A case for the banks

In 2011, I have noticed the divergence in performance between the banks and manufacturers on the Nigerian Stock Exchange (NGSE). Interestingly, looking at the performance of the Nigerian Stock Exchange All Share Index (NSEASI) over the past two years, I have found that events in the banking sector have been central to its overall fortunes over the period -as has been the case since the banking sector recapitalization in 2004. In recent weeks, I began to have hinged my expectations for recovery of Banking sector--and overall index--performance on attractive valuations and more importantly, the reduction in the uncertainties that have rocked the sector amid the resolution of the lingering crisis. On the latter point, I see the recent bad-loan purchases by AMCON, prospective merger deals and the approach of CBN deadline as reasons why uncertainty should decrease. However, I would like to demonstrate that this is in fact so.

 In order to achieve this, I examined two measures of market risk: quarterly standard deviation (SD) of the NSEASI daily returns and quarterly down-side deviation (DD) of daily index returns, for trend (I also got identical results in examining monthly figures). Both measures of volatility have declined since Q3’10, when AMCON was inaugurated, and even more so from the peak in Q2’09 when the current crises reached a head. In fact, both measures of volatility are near 5 year lows; suggesting a dissipation of the “fear factor” in market sentiment. In addition, I have verified that much of the market’s woes were indeed caused by the banking sector by comparing the patterns in market volatility to major announcements in the banking sector. My research shows an overall correlation of ~0.6 between banking sector related announcements and index volatility.

In my view, the combination of attractive valuations and a decline in downside deviation presents a compelling entry point into banking stocks, offering relatively limited downside and strong potential upside. In the light of the generally positive earnings results in the banking sector in H1’11 and impending resolution of sector problems (including the recent nationalization of three banks), this analysis buttresses my conviction that the sector presents very favorable opportunities at this point in time.