OVER the past few weeks the local equities market has flatlined coming off the strongest bullish run seen since the global economic recession. Since the start of the year, the Jamaica Stock Exchange (JSE) Main Index surged seven per cent or 5,465.41 points to 88,787.37 points up until May 6, 2010, before slightly pulling back and falling two per cent in the last four weeks.

When compared to a total gain of only four per cent in 2009, the performance so far this year is impressive. The current slowdown is in part due to the dampening of investor confidence given the recent volatility on the island and lower than expected quarterly earnings reports.

Additionally, as we approach what is historically known as the summer “doldrums” for the Jamaican stock market, investors are sitting on the sidelines as they carefully observe the aforementioned happenings or speculate by selling prior to the season. Notably, when compared to 2009 and 2008, buyers have been present even with large volumes traded on the local market.

Favourable investment conditions, specifically, the low interest rate environment are expected to continue to stimulate economic growth and foster market participation. The continued decline in interest rates up to this point that spurred an uptick in the local stock market continues to keep investors on the buy side for local equities.

Last Friday, the Bank of Jamaica (BOJ) continued its plan to lower rates, reducing the interest rate payable on its 30-day Certificates of Deposits (CD) by another 50 basis points to 9.5 per cent from 10 per cent, or an after-tax yield of 7.125 per cent. This follows the Central Bank’s previous announcements in December 2009, when it reduced its benchmark interest rate by 200 basis points and by 100 basis points in September. Last year, the BOJ cut its benchmark interest rate by a cumulative 650 basis points.

The latest example of the stock market’s reaction to reduced rates can be seen with the completion of the Jamaica Debt Exchange (JDX) on February 24, 2010, when the average yield on Government of Jamaica (GOJ) JMD denominated bonds fell to 12 per cent from 19 per cent. A direct consequence of this was a renewed interest in the stock market, as investors accepted that the high interest rate environment which they previously enjoyed could no longer support economic growth.

Not surprisingly, the JSE Main Index has risen by a convincingly 11 per cent since the completion of the JDX, indicating a vibrant and healthy stock market is brewing. Since the start of the year the demand for blue chips has been robust, with stocks like GraceKennedy Ltd (GK) and Pan-Jamaican Investment Trust Ltd (PJAM) hitting multiple 52-week highs.

Translating the effect of this into dollar value, if an individual had purchased 1,000 units of GK for US$45.01 per share the day the JDX was finalised, they would have had a gross return on investment of 44 per cent or US$19,990.00. Similarly, Carreras Ltd (CAR) jumped 20 per cent during the same period to US$50.01.

The result of reduced interest rates has not only restored interest and increased participation in the local stock exchange, but has also set the platform for sustainable growth for firms as well as for the economy. Notably, since March the appreciation of the Jamaican dollar has been a welcomed change and can be viewed as a step in the right direction. Since the JDX, the Jamaican dollar has strengthened against the US dollar, appreciating by 3 per cent to US$87.27 (as at June 8, 2010) from US$89.77. The revaluation of the local currency is partially driven by reduced demand for US dollars as the GOJ was able to lessen its USD denominated debt payments through the JDX programme.

So what does an appreciating dollar mean for investors? For one, it leads to a less expensive energy bill for the companies listed on the stock exchange. In the statements accompanying financial results, Chief Executive Officers across industries have been citing reduced foreign exchange gains in addition to high energy costs as the primary drivers for soaring expenses. For example, Kingston Wharves Ltd (KW), stated in its most recent statements for its first quarter ended March 31, 2010 that operating profit for the company fell 39.09 per cent due to a “reduction in exchange gains on assets, increased cost of fuel and electricity”.

Therefore, with the unit cost of oil becoming cheaper this should translate into bottom line gains. Additionally, for companies that import their inputs, they will now require fewer dollars to produce the same quantity of goods. Secondly, currency stability, or an appreciating dollar is an attractive characteristic for investors looking to diversify their portfolio with local equities. Typically, investors tend to shy away from equity investments due risks of JMD devaluation.

The effect of lower interest rates will also support a more active credit market. With the price of credit becoming more affordable, companies would be better positioned to expand existing operations, thereby boosting their earnings once demand justifies. Furthermore, entrepreneurs will be encouraged to borrow funds to facilitate start-up businesses as the credit markets permit.

As we have seen across the globe during the economic recession, many governments lower interest rates in an attempt to stimulate economic growth. As this strategy usually proves successful, it may increase the risk of higher inflation if rates were to remain too low for an extended period of time. As a result, the BOJ is carefully monitoring the movement in inflation and released the following statement:

“Inflationary impulses, particularly those related to recent tax measures, have abated, while the prices of key imported commodities, especially oil, have also moderated. These developments are moving the likely outturn for inflation in FY 2010/11 towards the lower end of the forecast range of 7.5 per cent to 9.5 per cent.”

Therefore as inflationary pressures ease the BOJ will be able to maintain its low interest rate stance. Furthermore, the Central Bank has also reaffirmed its economic growth forecast for the current fiscal year.

All in all, this means improved news for the local equities market and the economy.

Juvenne Yee is an Equity Trader at Stocks & Securities Ltd. You can contact him at srobinson@sslinvest.com.