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28 - 04 April 2007 
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Finance and Banking


It’s Not a Market Crash

The third week of March 2007 will go down in history as the worst week for equity investors in over a decade.  Out of all 53 companies listed at the Nairobi Stock Exchange (NSE), not a single one posted price appreciation.  Even the NSE 20 Share Index lost close to 800 points.

Going further down the same month, I must admit that as an Investor Agent, it has been the most challenging. However, the encounters have presented life lessons in equity investing.  With that, I have been able to draw a line between who truly is an investor and the majority of the players in the Kenyan equity market; the speculators.

Last week, a client sent me a text message that read, “Now that the market has crashed, what next?”  Though I knew what to say, I found it difficult to explain why the current happenings cannot be a market crash and what it was. 

I believe the client is not alone. Majority of the panic sellers are selling with the conception that the market has ‘crashed’.  In the simplest layman’s language, a market crash would mean a great loss in prices.  Indeed, if it was, then it would mean that some prices trade at below the par value of the security in question.  In addition, if you are holding a share certificate, it would mean that the certificate is just as useless as recycle paper.  Moreso, the early warning signs can always tell when it is a crash or just a normal trough in the life cycle of the market.

In the US for example, the largest stock market crash took place during the great depression in 1929.  Prior to the crash, there was an initial decline in output which stemmed from tight US monetary policy aimed at limiting stock market speculation.  Earlier periods had been characterized by a boom with the stock market not being an exception.  Stock prices had risen more than fourfold from the low in 1921 to the peak reached in 1929.  In 1928 and 1929, the Federal Reserve had raised interest rates in the hope of slowing the rapid rise in stock prices.  The high rates depressed interest sensitive spending with construction and automobile purchases being the most affected.  That reduced production.  A boom in housing construction in the mid 1920’s led to excess supply of housing and a particularly large drop in construction in 1928 and 1929.

By September 1929, US stock prices had reached levels that could not be justified by reasonable anticipations of future earnings.  Due to this, a variety of minor events led to gradual price declines in October 1929.  The climax of it came after investors lost confidence and the market bubble burst.  Panic selling began on “Black Thursday,” October 24th 1929.  The main driver for this was that majority of investors had bought stocks using loan money (margin trading).  The sale was exacerbated by the fact that only a small fraction of the shares had secured the loans.  The Cowles Index, which was used to measure stocks at that time, had declined 33 percent.

Currently, the NSE has had a major drop in all counters with majority going even below their 200 day average.  Kenya Airways for example has lost by over 50 percent from a high of Ksh. 137.00 to the current price level of Ksh. 60.00. Going by the current supply levels, chances are that the price could hit Ksh. 18.00, a level that the counter traded at more than a year ago.  The only two exceptions to this trend are Scangroup and Pan Africa Insurance Holdings Limited.  For Scangroup, its price has remained sturdy trading at between Ksh. 20.00 and Ksh. 22.00. For the latter, the current lock up period could be the reason for the stability in the counter.  Notably, CFC Financial Services and Standard Investment Bank, the underwriting companies had promised to absorb excess liquidity and there is still the underlying lock up period (24 months) which expires next year. 

Globally, Japan and the USA have shared a similar situation to what Kenya is experiencing today.  In Japan for example, there was a general decline in all counters in the 1980’s.  The market prices however retracted and gradually rose to above trading levels before the fall-correction.  Similarly in the USA, high level technology companies posted a major price appreciation that later reversed.  Investors in both these situations had made money but panic sellers still rocked the market. 

Although many investors, especially the corporate have been buying to average down their positions, a further drop could spell doom to majority of the Equity Fund Managers.   

Simply put, the current situation is no more than a normal price correction.  One tell-tale sign of this is the amount of credit balances lying in clients' accounts.  During this period, credit balances are expected to be high as more investors choose to hold their funds other than utilize the cash in trades uncertain of how low the market can go. 

It would be hard to tell how long the current situation persists as well as how low the index will hit.  The market, after correction, will re-emerge stronger than it was.  Most speculators will opt to try less risky investments while companies will end up having new shareholding structures as new entrants take advantage of the low prices.  The brokers cannot be left out of this; back office activity is likely to be heightened as fundamentals will be on the frontline of any buy/sell recommendations.  As for the regulators, we are likely to have more indices being developed to cover every sector as well as the general market.

The breed of investors will completely change, so will the need for portfolio diversification among the low net worth investors, that is, looking beyond equities.

By Michael Musau
CEO Emerging Africa Capital
Licensed by The Capital Markets Authority as Investment Advisers

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