Round 2

Someone once said “the ability to anticipate the market instead of reacting to it is the most important attribute that separates the consummate investor from the rest of the investing crowd”. Can we anticipate the market? Perhaps. Attempting to predict the direction of the market is usually a fools errand, but there is no harm in trying.

There is no doubt we are in bear territory. The NSE All Share Index has lost 23.5% since it peaked for the year at 30,925 on 2nd June. On June 2nd , the market had by then been on a spectacular run and was up a stunning 56% since its low of 19,804 established on 26th March. It was an incredible reward for those who went in during the dismal first quarter. Therefore the current bear run is not shocking when considered alongside the remarkable gains.

So how can we recognise the signs of a recovery from the current bear run? Can we anticipate the next bull and jump in at close to the bottom? Back in late January when i decided to jump back in big time it was because i felt stocks were cheap using various valuation methods. Using Price to Earnings (PE), Price to Book and Dividend Yield, stocks were selling at 4 year lows. The average Yield at the end of January was 6% while the PE was 14.3. That compared favourably with the average of 16.3 and Yield of 4.75% on 30th December 2005. The market did not bottom out until March after a suckers rally in February. At the bottom of the market on 26th March 2009 the yield was 6% and PE 12.5%. However, all the stocks i bought in late January and early February did not breach their lows in the March sell off. What i did not anticipate then was that i will be rewarded so quickly.

I used mainly two criteria to decide what to buy: the dividend yield and the PE. I placed more emphasis on the dividend yield. Deciding that at worst i will get a dividend. Most of the banks stood out. I selected those i was familiar with and those that have taken the worst beating. A number of non bank stocks also stood out. I bought those with the largest yields and a reasonable dividend paying record. I avoided Insurance companies. Having just taken a course on Risk management, the faith of Insurance companies in the UK during the stock market collapse in the early 2000’s kept ringing in my ears. Despite their “attractive” valuations i stayed away.

Within two weeks of my entry the February suckers rally was in full swing. I sold a few to reduce my losses from the previous year but mercifully held on most until May/June. I guessed correctly that the stocks had more to run and that they were still fundamentally attractive. Anticipating a selloff in the 3rd quarter i decided to bank some of my gains, I took out all the cash i put in during the first quarter plus more in May and June. I rebalanced my portfolio keeping a few banks and buying more non banks that i hope will act as stabilizers. I kept a nice amount of cash to take advantage of any opportunities that might arise. So far so good.

July has so far been testing. The Index has gained only 3 times in 13 trading days shedding 11.9% in the process. The average PE as at July 17th was 13 and the Yield 5%. The PE is now more attractive than in January but the Yield has dropped probably reflecting some of the poor dividends announced by some Insurance companies. A few stocks are definitely becoming more attractive. My eyes are firmly on non banks stocks for now. The banks need to fall further to compensate for the more uncertainty hanging over them. Insurance stocks are still a no go.

Another positive development that might affect the faith of the market is the reduction in Monetary Policy Rate by the Central Bank. Lower interest rates are generally good for the economy and the market.

I still believe the last half of the year will be tough due to the common year end for banks and the painful write downs some banks need to make. However, if one has a thick skin and some cash to last a long bear run, it will also present an opportunity.

The strategy is to try hard not to exhaust cash before the bear is finally slaughtered. Buy in bits and avoid needless risk like buying IAA or Transcorp for instance. And above all be patient and prepared for a long, bumpy and exhausting ride.

Ray of Hope

May provided further respite and ray of hope to beleaguered investors on NSE. The Index gained a stunning 38% , surely a record gain in any one month. It was a month in which investors who took the risk in the first quarter were rewarded beyond their imagination. Value of transaction at just over N56 billion was the highest for the year which is consistent with a rising market which generates more interest.

June on the other hand was a reality check. Value of transactions at over N94 billion was the highest in 9 months. The Index reached a year high on June 2nd at 30,925 and came within whiskers of the year opening. However, by the end of the month the Index had dropped to 26,862 a 9.6% decline from May closing. This was certainly not a surprise after the record setting gains in May.

As we enter the summer the dullest time of the year, it is likely that the index will drop further from its June closing before the summer is out. Already the first few days in July indicate a declining interest in the market. Value of transactions are declining daily albeit slowly. But the signs of a bear market are there: lower lows and lower highs combined with shrinking volume.

With the new Central Bank Governor talking tough and uncertainty still hanging over the faith of some banks this is the time for caution. A time to perhaps sit still. Except for some investors still holding on to dead wood. This might be another opportunity to exit with modest losses before another round of meltdown.