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Stock Market: What does the circuit breaker tell us?

Kalu Aja by Kalu Aja
November 17, 2020
in Op-Eds
Sulaimon Adedokun resumes as TRANEX Board Chairman  Dangote Cement, Zenith Bank, shares, stocks, ARM's Shares of fortune, Understanding securities lending, nigerian stock exchange, coronavirus, NSE, Bears return ASI down 0.13% as trading volumes plunge, What’s going to happen to Nigeria’s stock market in May?, What’s going to happen to Nigeria’s stock market in May?, Nigerian bourse gains N37. 26 billion, triggered by BUACEMENT, ZENITH
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On Monday, October 19th, 1987, the US Dow Jones Industrial Average (DJIA) lost 22% of its market value in one day – a day now referred to as Black Monday,  represents the largest one day fall in the history of the US stock markets. To put this in proper perspective, the largest one day drop in the US stock markets due to COVID-19 shut down occurred on March 16th, 2020 with the DJIA closing 12%.

Why does stock prices fall?

The simplest reason is because demand falls i.e. stocks are placed on OFFER to be sold. Same with rises? Yes, demand for stock rises, thus there is a BID to buy. So, ‘offer’ means prices fall, while ‘bid’ means prices rise.

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What caused Black Monday?

No one knows, but it is agreed the selloff started in Asia, then moved to Europe, and finally hit America. This was before the time of fully automated trading systems; so, the order was filled and executed by manually placing with a so-called ‘Specialist’ that guaranteed a market.

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On that Monday, there were more offers for stocks than bids. Traders also tended to move in a trading herd, if broker A offer to sell a stock, Broker B is likely to start to worry and ask questions like ‘why is he selling?’, ‘what does he know?’ However, if Brokers, A, B, C, and D start to sell off huge stock positions, then Broker F will not just worry, he will follow the herd. Why? Well, there is safety in the crowd, so it seems.

Black Monday was preceded by Black Friday on October 16th, where the stock market crashed by 108 points – a record before October 19th, so the market was already ‘on offer’, and traders were already spooked. In effect, the herd was jittery.

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The markets opened Monday 19th with more sale orders than buy orders, the markets essentially started to drop, and kept dropping until the DJIA closed at 508 or 22% fall.

(READ MORE: Seplat announces exchange rate of N385.78/$1 in payment of its interim dividend)

The stock markets are designed to facilitate trade and enable price discovery. The price of a share is discovered by the intersection of demand and supply driven by investors’ estimation of risk, return, and the overall economy. Black Friday, however, was pure naked fear. There was no war, no recession, no terror attacks; just the entire market moving as a herd and selling and pulling down other markets.

In the aftermath of this general fall in the prices of shares across the board, the New York Stock Exchange introduced control measures called ‘circuit breakers‘ that are intended to cut off excessive volatility in trading, if the market rose and fell above or beyond a set benchmark. The idea is to break up the ‘herd’ and allow time for contemplation and research to aid decision making. For instance, for the S&P 500, a circuit breaker may be triggered after a 7% fall and the market temporally closed for 15minutes.

Interestingly, on October 20, the DJIA rose to a then-record 102 points in a day.

The Nigerian stock exchange also has its rules on circuit breakers. According to the NSE, anytime there is a 5% market-wide rise or decline (Extraordinary Market move) in the value of the NSE All-Share Index (ASI), the circuit breaker will halt in all equities listed on the Exchange, for a period of thirty (30) minutes.

On November 12th, 2020 at 12:55, the NSE circuit breaker kicked in as the index went from 33,268.36 to 34,959.39 beyond the set 5% threshold.

So, what happened?

There were more bids to buy shares than to sell shares and these bids were across the board, not just in one sector. It does appear in my opinion that investors have started to move money away from low yielding treasury bills and bonds to the equity market.

Is this a one-off purchase? Or an asset allocation rebalancing? Is this a sign of expected higher earnings from Nigerian companies, or just new money causing a minor bubble?

If this is real funds transfer, then the Nigerian stock market is set for positive gains. The Pension scheme alone has N11trillion in assets, with nearly 9% allocated in Treasury bills earning a maximum of 0.30% in stated yields, an even 2% rebalancing away from Treasury Bills to the equity market may be the spark the NSE has been seeking.

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Tags: Dow Jones Industrial Average (DJIA)NSE circuit breakerUS stock markets

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