October 27, 2008 19230 VIEWS


The Precursors:

It is unequivocal that the happenings in the Nigerian stock market since mid-March 2008 (approximately 7months) till date will remain evergreen in the memories of all stakeholders. The usual bubbles identified with Nigerian stock market have completely disappeared. Instead, worries and groans pervade the market as investors, operators and regulators seek for remedies to abate the trend.


Prior to the melt down, analysts and a few market commentators probably saw it coming and immediately issued caution reports to alert all participants of the impending burst. On Thursday, April 3, 2008, Meristem Research called attention of the market to the looming signals and issued a few reports pre-empting the advent of a market correction and a long bears raid in one of the BUSINESSDAY Newspapers.


We did express that the stock market is an investment roller coaster which rides on four wheels: market fundamentals, psychology, globalization, and the macro economy. From the advanced to the least developed of markets, each of these factors commands significant impact on the workings of the stock markets. From the macroeconomic perspective, overall market size is positively correlated with the ability to mobilize capital and diversify risk on an economywide basis so that the stock market should grow as the economy progresses. In essence, the stock market reflects both underlying macroeconomic conditions and specific economic policy actions.


After a careful analysis and matching of the underlying fundamentals with the prevailing investors behaviour in the market during the bubble era, we submitted thus: The momentum for stock price movement has grown very strong and investors are now comparing virtually every form of investment to the stock market. Now, joining the investment train is becoming an all-comers affair.


But will the Nigerian stock market bubble burst soon, or will it ever prop?

Nobody has ever predicted accurately the when and how of bursts. Just before a major burst, experience has shown, the market will always look so promising and attract some late comers who are also somewhat fledgling.


Unfortunately, they are hit the most. .If the history of high market valuations is any guide, the public may be very disappointed with the performance of the stock market in coming years.


Situation Analysis:

Just as we foresaw, the Nigerian equities market has experienced large scale capitulation. Put differently, the market has witnessed a scenario when virtually all investors sell or are rushing to sell all their stocks because they want to exit at all cost. The sole motivation for trading is to get out of the market and seek shelter in "investments such as bonds, real estate to mention a few. There is no doubt, the selling frenzy is painful, but relatively quick and still lingers.


Without mincing words, the increasing selling momentum makes it crystal clear that the bears have taken control. Worse still is the rush by foreign portfolio managers to exit the Nigerian equities market as a buffer to augment their battered positions in the face of recessions in home markets.


As for domestic investors, the mass transfer of funds from stocks to safer investments and increased news in print media on investors apathy and daily losses in the stock market replaced the go-go stories of the early 2008, when every Tom, Dick and Harry poured money into penny stocks that had no fundamental strengths.

Another critical issue that has generated heated and controversial arguments amongst operators in the Nigerian stock market is the regulator's intervention towards stabilising the market. While some operators perceive this as a decatalyst preventing early bottoming out and eventual recovery, the authority of the Exchange sees it as one of the necessary measures to protect investors. They maintain that this measure is not only peculiar to the Nigerian market alone as instances of Russian and Icelandic markets and a couple of other markets in Europe were cited.


Market Bottom: A silver lining in the neighborhood?

A stock market bottom is a trend reversal that marks the end of a market downturn and the beginning of an upward moving trend. A "bottom" may occur because of the presence of a cycle, or because of panic selling as a reaction to an adverse financial development.


It is a fact that in a severe down trending market; there may be a certain threshold after which large numbers of investors can no longer tolerate the financial losses incurred as a result of the current downturn. This majority group of investors then capitulates (gives up) and sells in panic or finds that their pre-set sell stops have been triggered thereby automatically liquidating their shares of a given stock. This dramatic increase in the number of sellers causes a further increase in the speed and severity of the stock's price decline. Margin calls by banks and brokerage firms, mutual fund and hedge fund redemptions significantly contribute to capitulations.


However, bottom picking, i.e. identifying a bottom in hindsight may seem easy but fishing the bottom market is a herculean task. This is because the upturn following a decline is often short-lived and results in a continued price decline and hence a loss of capital for the investor who purchased stock(s) during a misperceived or "fake" market bottom.


Shrewd analysts advocate that the best time to buy is when the market has fallen drastically and investor sentiment is extremely negative. At that time, adherents of the trend following approach have already exited the market; however those who view the stock markets as a cyclical process and feel they have clearly \"picked a bottom\", would become interested in buying because this is when profit potential is at its peak.


An investor who enters the market at a perceived bottom has concluded that the market has fallen to such a degree that the current price is far below normal expected values, a valid uptrend is about to begin and the market is not likely to fall further.


Risks of attempting to invest at a market bottom

Without any prejudice, fishing market bottom is neither a joke nor a child's play!

It is very difficult to identify the exact time during which a market bottom is reached. Hence, investing at the time of a perceived bottom can be quite risky, and is often compared to catching a falling double-edge knife. Investors need be wary of a dead cat bounce scenario when the perceived recovery is only a short one. Therefore we recommend that investors should exercise extreme caution and suggest the following strategies:

Careful assessment of the current and future outlook of the Nigeria capital market relative to global markets in terms of growth and returns.

Invest only when the market and its component stocks are grossly undervalued. Focus should be on strong fundamentals and future prospects rather than sentiments and speculation.

We advocate that investors should spread their purchases over a period rather than making a single purchase.

Identifying a market bottom

Market timing is an investment strategy based on the outlook for an aggregate market, rather than for a particular financial asset. It is defined as the strategy of making buy or sell decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting from technical or fundamental analysis.


However, whether market timing is ever a viable investment strategy is controversial. Premised on the efficient market theory, a group of analysts and market commentators suggests that financial asset prices often exhibit random walk behaviour and thus can not be predicted with consistency. This group considers market timing to be a form of gaming based on pure chance because they do not believe in the possibility of predicting future prices of financial asset.


Harbingers of Market Bottom

The proponents of market timing posit that ample empirical evidences convincingly show that investor sentiment and psychology can be incorporated into profitable stock and stock market trading systems. Amongst analytical techniques for confirmatory tests are:


Market Valuation: It is a foremost and persuasive long term indicator used in timing market bottom. A proper market valuation is accomplished by considering both earnings and earnings growth using a Discounted Cash Flow Valuation Model. This reveals intrinsic values of a stock. Similarly, analysts also employ a crude interpretation method of P/E ratio metric of market valuation in determining the underlying value of equities.


Investor Sentiment: It is a potent long term indicator used to identify a bottoming market. When an extremely large percentage of investors and financial advisors express bearish (negative) sentiments, it is a strong signal that a market bottom may be near. However the predictive capabilities of this kind of investor sentiment are thought to be highest when investor sentiment reaches extreme values


CHART 1: Market Oversold Indicator: Relative Strength Index (RSI) - http://www.proshareng.com/blog/?attachment_id=1092


The following is a list of other probable signs that may signify market bottom and usher in a bullish regime.

1.  High inflation

2.  Decreasing interest rate

3.  Emergence of bargain price because of extreme pessimism

4.  High level of cash in circulation

5.  Decreasing flow of primary market activities (new issues can adversely affect the secondary market’s supply/demand balance).

6.  More sellers than buyers

7.  Improving earnings and dividend yields

8.  Undervaluation of stocks

9.  Extremely low bull/bear ratio

10.  Intense selling on heavy volume

11. Accumulation taking place as indicated by high volume on up days and low

12. Successive lows on decreasing values.

13. Book Value Per Share (BVPS) at above market price.


Our Submission

A careful diagnosis of the above factors in the context of the Nigeria equities market reveals instructive outcomes. Rising inflation rate (14 percent as at 3rd quarter 2008) has been accompanied by extreme pessimism of prolonged bearish market. While the general investment psyche remains continued capitulation,


stock prices have shrunk to bargain territory with fundamentals improving spectacularly resulting in above historic average yields. Market-wide earnings yield has soared to competitive average level of 6.28 percent just as some stocks pride themselves with a double digit earnings yield and competitively high dividend yield.


Besides, a crucial indicator of a company's worth is its book value. A cautious examination of this indicator, after due consideration for industry- and company specific peculiarities, suggests that the current market play has rendered some stocks to trade below or near their book values. Aside from opening up rare investment opportunities for astute and strategic investors, this phenomenon of book values trailing close to market valuation is a pointer to the threshold of market bottom.


A technical analysis of market behaviour shows sufficient evidence that oversold stocks are due for a rebound. From figure 1 above, market momentum as captured by its Relative Strength Index (RSI) is at abysmally low ebb. The RSI has broken completely out of its range below the threshold stretched from 30 to 20 points for a bearish market situation. This is the worst extremism in market readings in the last 12 months (see chart 1 above).


Currently, there is an intense selling pressure as decipherable from the downward spiral in the NSE ASI as there are more sellers than buyers. In the last couple of weeks, the Bull/Bear ratio has fallen extremely to the lowest recorded in previous past. But there is a ray of hope for a rebound. As shown in chart 2 below, a twelve-year trend analysis of the NSE ASI shows that the market has broken below its long term trend which signifies imminent up-trend.


Chart 2: Trends in ALL SHARE INDEX - http://www.proshareng.com/blog/?attachment_id=1092


We posit that a meticulous study of recent trends in the Nigerian market portends semblance to some of the attributes itemised earlier. As we speak, equities prices continue to nose-dive day-by-day and have reached a 52-week low while some are near 78-Week (1 and a half year) low. Perhaps this could have probably worsened, save for the maximum downward price movement of 1 percent.


On the contrary, quoted companies keep on posting juicy earnings reports and making announcements of strategic repositioning and alliances for improved performance and growth prospects.


In our market analysis report: “The Nigerian Stock Market: Gauging the Fundamentals (http://www.meristem.com.ng/uploads/files/Nigeria%20Stock%20Market%20Fundamentals.pdf), we maintained that the market risks being sent to suboptimal levels as a result of fear and loss of confidence. The market has been priced lower than our calculated justified P/E of 17.34x as current P/E (trailing 12 months) stands at 15.90x while stock yields are almost competing with money market yields. All these are pointers to the fact that the market is below its intrinsic valuation levels. Though it may not be accurate to conclude that market has completely bottomed out now, however, there are convincing evidences to confirm that the Nigerian stock market is currently undervalued using all benchmark metrics.

We are bullish about the Nigerian stock market in the medium to long term (9-12 months+) premised on facts above. Therefore, we recommend early positioning for value-driven individual investors and institutions after a careful selection among stocks with price multiples below market and sector averages (See table 1 and 2 below for a comprehensive list of stocks current and forward-looking valuation levels).

As the legendary investor, Warren Buffett recently said in the face of the meltdown in the U.S. and global markets, equities will almost certainly outperform cash or its equivalent over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky's advice: “I skate to where the puck is going to be, not to where it has been.

Lastly Buffett rightly put it: be fearful when others are greedy, and be greedy when others are fearful, it may not be out of context to say this quote perfectly suits situation in our market now.



While the Proshare website is renowned for its  accuracy and painstaking attention and commitment to factual data, we are not liable for any incorrect information included. We recommend that you make enquiries based on your own circumstances and, if necessary, take professional advice before entering into transactions.

This report is based upon information from various sources that we believe are reliable. However, we do not make any representation as to the accuracy or completeness of the report. This report is not an offer to buy or sell, nor a solicitation to buy or sell the securities mentioned therein. This report is provided solely for the information of clients of Meristem Securities Limited  who are expected to make their own investment decisions without sole reliance on this report. Meristem and PROSHARE (publishers of the report under approval) accepts no liability for any direct or consequential loss arising from any use of this report or its contents. Investments can fluctuate in price and value and the investor may get back less than was originally invested. Past performance is not necessarily a guide to future performance. This information has been issued by Meristem, which is licensed by the Securities and Exchange Commission (SEC) and the Nigerian Stock Exchange (NSE). Enquiries relating to any matters in this report should be directed to 234-1-2717350-5.

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