“Navigating market uncertainty: Strategies for investor

THE saying “Il rischio deriva dal non sapere cosa stai facendo,” meaning “Risk comes from not knowing what you are doing,” perfectly encapsulates the market dynamics observed from September 9th to 13th, 2024.

During this time, the market revealed important clues about investor sentiment, risk tolerance and the wider economic context. By examining these patterns through the lens of economic theory, we gain a clearer picture of the forces shaping the trends and behaviors seen throughout the week.

Market Fluctuations

Equity turnover fluctuated during the week, reflecting shifts in investor confidence. Turnover was 322.23m/- on September 9th, surged to 742.74m/- on the 10th, peaked at 1.11bn/- on the 12th and dropped to 276.81m/- on the 13th.

According to the Efficient Market Hypothesis (EMH), these fluctuations suggest new information entering the market and quickly influencing stock values, such as the block trade of 100,000 NMB shares on September 10th.

The sharp decline in turnover by September 13th may indicate that the market had adjusted,although it also suggests potential inefficiencies, as volatility persisted, possibly due to speculation or noise trading.

Risk Aversion

The noticeable shift in investor behavior towards bond market investments, particularly government bonds with high coupon rates, reflects a strong risk-averse sentiment. Bond trading was significantly higher than equity trading throughout the week, particularly on September 12th, when 42.57bn/- worth of bonds were traded. Long-term government bonds with high yields (15.95 per cent on a 25-year bond) were in high demand, with investors locking in these bonds at prices up to 114.78 per cent.

Behavioral Finance explains the shift toward bonds through loss aversion, where investors prioritise avoiding losses over gains. The high demand for long-term bonds indicates a focus on preserving capital and securing stable returns over riskier equities.

Prospect theory further supports this, as investors prefer the certainty of bond yields, especially in uncertain markets, even if equities offer higher potential returns. The perceived safety of bonds outweighs the risks associated with volatile equity investments.

Modern Portfolio Theory (MPT)

The consistent trading in both equity (particularly in banks like CRDB and NMB) and long-term bonds suggest a Modern Portfolio Theory (MPT) approach by investors, seeking to balance risk and return. MPT posits that investors can minimise risk by diversifying their portfolios across amix of assets with different risk profiles.

The focus on blue-chip stocks like CRDB and NMB, alongside long-term government bonds,reflects diversification aimed at reducing portfolio volatility.

The banking sector, known forstability in growing economies due to strong fundamentals and predictable earnings, attracts investors.

The demand for high-coupon bonds suggests investors are hedging against potential stock market declines, aligning with Modern Portfolio Theory (MPT), which advocates for optimising returns by diversifying across asset classes to manage risk.

ALSO READ: Beyond the yield curve: The Tanzanian investor’s appetite for stability

The Fisher Effect

The high demand for long-term government bonds with substantial coupon rates (15.95 per cent) can also be explained by the Fisher Effect, which posits that nominal interest rates reflect the real interest rate plus expected inflation.

Given the relatively stable inflation and exchange rates observed during the week, investors might have viewed these bonds as particularly attractive

because they offer yields significantly above the expected inflation rate.

The Fisher Effect suggests that these high coupon rates likely reflect a premium for future inflation expectations, but with inflation appearing stable based on exchange rate behavior, these bonds present a favorable return for investors seeking to outpace inflation over the long term.

This could explain the trading activity in bonds on September 12th, with a 25-year bond being traded at prices as high as 114.78 per cent, reflecting strong demand for instruments that hedge against inflation risk while providing consistent returns.

Exchange Rate Stability

Throughout the week, exchange rates remained stable, with the US dollars buying rate between 2,674/92 and 2,680/72 and the selling rate between 2,701/67 and 2,707/53.

According to Purchasing Power Parity (PPP) theory, this stability suggests alignment between inflation rates in Tanzania and its key trading partners, like the US and Europe.

This stable exchange rate reduces concerns about currency risk, supporting investor confidence in both equity and bond markets and enhancing the appeal of long-term government bonds by minimising the risk of currency depreciation.

Investor Confidence in Banks

The strong trading volumes of financial stocks like CRDB and NMB can be linked to Keynesian Liquidity Preference Theory, which suggests that in uncertain times, investors prefer liquid assets.

Banks, central to providing liquidity, are seen as safe investments. Investors likely view CRDB and NMB as reliable due to their strong fundamentals and potential to benefit from future government stimulus or infrastructure investments, which could increase loan demand and enhance their attractiveness.

The Tanzanian market reflected a cautious optimism, with investors favoring long-term government bonds while holding strong financial stocks. Their approach prioritised risk reduction and inflation protection, seeking steady, reliable returns over short-term, high-risk gains thus echoing the saying, “Slow and steady wins the race,” and highlighting their preference for stability and security.