In comments that may scare the investing community, Central Bank Governor, Godwin Emefiele said as part of yesterday Monetary Policy Committee (MPC) meeting held in Abuja. The MPC is a decision making body of the CBN that fixes the interest rate, and various ratios for commercial banks. According to the Governor, “the Committee noted the seeming bubble in the capital market, and cautioned on utilization of capital inflows.”
Why the CBN is sounding a note of warning
A bubble in the stock market occurs when market participants drive stock prices above realistic valuations. The Nigerian stock market was last in a bubble in 2008, shortly after which it crashed, The stock market crash was one of the factors that led to a banking crisis as many investors had borrowed money to buy shares, which they were unable to pay back. Banks were thus left with huge holes in their balance sheets, forcing the CBN to bailout some of them. Some stock prices have gone almost 100% from January till date.
2017 is different
The Nigerian Stock Exchange (NSE) All Share Index yesterday closed at an all time year high of 35,065.47 points, up 30.48%. While the market is currently one of the best performing on the African continent, and in the world, investors are merely repricing stocks due to the devaluation that occurred in 2016. Priced in dollar terms, stocks in Nigeria are trading at a much cheaper level. A stock market bubble usually precedes a financial crisis. Nigeria however, is on the verge of recovering from a recession. The CBN may have issued the warning to individuals from speculating.
What investors should do
Investors should exercise caution when buying stocks. Buy into companies that have good fundamentals and are trading at a reasonable price to earnings (PE) ratio. PE ratio, is the figure you get after dividing the price of a stock by the amount the company has made in a year or period. The PE ratio gives an idea of how long it will take to recoup an investment in a stock from its earnings.