Why is the US capital market booming as the economy flounders?
Asks Chamberlain Peterside, Ph.D
Best amongst equals
The news that Nigerian stock exchange was the best performing market in 2007 must be quite elating to investors. The all-share index appreciated by a whopping 115 percent, trumping all other stock markets in the world, including advanced and emerging markets. If you are in the majority, that doesn’t understand the market or don’t have excess funds to invest this virtually means nothing to you but rather raises some anxiety. Records show that about less than 5 percent of Nigeria’s population actually invest in the market. The bull-run since 2005 has been nothing short of phenomenal; number of listed stocks during 2007 increased by 12, as billions of Naira was raised by companies.
Banks were especially the front-runners in the fund-raising frenzy, some returning to the market several times since 2005 to source additional money, yet each successive stock-offering has been oversubscribed since then, according to published results. This trend has left many people questioning how the market could absorb such demand and post colossal gains whilst the overall economy is lagging. Others simply ponder how long the impressive growth will subsist or why turbulent market conditions abroad and looming global recession, instigated by the US sub-prime mortgage crises is not rattling the Nigeria market.
To be sure, despite relatively high economic growth rate that now trends around 5-8 percent in the last few years, unemployment remains quite high in Nigeria, (even higher amongst the youth in an environment where over half of the population are below the age of 35). Recent report (though debatable) actually indicate that at least 120 million people, out of a population of 140 million are surviving below the poverty threshold, which according to UN benchmark is when people live on less than $1 a day. In comparison, the European Union spends an average of $2 per day on each cow, according to Joseph Stiglitz former World Bank chief economist in his widely-acclaimed book - “Making globalization work”, but that’s beside the point.
The role of fear and greed
Logically, what goes up must come down, rightfully or not some pundits in Nigeria have since the middle of last year been predicting major downturn in the market. As historical evidence suggests, it is not a question of when, but an issue of to what extent or how deep a stock market correction could occur. Aside from technical and fundamental market indices such as economic conditions, price-earning ratio (P/E), dividend-yield and business performance that determines equity values/price trend, the underlying human factor that drives any market (and could result in market correction) is “fear and greed”.
Realistically, the Nigerian stock market has a lot going for it, which might give a false impression to some investors that a cyclical correction will never occur. The economy and indeed capital market in Nigeria has a lot of leg room to grow in the long run, weighed against the backdrop of ratio of the market capitalization to gross domestic product (GDP), which stands at less than 25 percent, albeit rising fast; size of investible assets being amassed by domestic institutional investors (banks, pension funds, insurance companies etc); increased flow of overseas portfolio investment and finally growing interest by local retail investors and Nigerians in Diaspora, who are steadily re-channeling their remittances from Western Union and Money Gram (for consumption) to the stock market (for investment).
As heart-warming as this might sound to bullish investors (optimists), the flipside of this trend is that growth and penetration of new listings, whether stocks, mutual funds or government/corporate bonds is just not keeping pace with the rising-tide of money. This should remind us of the law of demand and supply - when there is high demand (as we see today for securities in the Nigerian market), it results to substantial growth in prices, which doesn’t necessarily reflect the reality or true valuation of the underlying assets. Investors become somewhat exuberant, willing to stake their money in anything at any price. This creates a speculative tendency that drives up price of stocks, especially blue-chips like banks, insurance companies, petroleum and consumer product companies.
Some evidence in the price movement shows that even few moribund stocks are being scooped up by investors with the hope that the companies will turn-around or that someone else will buy the stocks at a higher price - talk about the “greater-fools theory”. The logical conclusion to deduce from this concept is that unsubstantiated high valuations can lead to a meltdown at the slightest chance, resulting in capital flight by investors, especially foreign investors/hedge fund and mutual fund managers to the utter detriment of long-term investors. History of tech-bubble during the early 2000s teaches us that when such deep ruptures in the yield curve occur prices could take a while to recover as fear sets in to scare investors.
Before you jump to conclusion
Before jumping to conclusion that the Nigerian stock market is due for correction soon, it is pertinent to reiterate that fundamentally over the long-haul (as the S&P index chart below illustrates), stock market performance trends higher, (Warren Buffet, Peter Lynch and John Boggle, worlds greatest investors can attest to that), despite any temporary disruptions. Moreso, for a potential emerging market like Nigeria, there is a significant upside that is still up-tapped but hard to quantify. The question is how well and how soon concerted efforts can be taken by policy-makers to harness those potentials.
As a keen observer and investor in the Nigerian stock market, what truly borders me is the obvious disconnect between the meteoric rise in stock valuation/prices and the condition/plight of the common folks/overall economy. The capital market is hardly a domain for the poor guy, but as a platform where capital is accumulated and recycled you would expect that the mass of SMEs and more productive companies could have begun to tap into it, to raise long-term funds and expand operations, thereby creating wealth and employment for the masses.
That hasn’t been the case in Nigeria, at least not yet and that's quite troubling. We have seen repeated stock offerings by banks that often crowds-out other sectors, consequently, there's just not enough diverse quality new companies and listings coming into the market in midst of strong flow of new funds. Financial stocks account for over 65 percent of liquidity and trading volume. That doesn’t make the capital market a veritable growth-engine as it should be. The current situation must therefore be a clarion call for the regulators to make effort and re-calibrate this expansion in the right direction so the benefits can trickle down and the bubble is not short-lived.
Wider measures
In midst of this apparent economic anomaly, I am yet to notice big-bang urgent measures since the advent of this administration, similar to drastic steps that brought about current improvements in the last four years; like the banking consolidation, Paris/London Club debt deal, de-listing of Nigeria from rank of money laundering countries/territories or assigning Nigeria BB- sovereign credit rating that could catalyze growth. We are witness to some recent efforts by Central Bank to continue the aggressive pace of reform that could transform Nigeria into a viable emerging market, which have been either delayed out shut-down outright. Yes, restiveness in the Niger Delta is a serious distraction, but historical high oil prices wont last forever.
Management of Nigerian Stock Exchange, Securities and Exchange (SEC) or Central Bank can take consolation in the saying that “if it’s not broken why fix it”, but beyond merely relying on market forces to dictate the direction of the growth some remedies worth considering sooner than later are:
a) Aggressively encourage emergence of more companies/securities in the market, whether equities or corporate bonds, especially in the productive, manufacturing, solid mineral, oil/gas, electric power, housing and infrastructure, information and telecommunication, healthcare and agro-allied sectors. The qualification criteria shouldn’t necessarily be length of operations, current/historical profitability or revenue-base, but potential for multiplier effect on the economy and soundness of the business proposition, caliber of management and growth prospects. MTN, Virgin Nigeria and other large successful companies that have sprang up in recent years are good target companies that should be attracted to list in the market.
b) Allow pension funds to invest in long-term real estate and infrastructure projects, initiated by reputable private sector sponsors or through public-private partnerships, that could have demonstrative effect on the economy rather than restricting them to only dividend-paying stocks and government securities, or packing their excess funds in money market. Certain long major projects like Lekki Toll-Road, or numerous power projects that have been approved and lacking funding should be supported to take-off. Government should quickly step-up and guarantee the long-awaited N100 billion bond offering by Federal Mortgage Bank (FMB) that will stimulate mortgage lending and ignite secondary market for mortgage securities.
c) Regulate the size or portion of fund that banks can invest in government bonds and commercial papers, because that investment option offers them guaranteed income, whilst depriving other sectors of essential life-blood. Most of all, excessive investment in government securities breeds arm-chair banking and discourages the banks from being innovative, sourcing private sector deals or investing in the real sector.
d) Strictly regulate margin accounts (portion of bank loans that can be invested in the stock market), especially for purpose of buying new stocks-offerings. The spate of over-subscription is becoming quite spurious and a sign that huge amount of bank funds might be chasing these stocks.
e) Establish a scale for capital gains tax - in other words, the longer you hold your stock the lower the tax and commission payable for the transaction. Ordinarily a draconian short-term capital-gains tax is a disincentive that could restrict the flow of hot/speculative money into the market.
f) Continously attract listing of Small and Medium Enterprises (SME) and emerging companies in the second and third-tier markets to build a pipeline of securities that will graduate into the first-tier market, while enabling these companies raise long-term money to grow and create jobs.
g) Above all, enforce strict corporate governance standards and strengthen economic and financial crime campaign to deter sponsors and companies that might see the stock market as a piggy-bank where they could swindle unsuspecting investors.
These measures might not guarantee that a potential correction will not occur in the near-term, but it can assuage investor-concerns and attract more long-term funds, align market growth with economic needs and energize productivity. Prosperity in that case can become more broad-based beyond what is seen today.