Meristem Securites prepared a good analysis on the current state of the NSE where the stock prices have been sliding continuously. Read below:
State of the Nigerian Stock Market & Options for Investors
The state of the Nigerian stock market brings to fore the strong reign of bearish mood and the general perception of a falling market. A bear market is defined as a period when the stock market falls for a prolonged period of time, usually by 10-15 percent or more. In the last 3 months, The Nigerian Stock Exchange All Share Index (ASI) has shed about 15 percent and currently falls below its All-time High of 66,371.20 points attained on March 5, 2008 by 22.2 percent to 54,328.21 points.
Market Capitalisation of quoted equities has equally slumped by 19.2 percent to N10.6 trn from the All-time historic peak of N12.64 trn, i.e. about 2.036trn has been lost in just six months from December till date. This has been the experience so far despite the jump in the number of listed equities to 222 from 215 as of March 2008 and additional shares listed resulting from Public Offer, Rights issue, Private Placement and script issues of companies.
Sharp decline in stock prices is perceptibly attributable to an array of causative factors such as harmonization of banks year end, directive on margin facility/trading, primary market activity, hike in money market rates and correction of market overvaluation (i.e., stocks are too expensive and are falling to more reasonable levels) amongst others.
Investors who are scared by the current stock market situation and subsequently got fascinated by upward movement in money market rates due to a sudden change in monetary policies, amongst others; sell down their stocks portfolio, causing further dips in equities prices. This has heightened the fears of portfolio diminution, and has led to panic selling in the market causing many investors to worry about losing their entire investments. This bandwagon scenario largely captures the prevalent situation in the Nigerian capital market.
Falling stock prices are sometimes a hard pill to swallow but long-term value investors should not be perturbed. Many investors have a hard time dealing with falling stock prices most especially margin traders who are caught in the web of bearish run. No matter how often you preach the virtues of the buy-and-hold method, the true test of courage comes when investors watch their holdings nosedive 5 percent consecutively for weeks without any end in sight. Anyone who has experienced a bear market knows that it takes tremendous discipline and dedication to stick to one’s guns while everyone else liquidates their holdings.
We believe that the Nigerian capital market has been plagued by the aftermath effect of correction, regulatory directive on harmonization of the banks year ends, monetary policy change, economic and political uncertainties, amongst others. These factors have combined to create a dreadful scene in the much-celebrated Nigerian stock market resulting in chaos, misconceptions and faulty logic. In what follows, we attempt a review of the causative factors responsible for the current downturn and options available for investors and stakeholders alike.
Primary Market Effect
There is no gainsaying that activities in the primary segment of the stock market have a tremendous impact on secondary market performance and vice-versa. The recent tide of events reaffirms this assertion as all market participants are witnesses to the recent shift of focus to the primary market in search of cover and comfort by investors of all classes. There is an investment psyche, especially in the Nigerian investment environment, that wealth is more preserved in the medium to long term by investing in Public Offers and Private Placements rather than playing active speculative role in the secondary market. The proposition becomes more genuine when secondary market activity reclines and the previous gains during the bullish run are partly or completely eroded within a twinkle of an eye.
The relationship in activity level between the two components of the stock market –primary and secondary markets - has always been of inverse nature when there are no any exogenous factors. This is evident by the fact that companies accessing the primary market for fresh funds usually consider the timing as one of the critical success factors for the new issues.
In the same vein, during the bears reign, activities in the primary market also stifle liquidity from the secondary market as investors dispose part or all of their holdings to take positions in Public Offers or Private Placements with a view to preserving their wealth at least. Recent events in the Nigerian Stock Market confirm this behaviour. Quite a number of companies have harnessed the primary market via placing of their shares while a couple of others are still on-going or about to open.
This has drained liquidity in excess of N500bn from the secondary market since January till date. However, the recent regulatory pronouncement by authorities of The Nigerian Stock Exchange in respect of Private Placements suggests the usual surge in price of newly listed stock may not recur.
It will be recalled that The NSE recently stipulated that henceforth company’s shares offered by way of Private Placement would be listed at the Placement price and that 5 percent of these shares would be made available on the Listing day for trading purpose from now till August 31, 2008 after which this becomes 10 percent.
Similarly, there seems to be a change in the market rationale concerning the usual vagaries that trail Private Placement as market participants change their investment pyshe to new realities in the market.
Monetary Policy Effect
The current restrictive monetary policy stance of the Central Bank of Nigeria (CBN) is not unconnected with the need to curb the surge in inflation, which has risen from 6.6 percent at the beginning of this year to 8.4 percent in April. With the deployment of two policy instruments of cash reserve requirement and the upward adjustment in interest rate, the apex bank seems unswerving at maintaining the macro objective of taming inflation rate within a single digit band.
As at last policy pronouncement, the reserve requirement was shored up from 3 percent to 4 percent while the Monetary Policy Rate (MPR), the minimum rate of interest the CBN charges banks for credit facilities, was reviewed upward by 25 basis points from 10 percent to 10.25 percent. Given the intricate link between the trend of monetary policy variables and the mood of the financial market, the current insipid nature of the stock market becomes explicable by the feedback effect of monetary policy pronouncement on the liquidity positions of both the money and capital markets.
The basis for the above stance draws its strength from the fact that the transmission mechanism of the effect of interest rate adjustment works through the financial market by curtailing credit expansion. This poses liquidity freeze as the cost of fund increases. This is consistent with the original intent of the policy. However, the appalling impact of this, among other factors, on the stock market is much more pronounced given the peculiar nature of the Nigerian capital market in which the greatest proportion of participants ride on short term or momentum trading. Besides, the resulting investment attraction in the money market provides an alternative investment window to the seemingly less attractive stock market returns. This crowds-out liquidity in the stock market.
Margin Trading Regulations
Margin is a means of trading in the traditional equity market by borrowing money from your broker to buy equities and using such an investment as collateral. Traders generally employ margin facilities to own more stocks without fully paying for it.
The huge volume of margin trading in the Nigerian capital market in recent times has increased stock market activity and improved liquidity, increasing investors’ purchasing power thus effectively enhancing price elasticity with profound effect on secondary market pricing mechanism.
Much as margin trading is a common strategy the world over, there has been a heated debate on the effectiveness of margin regulations and on their influence on equity prices. The consensus however is that margin trading has an influence on stock price volatility and hence the overall health of the market. As a result, developed and many emerging markets alike usually evolve regulatory framework to control the practice of margin trading. This usually involves guidelines relating to the nature of marginable securities (securities that qualify for margin), interest rate on margin loans, (since brokers outsource margin credits as risks to third parties), margin calls (since calls have the natural tendency to create a selling pressure with attendant downturn in major market indices).
Margin trading has become an issue in the current stock market debacle in Nigeria due to the absence of a coherent and strict regulatory mechanism governing the practice as obtained in other markets. This has led to the arbitrary margin calls by banks to shore up their balance sheets as their uniform year-end deadline approaches. We are of the opinion that margin trading system is a practice globally.
It acts as a lever to ensure market liquidity, stimulate and further deepen the capital market activity. However, we advocate for its regulation and control for greater effectiveness and market efficiency.
Banks’ Year-end Effect
In order to promote a level playing field and provide a basis for assessing banks and juxtaposing their performances at the same date, and of essence, knowing the true financial state of each of the Banks; the CBN recently issued a policy directive that banks should adopt a uniform year end as from December 31, 2008.
In compliance with internationally accepted accounting practices, it is expedient for Nigerian banks to report to a similar date in order to allow for comparison with their peers across the globe. This is also in furtherance of the banking reformation exercise heralded by the consolidation policy in 2005. Industry experts opine that adopting a uniform accounting year date may reduce the possibility of creative accounting and window dressing in which some banks do interbank transfers to boost their financial position as at the reporting date.
Following this directive, banks now race for deposits to buffer their financials prior to the December 2008 deadline. In order to attract sufficient deposits, banks are being constrained to increase interest rates. This has also led to the unsalutary state of the market as investors run for safety by cashing out of the secondary market to the money market to take advantage of the current attractive rates. Early margin calls and possible refusal to grant more margin facility towards year end are likely factors that may continue to mop up funds from the capital market.
Trends in the Global Capital Market
Current experiences across global capital markets show trend similar to the Nigerian situation. The Chinese stock market sank to a 13-month low in April 2008, now stocks have gone even lower, and there is no sign of a recovery. The US S&P Composite Index has shed 6.38 percent in the last one month and 10.02 percent in the last 6 months while the Hong Kong Hang Sang Index has shed a whopping 17.5 percent in 6 months till date.
Options for Investors:
The contrarian thinking has long, lofty and illustrious underpinnings. The treasure trove of contrarian behaviour lies in acting against the tide. It espouses the notion that most investors are too emotional reflecting their herding instinct unconsciously forcing them to drift with the trend. The crowd has the tendency to latch on to an idea and carry it to an unjustified extreme. Except for a miscalculation of the bottom of the market, the contrarian idea, in the quest for bargain, guides against overhyped, over-extended investments that are ripe for the devastating falls that catch up with most investors.
Since the market is in the dumps, everyone is heading for the exits. This is in line with a general convention in every market world-wide. When stock market is down and the mood is pessimistic, people tend to sell even if there is no specific reason to let go of an individual stock. This common trading mistake costs investors dearly.
When debates about market conditions continue to generate ripples and speculation is high in print and electronic media as well as other public places about an impending doom, many investors dump their stocks in preference for cash or other “safe” investments.
Recent developments in the Nigerian stock market point in a direction where perfectly good blue chip companies would begin to sell for fractions of their true value, despite a lack of change in the long-term economics of their businesses/strategies and very impressive performance valuation metrics.
We advise that investors should not be frightened off a stock just because the overall market is sour. If the fundamentals of a company are solid, a down market like this may suggest a great time to go on a shopping spree for discounted stocks. However, it is very pertinent that investors give more preference to the potential of a company relative to its current share price. This investing approach takes some courage and confidence in one’s ability to distinguish between a stock price depressed by a down market and a stock that is fundamentally flawed.
Share/Save
donne4real | July 11, 2008
