With due respect to James Carville, but ever since he coined the winning campaign slogan, ‘It’s the Economy, Stupid’ when he was the campaign manager in charge of Bill Clinton’s 1992 US presidential bid, several commentators have rephrased it to emphasize different themes and view points. Borrowing a leaf from Mr. Carville it has become necessary to re-coin his catch phrase with some assist from Alan Greenspan, the former US Federal Reserve Chairman, as a basis for assessing the true state of the Nigerian capital market.
Last month, the Stock Exchange’s Director-General, Ndi Okereke-Onyuike, tried to shore up investor confidence in the capital market when she told international investors at a forum in London that return on investment in the Nigerian market was one of the highest in the world. According to her, returns were as high as 400 per cent making it an attractive investment destination for hedge funds and institutional investors. The Director General was absolutely right.
The Nigerian capital market has consistently posted impressive results in the last couple of years, and has continuously bucked market trends particularly during bear runs and market corrections in other parts of the world. For instance, year to date indices for the first half of 2007 show that the All Share Index (ASI) rose by almost 54 per cent to 53,336.46, while market capitalization hit N7.8 trillion by the end of June, representing a gain of almost 80 per cent from the beginning of the year.
Investor confidence in the market has been buoyed by strong demand for stocks in mostly the banking sector, which by the end of last month accounted for 45 per cent of market turnover. This is in spite of the fact that dividend yields in the banking sector were far below the market average. The building and construction sector has also enjoyed a good rally on the back of macro-economic variables and an anticipated huge infrastructure spend of N1.5 trillion by the Federal Government between 2007 and 2008 which should give cement manufacturers extraordinary potential for increased revenues.
Also, isolated stock price gains made by Dangote Sugar Plc after an initial public offer, UBA after its hybrid offer and an anticipated First Bank rally once the technical suspension is lifted on its share price following the collation of returns on its N100 billion offer, will push the market to new record highs before the end of the third quarter. The resultant effect is that the massive capital gains posted in the market has attracted a deluge of investors who want to cash in on an unbelievable rally before it bottoms out. Hang on a second. Did I just predict gloom?
Yes I did, because in spite of Okereke-Onyuike’s rosy outlook, the Nigerian stock market is bound to bottom out in the months ahead because the fundamentals just do not add up. First and foremost, a capital market cannot be isolated from the environment in which it operates. The market, according to Financial Derivatives Company, an investment and economic and financial advisory firm based in Lagos, was by June ending trading at 43.67 times earnings, which when factored against real or nominal GDP forecasts for the year of some 6 per cent, does not justify the stock market rally. Second, dividend yields on actively traded sectors like banking are on average falling because their earnings relative to share capital are weak. In fact, with dividends yields in the market falling to an estimated 3 per cent (as against bond yields of 14 per cent), this should make a stock market plunge inevitable as investors will begin to look for more attractive avenues in which they can invest their funds.
Of greater worry is the fact that most stocks have become overvalued due to market manipulation by operators, excess money supply and irrational exuberance on the part of investors looking to make quick gains from the capital market. If truth be told, most of these investors are speculators, as opposed to long term investors, who are by nature fickle and just want to make huge capital gains before cashing in on their shares once there is any sign of instability. Investors in this category are mostly made up of international hedge fund managers who have been bringing in ‘hot money’ (it is estimated that hedge funds have invested some $4 billion in the Nigerian capital market since 2006).
However, hedge funds will normally be the first to make a run for the exit once there is any form of instability, a significant policy flip flop or in the event Nigeria suffers a sovereign-risk downgrade. For them, they would not lose sleep over Nigeria because their investments here account for an infinitesimal part of their portfolio. Yet these same funds constitute a significant chunk of the NSE’s market capitalization, and if withdrawn hurriedly to safer destinations, could portend a bad omen for the market.
In addition to hedge funds are Nigerian speculators who have been borrowing huge sums of money from banks to invest in stocks. Presently, it is estimated that speculative trading being funded by borrowed funds has risen to 85 percent. And although the banks that are lending the funds are holding onto the share certificates as collateral, the snag is that if there is a systemic default on the part of borrowers, banks will be compelled to sell the shares to recover their funds. If this were to happen, selling the shares will become a self fulfilling prophecy as prices are bound to crash.
Already, the Central Bank has read the writing on the wall by expressing concerns over the level of margin that is available to speculative investors and is preparing to sanction banks that have been financing margin trading in the stock market. The National Pension Commission (Pencom) also recently disclosed that it intends to scrutinize Pension Fund Administrators’ compliance with investment guidelines and portfolio composition to ensure there is no overweight in equities investment.
It is quite apparent that the Nigerian capital market may be heading for an imminent market correction of sorts. Whether the correction will take the form of bear run for a prolonged period or a fast and furious crash is still subject to debate among market analysts. What is not being debated is that share prices in the Nigerian market are generally overvalued and cannot be justified when subjected to any form of analytical rigour. Concerns also continue to abound that the overstatement of its financial accounts by Cadbury Nigeria Plc may not be an isolated case, and that there could be other major blue chip companies buried in concrete. Should information sip into the market that other companies have been trading on false information the market is bound to take a massive hit.
The consequences of a financial market melt down and its systemic consequences especially in the banking sector need not be repeated on this page. What we have today is a stock market bubble that has been kept afloat under the wrong assumptions. Regulators would need to step promptly with all sense of responsibility to ensure it does not happen. The market must be protected from ignorance, market manipulation and pervasive irrational exuberance which have taken hold of investors. The Nigerian market remains an exotic one and unfortunately does not have the circuit breakers that have been introduced in more mature markets to stem a free fall. As Mr. Rewane Bismark, CEO of Financial Derivatives Company, during a presentation on the state of the Nigerian Economy at the Lagos Business School three months ago warned: “Don’t be long and wrong.”
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