‘Monetary policy remains the greatest threat to stock market recovery’
On May 27, 2012

House of Representatives Ad-Hoc Committee probe of the near collapse of the Capital Market has turned out to be intriguing and quite revealing. Blames and counter blames have continued to pour in as  the probe panel  got more than it bargained  for  but even appears more determined to unravel the mystery behind  the crash of the Nigerian  Stock Market.

So far, some of the findings of the panel revealed that the unhealthy practices of some of the banks in the country were largely responsible for the problems in the market as they manipulated their share prices using depositors’ money. Mr. John Chukwu,  the  managing director/founder, Cowry Asset Management Limited, is a leading investment banker and a multi-dealing operator in the capital market. In this interview,  he speaks on  how sound government policies can  revive the dwindling  sector and unlock Nigeria’s  economy potentials. Excerpts:

How would rate the state of Nigeria’s stock marke?
The past four weeks or thereabout has actually witnessed some level of recovery in the market. The market at some point appreciated by 9. 4 percent year-to-date. That was a significant improvement to what we have seen so far . So, I would say the market is on the recovery path particularly because some of the fundamentals have actually changed positively as to drive a market recovery. One of these factors is the kind of return that companies are reporting . We have seen that the banks are leaving their industry crisis behind them.

We have seen a lot of credible results by the banks. If you look at the 2011 Financials of the banks, despite the heir cut suffered by most of them from their sale of non-performing loans to AMCON, many of the banks reported significant improvements in earnings and profitability. Aside from that, their first quarter results have showed that the banks are on recovery trajectory . So, if the earnings of the companies on the exchange are improving, their market prices would also improve. Beyond that, we have also seen high dividend yield, in some instances as high as 17 percent.

These yields are comparable or even better than what obtains in the money market . So there is enough incentives for investors to come back to the market and that’s why the market has been on the recovery path. So I think one can safely say that the past one or two months have witnessed some level of market recovery and that the Nigerian equity market is on the verge of coming back .

What measures do you think the market regulators and operators should adopt in other to sustain the little success recorded so far?

On the part of the regulators, I think among the things they need to do is to make sure that the integrity of public accounts are maintained and time limits for rendition of reports are adhered to . Right now the NSE is insisting that quoted companies must adopt International Financial Reporting Standard . It’s adoption would lead to an improvement in the level of regulatory compliance as well as transparency of financial statements.

On the part of listed companies, it would lead to higher level of management integrity and efficiency. As for market operators, they have a duty to bring opportunities in the market to the knowledge of investors. For instance, if you look at the investor that took position in Okomu Oil, their brokers must have brought the prospects of the stock to their knowledge because Okomu Oil was actually outside the radar of most investors .

So, the market operators really have a major part to play by creating the necessary awareness particularly to their clients (investors) on market opportunities that have strong probability of crystallizing such as projections of strong dividend yields. If such projections are realized consistently, investors would naturally want to come back for more opportunities.

What do you consider as a threat to the much expected bounce back and growth of the market ?
The biggest threat we have in the market is the monetary policy direction of the government. If the authorities decide to drive a restrictive monetary policy so as to keep inflation down, this would lead to increase in the interest rates. If interest rates continue to go up, fixed income instrument would become more attractive to investors. Conversely, if interest rates go down, investors would see equity market as of better attraction than the fixed income market. So, the greatest threat to continued equity market recovery is the monetary policy directions of the Central Bank.

Former Chairman of the House Committee on Capital Markets, Hon. Herman Hembe and Director-General of the Securities and Exchange Commission, SEC, Ms. Arunma Oteh

Of course, there are other threats including the fiscal policy disposition of the federal government. If the Federal government fiscal stance is expansionary, this will trigger an inflationary pressure, which may compel the monetary authorities to respond with a contractionary monetary fiscal policy. Another factor that may affect the market negatively is the removal of the remaining fuel subsidy. Should the government adjust upwards the pump price of petrol, the implication would be that the discretionary income of the investors would be drastically reduced as basic necessities would take up a greater share of their income leaving out little for investment.

So, if the government does increase the fuel subsidy it would erode the capacity of retail investors to come back to the market because such retail investors would now prefer to put their money in necessity supplies. Those are some of the domestic threats although there are other threats from the external environment. For instance if the crisis in Europe snowballed to other parts of the world.

It could lead to a drop in commodity prices which would put our foreign exchange earnings and reserves at risk. If our foreign exchange reserve is eroded, foreign fund managers who currently account for more than 70 percentage of the market activities would want to wind down their portfolios because they would not be so sure that Nigeria would be able to provide the exchange resources that would enable them convert the proceeds of the investment into foreign currency. There will also be heightened risk of devaluation of the Naira, which will erode the value of the proceeds of their investments.

That brings us to the call that major oil firms and telecoms industry should be compelled to list on the Exchange. What incentives do think you would help to lure them in to revive the ailing stock market?

My position is that the regulators and the government should create enough incentives to encourage listing on the floor by the telecoms companies, oil and gas firms as well as other multinationals operating in the country. We should ask ourselves what do we need to do to lure the Telecoms majors and Oil & Gas majors to come to the market. Among the things I have always advocated is the use of fiscal instruments such as tax incentives to attract these companies to list on the Nigerian Stock Exchange.

For instance, the government can offer lower corporate tax rate to publicly quoted companies – instead of a tax rate of 30 percent, government can grant quoted companies concessionary tax rate of anything between 15 and 25 percent. If this is done, shareholders on unquoted companies will compel them to seek listing. The government can also consider exempting dividends of quoted companies from tax.

This will encourage more people to invest in the secondary market as the effective dividend yield of quoted companies would be higher than those of non quoted companies (though they may be paying the same amount of cash dividend and have the same market value). I believe that if you waive tax on dividend and have a differential corporate tax rate for quoted companies, the telecoms companies, the Oil & Gas companies and other multinationals will have compelling reasons to list on the Exchange. I strongly believe that we should use incentives instead of sanctions to attract more companies into the market.

As for the upstream Oil companies, aside from the above incentives, the government first have to address their fiscal framework. At present they operate as unincorporated joint ventures with NNPC but for them to get listed, they first have to be incorporated as Nigerian companies. If the government is serious with getting these Oil majors to be listed on the Nigerian Stock Exchange, it should make sure that the Petroleum Industry Bill makes provision for incorporating the joint ventures.

If this is not done, then the only avenue under which the upstream Oil & Gas companies can be listed on the Nigerian Stock Exchange is through a cross-border listing. This may be a tall order as no company has yet come from outside the country to get listed on the Nigerian Stock Exchange. Our market is still at the early stages of its development, maybe when we develop to the level of South Africa or other advanced economies, it may then be attractive to companies to seek cross-border listing in Nigeria.

What is your view on outright acquisition or merger of stock broking firms. Will that impact positively on the market?
I think that a shake-out is almost inevitable in the capital market sub-sector. The fact that most operators in the market are not able to cover their operating costs will make it imperative for some of them to either merge or close shop. The reality is that the current volume of transactions on the floor of the Nigerian Stock Exchange, which is about N2billion daily average, is not sufficient for the over 200 brokers in the market.

Added to this is the fact that the market is gradually consolidating, we now have about 5to 10 operators controlling over 80 percent of the market turnover. So for operators whose businesses are principally broker/dealer and who do not engage in other capital market activities like issuing house, financial advisers, etc, the likelihood that their income would be sufficient to sustain them in business is remote. In the not too distant future business exigency now would compel those small operators who are not earning enough income to sustain their operations to either sell their operations to those who are capable of sustaining it or merge with such other companies.

Indiscriminate grating of margin loans by banks to all manners of operators has be linked to the collapse of the stock market. How would you react to that and what is the way forward?

It is a statement of fact that margin loans contributed to the crash in the market because there was so much leverage that it created an asset bubble in stocks. Basically what happens in any economy where credit is cheap, easily available and pursues a particular asset class, that asset class would eventually be overpriced and once it is overpriced, then one day the bubble will burst. That is exactly what happened to Nigerian equities.

By the time the banks finished their consolidation, they had so much liquidity and foreign fund managers were also granting them credit lines, which actually meant that their liquidity was further boosted by the foreign lines. The banks channeled most of these new found liquidity into the equities market, through margin lending and proprietary trading, leading to the pricing of equities beyond their intrinsic value. At some point we were seeing PE multiples running into twenty times, which was clearly an indication that the equities had become overpriced and that a bubble has built into that asset class. Eventually, when the banks lost their liquidity through recall of foreign lines by offshore banks in response to the economic crises in US and Europe, Nigerian banks responded by also recalling their margin loans as well as selling down their equity positions in order to reflate their liquidity.

This was exacerbated by the exit foreign fund managers who also had to sell down their portfolio partly to escape from riskier markets and to meet their credit obligations at home. A combination of these factors and the impact of bubble capital created by some banks in the course of the capital raising exercise led to the capital market crash. Of course there are other factors but I agreed with the former NSE boss that the level of margin loans contributed significantly to the crisis in the market.

To forestall a re-occurrence, the CBN and SEC have come out with a policy on margin lending, restricting the amount of margin loans that banks can actually give out. Secondly, operators have actually come to appreciate the triggers to capital market crash. Right now, operators are going to be more careful.

May be in the next 20-30 years when the pains of the crash would have gone, and a new generation would be in charge who did not experience the current crises, it may happen again but I think for now several regulatory policies have been put in place to avoid a repeat and I don’t see another crash happening in the immediate future.

On market recovery, I believe that that is subject to certain factors. One is the quality of quarterly results/performance of quoted companies. If the companies report consistent improvements to their first quarter results, investors will be encouraged to take positions in their stocks. Other factors include the interest rate and inflation rate in the economy. Should interest rates go down, equity instruments would be more attractive, the reverse is also the case if rates move up.

Finally, we need some level of stability in the political environment because if we don’t have political stability investors will be scared of taking position in equities. If we have quoted companies turning out impressive results , interest and inflation rates moving southwards and no dislocation in investors disposable income (no increase in the pump price of petrol), then we should see further appreciation in the equity market.

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