As the pendulum swings, so moves the herd. Market cycles are invariably the result of the behaviour of the majority of its participants in similar and unplanned fashion.
What prompts humans to do that animal thing is debatable, but an important factor is risk dilution. It is reasoned that if one makes the same un-coordinated decision as the majority, then the probability of that individual experiencing losses is less. On the other-hand the higher the number of participants the smaller will be the individual share of the prize.
Although the herd is unstructured, there may be one or two participants who are imitated by the others and it is they that will benefit from the first mover advantage; herein lies the contrarian approach.
Investment options in Jamaica
The aim of the rational investor in normal times is the maximization of returns, at other times its preservation of capital. “Old money” at all times is concerned with the latter, and possibly so because they have a much longer time horizon and certain asset classes have been proven to consistently achieve that objective.
The following classes of investments will each be considered in detail below:
1. Government Paper
2. Entrepreneurship
3. Real Estate
4. Foreign Exchange
5. Stock Market
Government Paper
Old habits die hard, and so it is for those investors that grew up on interest income in the 1990s. Back then, nominal return ran as high as 60% p.a. and real return was highly positive. Today, real return on government paper is negative but successive issues are over-subscribed. An interesting thing about it is that the tenor of these instruments is much longer than in earlier times when interest rates were higher.
What motivates investors to behave so irrationally is beyond me, as inflation will likely persist at double digits for the foreseeable future. The herd has moved on but these renegades remain, chasing the mirage.
Entrepreneurship
The last major wave of entrepreneurship happened in the 1980s when the thing to do was trading. Professionals and unemployed alike became higglers, first as importers and later they pioneered the export of several indigenous products. Some of the few that survived the imposition of tariffs and the high interest rate regime have transitioned into the formal sector.
The economic environment and social decay over the last three decades, does not foster the nurturing of small start-ups. Venture capital is absent and the financial intermediaries have lost the little appetite they had for granting un-secured loans. The cost of security is prohibitive, making new entrepreneurs sitting ducks to gun-totting youths.
Those that brave the odds, find it difficult to sell their fledging businesses to established players and entering alliances with the latter is perilous; their financial power will deprive and deny any share of the venture. Rather than buy a good prospect, the tendency is to copycat and replicate. The few start-ups that grow into something meaningful is stunted by selfishness, they seek loan rather than equity and very often misses growth opportunities due to inadequate funding and poor management.
It is clear what leads the majority to become lifelong employees when an employee and an entrepreneur bear about the same amount of risk, but unequal reward. The education system is partly to blame as it is tailored to churn out conformists and not thinkers. People who sell the most powerful factor of production at the lowest price and for praise and promotion, so at the next round they can offer more at still lower prices, while they struggle to keep their heads above the proverbial water.
Someone once said, the majority is seldom right. And it is general knowledge that it’s the minority that controls the majority of the wealth. From the list of the 10 richest men of all times, two were kings and 8 entrepreneurs.
Real Estate
Acquiring real estate is the lifelong dream of most individuals and likely their single largest monetary transaction ever. The ability to finance it through a mortgage presents an important leverage to the homeowner, for as the property value rises and the loan balance falls equity is freed-up for other investments.
Unfortunately, the majority of real estate transactions are for home ownership and not income generation. Most homeowners are in undue haste to pay-off their mortgage, they don’t want to owe for it. In other words they want to be mortgage free, without recognizing that they will bear all the risk of ownership. Also, the financial discipline that is required to maintain a mortgage could lapse and that money end up going into consumption.
Jamaica’s real estate market has gone unchecked for far too long. Except for a period in the 70s, prices just keeps going up and people are of the notion that it will always be that way; they argue that the amount of land is not growing so the price must increase.
Following the stock market collapse in 1993, very much the same thing happened. Investors who were fortunate enough to escape the slaughter went into real estate only to see prices languish, this time it’s a different ball game. Prices were at astronomical levels before the 2005 stock market slump, add the level of crime to the mix and it becomes a lot more difficult to justify. The disruption to the criminal network by the security forces, and especially the killing of “Bulbie” will resonate in property prices as relatives and associates try to disaggregate assets to avoid confiscation.
Home ownership is consumption not investment, so if the real value increases over time, count your lucky stars and don’t bank on it. Since for most people their home is their most valuable asset, in later years they will become financially exhausted. There is however a unique innovation waiting for people with this mindset, it is called a “reverse mortgage”. When they retire and have no income, they can either live out their days in financial distress or commit the property for mere subsistence.
Foreign Exchange
Worldwide, bad governments dislike the idea of its citizens holding alternate currencies yet it offers one of the best protections against inflation and taxation in the short run.
In early 1978 the Jamaican dollar slipped to par with the US$, by the end of 2004 it took Ja$61.63 to buy the US dollar. In the same period cumulative inflation was 11,621%, compared to an exchange gain of 5,769%.
To the man on the street, a regular passbook savings account is the norm. As a more sophisticated investor, one moves into government paper. Both are losers nonetheless, and the investor would be better served to either save in a foreign currency account or purchase foreign currency bonds (not recommended). This all assumes that this is the portion of a persons saving to meet the liquidity motive.
Pertaining to currency depreciation, the one good thing about it is that a currency cannot lose a hundred percent of its value, but in the long run it is a poor protection against inflation. What therefore accounts for Jamaicans affinity to the US dollar is one of those mysteries!
Stock Market
After five solid years of performance, the raging bull is now deranged. During the second half of 2004, historical P/E ratios started approaching levels not seen since late 1992: it could not be justified on future earnings, so by the time Q4 results rolled-in in mid February’05, overblown stocks started losing value.
In 2004 the herd came trampling, pushing 85% of the stocks into positive ground with the said 85% yielding real return. As expected, the herd is now on their way out, sparing nothing in its wake. The index will likely close the year 2005 down over 15%.
A case in point is Lascelles DeMercado: In January 2004 the stock was trading under $70 with few takers while the benefit of the massive capital expansion worked its way into efficiency. The argument at the time was that the stock was too expensive, but by the time the 2003 year-end results hit the street, the crowd rushed in oblivious to the fact that the company trades historically around six times earnings. They there managed to heighten the price of the stock to peak at over $370; now there is a distinct possibility of the price falling to a reasonable $165 by the end of December’05.
It is said that timing is everything and so it is here. The market will not have a broad run in the 1st Quarter of 2006 and could remain in the pits into 2008. During that time there will be good buys, as even now some stocks have hit bottom, example Pegasus and Freeport.
With all the market gyrations since 1978, the index is up a tidy 228,503%, almost twenty times the rate of inflation. I think it is appropriate here to borrow the maxim- “buy, hold and prosper”.
