Handling the Current Volatility in the Nigerian Markets
The Nigerian financial markets are currently undergoing some serious turmoil because of the fallout of macroeconomic uncertainties. Everything seems to be going downhill because of the heavy pressure on oil prices; this will only be compounded if the Iran-US nuclear deal is finally sealed. Because of lowered oil prices, Nigerian foreign reserves have taken a hit. Because the foreign reserves are down, US Dollars have become scarce on the streets, thus putting pressure on the Naira. Because Naira has been depreciating against the US Dollar, inflation has been on the rise because Nigeria is heavily dependent on imports. We import everything down to toothpicks.
Oil Price Performance Over the Past One Year
Inflation rose to 9.20% in the month of June 2015, which means we are just 80 basis points away from hitting the dreaded double digit inflation figure. But that is not the point of this post. How do we position our investment portfolio to weather the ongoing storm in the Nigerian financial markets? Sometimes, one of the worst investment decisions is to go contrarian because Warren Buffett said we should be greedy when others are afraid.
I will let the numbers speak for themselves.
NSE Performance Over the Past One Year
From the chart above, we can deduce that the market is currently somewhere around where it was in December 2014. A little analysis shows that the one year standard deviation of the Nigerian Stock Exchange Index (NSE Index) stands at 31%. This means that we have about 68% confidence that the market will not lose more than 31% of its current value over the past one year. I don't feel very confident in that figure. The market volatility is still pretty high, although the slope downwards from right after the election in April seems quite gentle. But I am not too convinced about that gentleness. It is at this time that the market reacts really rapidly to tiny shocks. And tiny shocks are currently in abundance.
But hold on a second! What is that funny looking pattern between November and March in that chart? It has everything to do with the election period. That was a period of extremely high volatility. This funny looking pattern made me take a closer look at the fixed income market and here is what I saw.
10 Year FGN Bond Performance Over the Past One Year
The chart here is the 10 Year Federal Government of Nigeria Bond (FGN Bond) price performance over the past one year. That same funny looking pattern also found its way here within that same November to March period. The election period did not spare even the fixed income markets in Nigeria. There seems to be nowhere to hide. The chart here looks even more jagged than that of the NSE Index but the standard deviation is only 15.4% - almost half of that of the NSE Index.
But here is the real difference. The 10 Year FGN Bond is just one fixed income security,while the NSE Index is made up over 200 equities. By the time you add more fixed income securities to the FGN bond, the standard deviation will drop below 15.4%. A basket of fixed income securities could actually have a standard deviation well below 12%. This means it is safer to hold a basket of fixed income securities than to have high exposure to the stock market.
I know I have gone all hard core on finance jargon. Let me make it simpler.
What all these numbers are simply saying is that it is better to do a tactical asset allocation switch at this time. Oops. I mean you should protect your portfolio if you are holding Nigerian assets because "Winter is here". My advice, which is what I am currently doing, is to reduce exposure to equities to the lower limit and raise fixed income securities to the maximum limit at this time. At least, until the storm is over.