Over the last week, the Tehran Stock Exchange (TSE) index fell 13 percent after breaking record after record despite the dire situation the Iranian economy has been facing since 2018. In New York, London, Frankfurt, and Tokyo, the coronavirus pandemic and associated turbulence pushed major stock indices off their peaks. Yet the TSE index has continued to surge, even though Iran has to contend not just with a worsening outbreak of COVID-19, but also high inflation, negative growth, massive depreciation of the national currency, shrinking reserves, falling exports, and a rising trade deficit.
The TSE is the only part of the Iranian economy that appears to be thriving, with an extraordinary 421 percent nominal return until its recent wave of correction, following 134 percent in 2019, and 69 percent the year before that. Despite a third consecutive year of recession, driven in no small part by punishing U.S. sanctions, the TSE has witnessed exceptional returns across all classes of stock.
The question facing Iranian investors is not whether there will be a major correction, but when. Today’s astronomical valuations reflect the narrowing of investment options and major increase in the money supply at a time Iranians are seeking refuge from a collapsing currency and an annual inflation rate in the mid-thirties.
Both high inflation and a declining currency mean that those who hold cash lose money at a very rapid pace. Iranians are thus looking desperately for assets that hedge against this risk. Considering the country’s overall economic chaos, especially in the job market, Iranians also want assets that are liquid. The TSE meets these criteria.
The regime’s economic policy has limited the appeal or availability of three other investment options—bank deposits, foreign exchange, and precious metals—that might be attractive for those seeking a liquid hedge. By forcing banks to pay interest at a rate below inflation, the government ensures a real decline in the value of deposits. The consistent prosecution of currency traders and investors has made it extremely difficult to invest in foreign exchange. The government’s continuous interventions in defense of the rial also render the currency market a less reliable and less than fully liquid hedge. There is a similar pattern of intervention and intimidation in the precious metals markets, although with a lower intensity.
A useful long-term hedge, the real estate market has also suffered from Iran’s multi-year recession. The market is not very liquid by nature and the recession, high prices, and diminishing purchasing power of the population have made it even more illiquid. For those few who can afford to invest in real estate, cashing out is immensely difficult and may require a huge discount. Consequently, the stock market is offering a better option, not just to those who need a short-term liquid hedge, but even to long-term investors. At this point, investing in the real estate market makes more sense just as a diversification asset for high net worth investors.
While investment options have narrowed, there has been a massive increase in the money supply over the last few years. The regime is rightly worried about the consequences of a gigantic and sudden injection of this liquidity into the currency, precious metals, shadow banking, or real estate sector. This kind of wandering liquidity, searching for a hedge against inflation, has hit various markets over the last few years, causing significant economic turbulence. For example, wandering liquidity hit the currency market in 2018, driving the rial-to-dollar exchange from 40,000-1 to 190,000-1 from January to September. This kind of turbulence may lead to political unrest, to which the regime responds with violence, further weakening its legitimacy among the population.
The stock market provides a partial answer to the problem of wandering liquidity, since it can direct that liquidity to funding corporate investment while share prices rise in expectation of future cash flow. Since the regime is in the process of privatizing assets via the TSE, additional liquidity also helps to narrow budget deficits by raising the value of the assets to be privatized. In fact, Tehran announced that in just four months, its revenue from privatization surpassed the expected total revenue in the budget for the entire fiscal year. That is why, the government has encouraged and guided wandering liquidity toward the stock market, leading to an unprecedented real return.
However, in the midst of multiyear recession, it is unlikely that this injection of liquidity into the TSE will spur real growth and higher earnings. Rather it is inflating a bubble as prices diverging more and more from the shares’ underlying value. Up to a point, prices can continue to rise as long as the government grows the money supply and encourage investment in the TSE. But once that point is reached, investors will begin to flee as they anticipate a collapse. The downward spiral can be too rapid for the government to stop, the market will become illiquid, and many will lose their life’s savings.
The question is not whether there will be a significant correction in the market or not. There will be. The question is whether the government can decrease the velocity of the fall to soften its impact on the economy and shareholders. In other words, will we see a crash followed by a bear market or the market will land into a bear territory without suffering a crash? The recent correction in the market is most probably not the end of the bubble in Tehran Stock Exchange as the underlying conditions that inflated the market still exist. However, investor should see it as an early warning that the unstable bubble in the market can suddenly turn on them and wipe off all their gains.
The opinions expressed by the authors do not necessarily reflect the views of Radio Farda