The stock market: Investors shaken by damning analysis

By Barney Jopson

We are republishing this article, first published by the Financial Times on June 23 2008.

What goes up, went the stock market slogan from Zenith Bank, just keeps going up. A classic expression of bubble sentiment, the belief took hold in Nigeria last year as the market rocketed upwards to become one of the best performing in the world.

In the past three months, however, passions have cooled, prices have fallen, and no one now expects a repeat of last year’s 75 per cent rise in share prices. But at the same time a significant split has occurred: whereas most analysts once held broadly similar views on the market, opinions are now divided into two distinct camps.

A growing number of sceptics outside the country have become troubled by high valuations, dubious corporate governance, rampant speculation, and suspicions of market manipulation, which are reviving old assumptions about the hazards of the Nigerian market.

But in many Nigerian-run finance houses in Lagos, the sentiment of the Zenith Bank slogan lives on. Whatever the foibles of the market itself, some are convinced that structural changes mean corporate Nigeria’s fortunes are on a one-way path upward, driven by high oil prices, better banking, an expanding middle class, infrastructure investments and the country’s in-your-face entrepreneurialism.

One effect of the end to the good times and the split in opinion is that the market is now subject to more scrutiny than last year.

The Lagos stock exchange has just over 200 listed companies boasting a combined capitalisation of about $100bn. But whatever brokers say in their research notes, the performance of the market was driven by one factor above all else: a glut of liquidity from Nigeria’s oil.

While the price of oil climbed from $60 at the start of last year to $93 by the end of it, more and more dollars swilled into the coffers of the federal government. It trickled down to state governments, government-hired contractors and beyond – as it always has – via banks that became flush with deposits and encouraged their customers to invest them in the stock market, or indeed invested the money themselves.

The banks’ role as a transmission mechanism for oil dollars has caused the sector to balloon far beyond the size of all others, to the extent that the 20 or so listed banks make up about 60 per cent of Nigeria’s entire market capitalisation.

“Nigeria is a play on the oil price. Make no mistake about that,” says Fola Fagbule, head of research at Afrinvest, a Lagos-based investment bank that is bullish on the country and its equity market. “Everything is tied to the price of oil and we’ve seen this before. The difference is that this time there’s a stock market, whereas in the 1970s and 1980s most companies were government- or privately-owned.”

The Nigerian stock exchange is not correlated with US and European markets and has not been affected discernibly by the global credit crisis. But between January 2007 and the middle of last month there was a 0.91 correlation between the oil price and the Nigerian stocks, according to Renaissance Capital, an emerging market investment bank, although the pattern has weakened in the past three months.

Bismarck Rewane, director of the Financial Derivatives Company and a contrarian investor, says the market’s trajectory cut loose from the trend of corporate earnings growth long ago. “The market has been a reflection of liquidity and the amount of speculation and manipulation,” he says.

The correction that began in March – a 15 per cent fall in three months – indicated how fragile the market’s foundations were. It was driven partly by a rumour that the central bank and the securities regulator had ordered banks to stop making loans to stockbrokers for margin trading. No formal order was ever confirmed, but the authorities may have floated the idea unofficially due to worries that trading on borrowed money was turning the market into a gambling den. If so, it had the desired effect because investors were shaken, stock prices sank, and liquidity from margin lending evaporated.

A more significant moment, however, came on May 13 when JPMorgan, the US investment bank, initiated its research coverage of Nigerian banks with a damning report that flew in the face of the bullish consensus of 2007. While the best bank stocks were trading at fair value, it said some institutions were overvalued by as much as 57 per cent. “Bank share prices have run well ahead of fundamentals and do not incorporate the numerous risks facing Nigerian banks,” it went on. The report reshaped a lot of views on Nigeria among investors outside the country, who are estimated to own only 5-10 per cent of the market but whose opinions carry weight beyond their shareholdings. For hedge funds in London, however, it was articulating private opinions that had hardened several months before and been acted on in April. “They knew there was little real value left in the market,” says one analyst who has hedge fund clients, “but they held steady as long as the bubble-era mentality of others ensured prices kept going up.”

Renaissance Capital’s latest report says “significant returns remain”, arguing that while price-to-earnings ratios appear high when based on reported figures, earnings growth has consistently exceeded expectations and is likely to be 50 per cent across the market this year.

Mr Rewane is less optimistic, predicting that many stocks will finish down and that overall gains will be “narrow”. But he is heartened by a change in the attitude of at least some Nigerian investors: “They are going back to the fundamentals and beginning to ask the question: where is the beef?”