Navigating the Bear Market

Published on 30th March 2009

Frontier markets such as Mauritius have historically enjoyed low correlation with other emerging and developed market indices. This coupled with the inefficient characteristics of such markets increased the potential for portfolio diversification by fund managers worldwide. It should not surprise the readers then that the recent launch of various frontier market indices was followed by relatively large foreign investments in these markets.

The problem with this assessment is that return distributions of frontier stock markets are far from being normal and that the over simplified correlation coefficient only measures linear relationships between two variables and is highly sensitive to outlier events.Due to heteroscedasticity and the non linear nature of financial time series data, this coefficient cannot possibly give you the whole picture and may not always be relevant.

Mauritian stocks may have historically enjoyed low correlation with other markets, but since the economy is highly impacted by what happens to the countries that it exports to or from which the tourists come from, eventually correlations change. There was no evidence of increased correlation for example until the middle of last year.

The diversification benefits are not constant over time and at best markets such as Mauritius may simply be lagging global markets. Furthermore, if one were to look at the daily data of the past three years alone, the local market has been characterized by a Kurtosis that is superior to 10 with a slightly negative skew, something that cannot
possibly be ignored when local and foreign institutions allocate funds to such a market. Quantitative models in fact have always suggested that the traditional 60:40 local/foreign allocation is based more on subjectivity than on anything else.

When one considers the number of available sectors, stocks and the illiquid nature of such a market, overexposure to local stocks can be dangerous. Sometimes, certain quarters in Mauritius will tell you that the Beta coefficient of their listed company is low and offers good diversification potential. What they fail to tell you is that when stocks are illiquid, their Betas will obviously not be statistically significant or/and may be low due to the smoothed price series data that come with low liquidity.

Uncertain outlook for the Rupee

It is not too hard to manage funds while it can be less obvious to notice anomalies when the local market is giving out 60% growth per annum. But when the value at risk (VaR) measures began to pop upwards (tail risk) in 2008, it was no laughing matter. My views on the Rupee (MUR) and on Mauritian stocks have been fairly constant since early last year. Unless you have a long term view (more than 5 years), you should be in cash and in FOREX. For those with longer term investment horizons, buying on the dips is the only viable play at this point and even there, you need to go in at the speed of a turtle.

Professional traders can look at pairs trading opportunities. I have also been very negative on commercial real estate, especially commercial real estate fund investing in a sector that is characterized by unattractive rental yields relative to long term bond yields, captive real estate funds and highly optimistic valuations and Internal Rate of Return figures in general. We are still waiting for the Central Statistics Office (CSO) to set up a real estate index.

If one is to chart the SEMDEX, the broad-based index of the Stock Exchange of Mauritius, one must first look at the evolution and the outlook on the Rupee. When foreigners sell stocks en masse to exit the island in an environment where the supply of FOREX continues to tighten, you do not need to be a financial guru to realize that the outlook for anything Mauritian is not stellar. If foreigners want to buy Mauritian stocks, they will have to buy Rupees first.

As at mid February, net outflows by foreigners (year to date) stood at the tune of MUR 127.6 million! The MUR/USD exchange rate has been breaking its 40 day highs on a consistent basis as both short and longer term momentum have continued to increase. The divergence index has continued to point towards selling Rupees on any pullback. The 10 day moving average crossed the 40 day moving average weeks ago and remains in bearish territory. The dollar has also strengthened versus most major currencies in recent months as investors have fled to the perceived safety of the greenback.

The outlook for the Rupee remains uncertain with only weak evidence of trend exhaustion at Rs34/USD (selling) detected. There is no reason to call a bottom on the Rupee so far based on such weak technical evidence.

Foreign investors want to avoid countries with high current account deficits, near zero or negative balance of payments outlooks, low productivity growth rates and countries whose central banks are controlled by politicians and lobby groups via an almost incompetent Monetary Policy Committee (MPC) that is made up of more accountants than real economists. Some may argue that the differential continues to favor holding onto Mauritian assets but the fact is that risk premiums are not constant over time and if you had followed that high differential argument, you would have lost a lot of money.

In this current environment, investors have more confidence in the near zero interest yielding dollar than on the 6.5% yielding Rupee. If policy makers want to reduce volatility, then they need to at least maintain the differential as is, something I had mentioned months ago. But then again some do not like to listen or prefer to revert to the “competitive Rupee” or “cost of capital reduction” arguments.Besides, the lobby groups want rupee depreciation and push for it as it artificially boosts accounts of exporters and hotel groups.

Banks are expected to continue to favour holding onto treasuries rather than lending it in this uncertain environment and hence short term and medium term bond yields are expected to continue to face downward pressure, which is why risk premiums and expectations of where the differential will be impact the exchange rate as explained above!

The Finance Minister has also already talked about how there is “more room” for further monetary easing to the Joint Economic Council, the mother of all lobbies, recently despite the fact that officially the MPC of the “independent” central bank has yet to meet or even debate the issue. I think that we all know where interest rates are going over the next two MPC meetings and unfortunately this expectation is more based on politics and the control that the lobby groups have on the media and election financing than on the “ambiguous” inflation outlook.

When the Governor of the Bank of Mauritius (BoM) dared to point out his views on interest rates and inflation in 2008, media articles about his administrative skills suddenly appeared on a weekly basis. Now that “the King” has backed down due to political pressure, these articles have also disappeared. If you are looking for correlation in Mauritius, just look at the amount of articles about export sector difficulties that appear before an MPC meeting and the interest rate decision that tends to follow! I cannot possibly be the only one to have noticed that interest rates tend to go down after Mauritius Exports Association meets with the BoM!

To be continued

By Sameer Sharma

Sameer Sharma is a Canada-based financial analyst.

First published in Conjoncture, a Bilingual journal of PluriConseil

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