As We Welcome Back the Bulls

The last few months have been very emotionally challenging to the average investor on the Nigerian Stock Exchange (NSE). As at 25th June the All Share Index has lost 19.6% from its all time high of 66,371 achieved on March 5th. The Index closed 53,366 on June 25th the lowest point since 16th November 2007 and down 8% for the year.

Fortunately for most of us, the worst seems to be over as the index went up for the first time in nine days on June 26th. Since then the index has appreciated 7% although it is still 1.6% down for the year. So what have we learnt from all this?

Keep an eye on market valuation

The Index closed at an all time high on 5th March at 66,371. The average market PE was 35.9 while the average dividend yield was 1.6%. If we compare this to the market PE and dividend yield on the last trading day of the last 3 years, we would definitely conclude that the PE was high and the yield low. These two indicators are used in other markets to access the valuation of the market. Our experience in the last four months indicates that these indicators can be used to good effect in valuing the NSE.

Year.....................PE......Yield %
5th..March 2008....35.9---1.6
31st.Dec 2007......30.0---2.1
29th.Dec 2006......23.4---3.88
30th.Dec 2005......16.3---4.75
25th.June 2008.....27.0---2.1

It is therefore very important to keep an eye on the market PE and dividend yield. A large diversion from historical trends calls for caution. While these two might not be enough to be sure of an over extended market, they can be used in addition to other factors such as excessive bullish outlook by analyst and the media, excessive speculation on penny stocks and stocks no longer responding to strong earnings announcements. All these were present in our market in the last few months. Therefore, in retrospect some correction was due. When such factors are observed, it is time to be cautious and consider taking money out of the market.

Stick to fundamentally sound stocks
This is an advice for all seasons but becomes even more important during a bear run. It is emotionally easier to stick with sound companies when the going gets tough. Weak companies tend to fall more in a bear market and recover less quickly when the bull run starts.

Most of the banks listed on the NSE are very sound companies. Although they took a beating during the bear run, they also led the recovery. In addition, at the bottom most of the banks were selling at very attractive valuations and provided a great opportunity for entry and subsequent gains.

Get rid of overvalued stocks

Once it becomes clear that a bear run is on the cards, it is advisable to get rid of over valued stocks. These will typically be stocks will high PE’s and low dividend yields relative to their sector and market. Intercontinental Bank and IBTC were two stocks that were selling at a premium compared to other banks. They suffered like most of the banks and they have been sluggish in the current recovery.

Cash

Always have some cash to take advantage of some great opportunities that will appear at near bottom. There were great opportunities from June 19th to 25th. Only those with cash were able to take advantage. Several stocks such as GTB, Costain and Dangote Sugar have already returned more than 20% from their lows attained in the last two weeks.

Cash can be kept in money market investments that could be easily liquidated to take advantage of bargains.

Finally

Whatever you do, once a bear run starts do not panic. Everything has an end. The long Bull Run ended on 5th March and so did the Bear Run after almost 4 months.

The market looks to be favorable in July although expect the current run to slow down in the next two to three days. Positive earnings announcements will ensure July provides investors with needed respite.