In this article, the analysts at UBA Global Markets review the Nigerian equity market with a view to identifying the nature, causes and effects of recent liquidity squeeze in the market.

Here are the main points and summary:

1. The Nigerian equity market has recorded strong growth in key parameters over the last few years. The performance was particularly more over the last two years due, mainly, to several economic and financial market reforms. The reforms led to an increase in investor confidence, thus, driving the influx of local and foreign capital to the equity capital market.

2. Fitch assigns Nigeria a BB rating. In the latest release of its sovereign ratings, Fitch has reinforced the outlook of the currency as stable by raising Nigeria’s long term Naira issuer default rating to BB, from BB– awarded last year.

3. Improved key macroeconomic indicators… Nigeria’s external reserves rose steadily by 10.9% to N60.1bn in June 2008, while inflation rate rose to 9.7% in May 2008 due to perceived increase in aggregate market liquidity. Nigeria’s GDP was estimated to have grown by 6.6% in Q2, 08. Aggregate growth in output is driven by the non-oil sector, which grew by 9.8% in 2007. Economists say the real GDP should remain robust at over six percent /year between 2009 and 2012.

4. As the CBN moves to check growth in liquidity. On June 2, 2008, the Central Bank of Nigeria (CBN) announced an increase in local benchmark rate, Monetary Policy Rate (MPR) by 25 basis points to 10.25%. It also raised the Cash Reserve Requirement (CRR) for commercial banks by 100 basis points to 4%. The strategy was to tighten overall capacity of the banks to create credit and put aggregate money supply at acceptable levels.

5. New listings continue to drive equity market activity. In 2008, the equity market has performed below stakeholders’ expectation.  Much of the performance/activity recorded since the turn of the year has come from newly listed issues. The surge in aggregate market liquidity (as measured by turnover volume) resulted from trading in newly listed insurance stocks with large number of shares in issue. Notable amongst them are Investment & Allied Assurance (28bn shares), Universal Insurance (16.5bn shares) and Goldlink Insurance (9.1bn shares).

6. As a result of the speculative positioning that pervaded the market early in the year, we saw the market appreciate at a fast and unsustainable pace. Speculators that were quick to enter the equity market were just as quick to exit and take their short term profits. Hence, the sell off that was experienced at the early stages of the market decline could be said to have resulted from continuous profit taking by speculators, who were exiting their positions. While we note the impact of this sell off on the market, it ordinarily should not hold any significance to the long term investor. If not for anything, it should serve as another opportunity to purchase stocks that are still fundamentally viable at lower prices.

7. In our view, the experience of the recent downturn in the market comes with a vital lesson and highlights the need for the emergence of a quote driven market as against the existing order driven market. It also makes a strong case for investors to place greater emphasis on portfolio diversification in non-correlated or low-correlated asset classes.