losses for investors, mainly in the developed markets. There have been several casualties since then - The notorious collapse of investment banking giants like Lehman Brothers and Merrill Lynch are too fresh on our minds to be forgotten. Millions of people in the developed markets have also lost their jobs and are a now living on the margin.

Consequently, financial markets across the world have been under enormous stress. Perhaps, the world has not seen such a crisis since the Great Depression of the 1930’s, during which the Wall Street fell by over 90%! As at the end of December, 2008, most capital markets in developed markets recorded negative performances (China,-48.71%; Italy, -54.13%; USA, -38.58%; Japan, - 13.64%, see Figure 1 below). In practical terms global markets lost over $ 30 trillion in 2008!

Fig. 1:

Source: Databank Research

African Markets in a Correction… In 2008, African stock exchanges were generally bearish, posting an end of year return of -15%). As at the end of December, 2008 only four African markets (Ghana, Tunisia, Malawi and Tanzania) out of 15 capital markets, made positive gains. Since the beginning of 2009 to date, all African equity markets are in the red, save for Tunisia and Morocco.

It is instructive to emphasize, however, that the current declines in African markets and, particularly, that of Ghana are largely the results of ‘market corrections’ (downward revision of prices of stocks in line with their perceived intrinsic value). Share prices on African stock exchanges have been on a consistent 'bull run' (upward movement) for the last 5 years until mid 2008. Thus, it can be safely asserted that most African markets are not yet in a recession. According to economists a ‘recession’ is marked by two quarters (6 months) of negative growth. But to the man in the street, it is a period of job losses, home repossessions, wide fluctuations in the stock markets etc.

Off course, it cannot be denied that the current downturn in African markets has been further accentuated by the global financial crisis: The fall in demand for shares by investors, especially, institutional fund managers from the developed markets, has in no small measure dampened ‘bids’ (demand) and increased ‘offers’ (supply) of shares. This imbalance in demand and supply, coupled with the overvaluation of most stock exchanges in 2008 have all conspired to bring about downward in slide African markets. Not surprisingly, most capital markets in Africa, including the Ghana Stock Exchange (GSE) have been on a decline with an average year- to- date (as at 13 March, 2008) fall of -18.2% in dollar terms (Ghana:-20.78%).

…And Stocks have Become Attractive From all indications, the market corrections in global markets are expected to continue up to the end of 2009. It may, however, interest investors to know that most stocks now have attractive valuations and are expected to become cheaper as prices continue to fall. The Price-to-Earnings (PE) ratio of African bourses, which is an indicator of the relative attractiveness of stocks, has fallen from an average of 18 in mid 2008 to 10 as at 13th March, 2009. In order words, the average prices of stocks have fallen by over 44%! In the specific case of Ghana, the PE of the GSE has declined from 21 to 12 over the same period. Interestingly, many investors are selling off their stakes in shares and investing in Fixed Income instruments, which are currently providing attractive yields.

Tips for Investing Conservative portfolio management philosophy dictates that it is prudent for investors to consider investments in Fixed Income securities, like Treasury Bills, as a complement to shares to reduce risk. But keeping all investments in short-term instruments or avoiding investments in the stock market for fear of losing funds is not always a smart investment decision. Without doubt, it is prudent to reduce investments in very high risk assets, but the timing of such decisions, and which assets are disposed off are crucial - We must avoid throwing the ‘baby away with the bathing water’! Moreover, one needs also to be careful where one invests. In general, industries which provide non-essential commodities and services have a tendency to under perform sectors which offer essentials like household items and food. For example, it is expected that sellers of basic and affordable foods and discount retail shops will make more money in a recession as demand for these items are relatively inelastic. Investor in real estates may suffer low return on investment as demand falls in a recession but it may be the best times to acquire landed property at lower prices.

Making Money in Stock Markets According to Benjamin Graham, ‘The Father of Value Investing’, value is obtained by buying assets at lower prices than their real value as captured in the quotation below: “Price is what you pay; value is what you get. Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”

Thus, in capital markets, wealth can be created when investors acquire fundamentally sound assets at prices lower than their intrinsic or fair value.

Some readers may acknowledge that shares listed on the GSE and equity mutual funds like Epack Investment Fund, whose prices are currently declining, have been in similar downturns before (1996, 1999, 2005), when Treasury Bill rates were higher but through it all, the capital market and Epack have proven to be better performers over the past twelve years, as shown in Figure 2 below.

Figure 2:

Source: Databank Research In particular, during the past twelve years, verifiable records show clearly that EPACK, an equity mutual fund investing in Ghana and 10 other African Stock Markets has far outperformed Government Treasury Bills by over 3 times! In addition, empirical market data in Ghana further supports the ability of good quality stocks to generate higher returns than short-term and less risky instruments like Government Treasury Bills and dollar substitution investments even in a 3-year cycle.

But Not All Stocks Generate Wealth! But it is equally correct to admit that not all stocks which dip during market declines recover well in time to compensate investors with a real return on investment. Indeed, records show that some investors elsewhere, in markets like Japan, France, Germany and Spain have had to wait for over 50 years to earn real positive return on their investments! And perhaps, one need not go far, some Ghanaian investors have not had any romantic experience with investments made in stocks like AngloGold Ashanti in the 1990’s.

Thus, to create wealth in the stock market, it is crucial to purchase GOOD QUALITY shares or funds at the lower end of their price trajectory. By good quality, I mean a stock or fund must have a high potential to generate high earnings, and not be burdened with too much debt. Unfortunately, most investors tend to move with the herd, and rather seek comfort in loss minimization rather than purchase under valued long-term assets which may have future prospects.

Contrarian Approach It is all well and good to cut losses in investments which have no future, but it is equally important not to ‘close the stable after the horses have bolted’: The ordinary investor may not know when to enter or exit an investment. But there are very simple qualitative indicators using insights from the social-psychology of the investment market - When you hear ordinary investors rushing to take positions in rising stocks and almost every body is interested in buying, it may be too late! Astute investors tend to watch the stampede of the herd, and take the opposite direction - Otherwise known as the CONTRARIAN APPROACH. This approach is obviously risky, but remember the faint-hearted never won a fair lady!

All indicators point to a very challenging year for the global economy. In particular, Africa and Ghana are expected to experience a slow down in donor inflows, export earnings and remittances. These could lead to instability, as local currencies depreciate, governments borrow more from domestic sources, and raise interest rates. Investments in Treasury Bills and currency substitution would become more attractive options in the short-term for most investors, but wealth is not created merely by holding funds in safer assets.

The current meltdown in global financial markets and the looming recession in Africa could, however, be fine moments for some smart investors to become millionaires as some good assets are trading at very steep discounts. These smart investors will be those who can tread the narrow path, opposite to direction where most investors are thronging, and seize strategic positions in undervalued but promising investments. Only a few may do this. And for these, I am very confident they can create wealth, even in a recession.

By: Dr Kwabena Frimpong The Writer is a Vice President of Databank Asset Management Services Limited.