Stock Market Crash, have we found the black box?

Sometime in 2006 the Nigerian Stock Market began a fateful journey, it rose to an altitude far above it’s pressure levels. The stock market had Ndidi Onyuike, C. Soludo as the pilots of the doomed flight. The flight plan was well orchestrated bottom up, up bottom. Every body was invited to come on board, beginning with stock brokerage houses, banks, organized private sector, politicians and eventually you and I. It was a fast flight comparable to the speed of a fighter plane. In a little over 2 years the Nigerian stock market All Share Index will rise by 37.8% in 2006 compared to the 1.1% rise in 2005. The All Share Index even rose to a year high of 35,068.84 in 2006 before dropping to 33, 189 at the end of the year. It will then peak at about 57,990.22 in 2007. This was an historic high despite the turbulence in the global stock markets at the time. Market capitalization stood at a whopping N13.295 trillion in 2007. First Bank topped the table with a
market cap of about N889b.

At the time the NSE attributed this rise to “price appreciation by equities consequent upon macroeconomic stability and improved corporate results….” in hindsight don’t that just sound gibberish? Effectively we were on auto pilot as the Regulatory authorities didn’t know why we were on such a high altitude especially with so many innocent investors now on board. All sorts of goodies were served as we are all now aware. Everyone aboard were treated as first class passengers. With as little as N50k you could make twice that within a month.

As with a plane on high speed and without a pilot when there is an engine problem or a sudden impact from turbulence an aircraft nose dives to a mostly catastrophic fate. The Nigerian Stock Market witnessed a sudden if not expected nose dive. The stock market dropped in 2008 by 28% N9.5trillion. The All Share Index dropped by 45.8% to 26,539.44 points. First Bank remained number 1 dropping to N524.8b in market capitalization. The NSE in it’s usually dramatic fashion attributed the decline to “the decline in market capitalization resulted mainly from price depreciation in equities, the delisting of 19 companies and the maturing outstanding bonds”. No mention of the bubble that was the stock market at the time precipitated by hot money from the newly artificially recapitalized banks. Off-course the slide is still evident as the stock market capitalization as at Sep 16, 2010 stands at about N5.6 trillion with the All Share Index dropping further to 22,993
points. Our reference Bank currently has a market cap of N388b

As with plane crashes, air crash investigators sought to look for the black box. It’s gives them an insight into what must have happened to the plane at the moment it crashed, what the pilots did right or wrong, the state of the aircraft etc. All these help towards making the plane and the airspace a lot safer and to ensure a repeat is avoided. Similarly we must ask ourselves if we have found the black box resultant from the crash of our stock market? Well going by various analysis trailing the crash I guess we may have or have not depending on how you assess the governments response. It’s one thing to find the box and another to have learnt the right lessons and put in place enabling structures to ensure the mistakes are not repeated. The most difficult part of plane crashes for airlines is getting back the loyalty of passengers. To achieve this airlines go along way toward assuring customers that the right lessons have been learnt and a repeat in unlikely to occur.

Going by how long it took the government to change the DG of the NSE, one might infer that they may have learnt the right lesson in a painstakingly slow way but have no clue about how to revive investor confidence and participation in the market. It is therefore not too difficult to see why investor confidence is at it’s lowest in years. Stocks that traded at P.E ratios of 20-30x are currently trading at about 10 times below that ,with some even trading close to their price to book ratios. Why wouldn’t an investor buy a First Bank share for N11 at a cheaper P.E ratio considering that just 3 years ago the share was going for as high as N46 and at a higher P.E ratio? This obviously translate to a loss of confidence and a case of once beaten twice shy.

Investors that have lost so much money over the last 2 years obviously don’t see investing in stock as an option at the moment. This is despite the fact that some of these companies even with their reasonably low share price are very profitable and have long term growth prospects. So what should the government do? They have actually started in the right direction by first of all cutting down the interbank rates to its lowest in decades. This should ordinarily deter investors from saving in banks and push them toward sectors of the economy that portends increased yield even if it’s in the medium term. But this doesn’t seem to be working as investors continue to shy away.

This may even take longer to provide desired effects as investors will mostly for long remain cautious after taking a beating in the stock market. They will often incline towards bonds, real estate or gold especially when interest rates are low. But in Nigeria commercial real estate have also taken a beaten especially in terms of capital appreciation evident by the empty apartments taken over from defaulting obligors. There is no robust bond market and neither is the gold market too. Manufacturing is still unattractive. This probably means people are spending most of their money on repaying loans, purchase of goods and services, religious bodies and on holiday and recreation. Purchase of goods and services probably take a large chunk of this. This ordinarily should be a good thing except that as a net importer of goods and services it hardly reflects very positively in the GDP.

The Government probably needs to do more to jump start the market. Creativity, pragmatism and out of the box thinking should take center stage. The NSE should channel lots of energy towards reviving investor interest and confidence. Much of this can be achieved by enacting legislation geared towards achieving the above. The government can and should, even if it’s on the medium term, lift the threshold on the amount pension fund can invest in the stock market. This can be be done in such a way that investment will be limited to companies that have a track record of paying dividends for over 10 years and with a strong capital base.

They should also by legislative enactment create private savings scheme for workers in stock markets and bonds. Such schemes should be tax deductible attracting low or suspended withholding tax on capital gains. The government can also assist by revitalizing the 2nd tier market fro increased participation by small and medium scale companies. It’s no news that the 2nd tier stock exchange have been in a moribund state attracting little or no investment even during the bubble years of 2006-2007.

The government should also embark on massive PR drive geared towards creating awareness amongst the populace of the benefits of investing in the stock market. It is well known that the stock market has posted more returns over the last 50 years when compared to other investment outlets. This might sound tepid but then the power of information can never be underestimated.

The government should also consider granting pioneer status to companies who are going public for the first time. This will encourage investor to subscribe their shares as their profits will not be taxed for at least the first 3 years. This can even be limited to companies who are operating in business that create huge jobs and incur significantly high capital expenditure.

I have deliberately left out the more stereotype measures such as lowering interest rate, relaxing limits on margin loans etc;as they where the major causes of the last crash due to their propensity to create asset bubbles. I have also left out foreign direct investment as they mostly bring in hot money which as usual always mostly evaporates leaving for dead the bubble they created. Contrary to popular beliefs the so called FDI’s more often than not ensures a country’s current account deficits is widened, which can be catastophic in times of crisis. The government needs to be creative in tackling 3rd world stock market crashes by approaching them in a much more pragmatic manner. If there’s anything I’ve learnt from the global economic crisis, it is that when the developed economies sneeze we catch cold however,the medicine for their cure is more often not the same with ours.

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