The Nigerian Stock Exchange: Elections Loom
The Nigerian Stock Exchange All Share Index (NSE Index) has been quite volatile in the first eight months of 2014. The first quarter was full of intrigues especially with the suspension of the erstwhile CBN Governor, Lamido Sanusi.
The chart below shows the performance of the NSE Index over the past one year.
The Index experienced a bullish run in the last quarter of 2013, then took a breather and resumed in the second quarter of 2014. However, it looks as if the market has started taking another breather. Now, the question on every stock investor's mind is this: what is the way forward?
As we all know, nobody can accurately predict what the market will do tomorrow, but there are pointers, and other variables, that can tell us what to expect in the near future. The market doesn't always respond to these variables, but as investors, we need to device strategies to help us determine the way forward in optimizing our portfolios.
So this is the time to insert a caveat: what I am going to write about is just my opinion, and the strategy I intend to deploy in managing my personal portfolio.
Over the past one year, the NSE Index has gained 13.4%, largely because of the bull runs evidenced in the chart above; however, the market has actually lost 0.29% year to date. That is a brief review of the performance. So, how does this all stack up? Let's dig in a little deeper into the numbers.
The Nigerian stock market has the largest share in the MSCI Frontier Markets Equity Index, at least until Saudi Arabia is added. Strangely, the NSE Index is cheaper than the MSCI FM Index. The NSE Index has a price to earnings ratio (PE) of 11.9x, but the MSCI FM Index has a PE of 13.9x. While the NSE Index has a price to book value (PBV) of 2.4x, the MSCI FM Index has a PBV of 2.8x. And lastly, the NSE Index has a return of equity (ROE) of 19.4%, while the MSCI FM Index has an ROE of 16.5%. On a relative basis, the Nigerian market is looking cheaper than the stock exchanges in other frontier markets. If the NSE Index is stripped off from the MSCI FM Index, the difference in valuation will actually become much wider because of the weight that Nigeria occupies in the Index.
Now, I decided to take a closer look at other stock markets across Africa, and my findings were startling. Nigeria looks undervalued compared to the other markets across Africa.
PE - 15.4x
PBV - 2.2x
ROE - 15.1%
PE - 12.5x
PBV - 2.5x
ROE - 28.4x
PE - 13.1x
PBV - 1.3x
ROE - 13.2x
PE - 15.1x
PBV - 2.5x
ROE - 18.3%
Apparently, the NSE Index is quite cheap at this time. But is this the right time to plunge into the market? I don't think so, because I believe the market is still going to become much cheaper than it currently is.
Inflation currently stands at 8.2%, but the minimum yield on Nigerian Treasury investment is 10.2%. That is a minimum of 200 basis points real returns on fixed income investment. Why should investors plunge into the stock market when they can get to preserve the purchasing power of your funds at zero risk? Another reason why I believe the market will still become cheaper is the current volatility the NSE Index has displayed so far. The weekly standard deviation of the NSE Index over the past one year stands at 1.95%, while that of the FGN 2022 Bonds stand at 1.08%, which means that the stock market is still quite volatile and this volatility is likely going to drive it down a little further than current levels.
Another major concern for the stock market is election fears. The presidential elections is less than six months away from now. A lot of politicians would be keeping liquid cash at the moment to fund elections, and this may make them to sell down assets to meet up with electioneering needs. With rising liquidity will come rising inflation, and in order to curb this inflation, the Central Bank may be forced to tighten liquidity by conducting more frequent open market operations (OMO auctions). Frequent OMO auctions may force interest rates to rise further from current levels, and thus increase the real returns on investment for fixed income.
A lot of investors are also likely to stay by the sidelines until the elections are over, and this will lead to reduced appetite in the stock market over the next six months. The stock market is not likely to decline in a straight line; I expect a little bump towards the end of 2014 and early 2015, before it continues its downward trend until the elections are over. The outcome of the elections will also determine how soon the stock market would recover. If the incumbent government is returned, I expect the market to trade sideways for a few weeks that may last up to six months before a massive rebound. This sideways will be informed by the traditional noisemaking that will be made by the losing side(s). If, however, there is a change in government, the market is likely to experience an immediate decline as market participants take off to examine the policies of the new government, and the recovery may not happen for at least one year. The return of the incumbent will guarantee a continuity in policies and the market will react positively to this.
The last question is the likely impact of terrorism in the North Eastern part of the country. I believe that this threat will be contained just before or immediately after the elections in February 2015, and the chances of a degeneration into an upheaval of the general economy is less than 0.05%.
In summary, despite the cheapness of the Nigerian stock market, I am going to tactically remain underweight for the next six months. But this does not preclude me from cherry picking some very juicy opportunities as they emerge.