Troubling Times
Last week, global equity markets dipped sharply as the European debt crisis worsened and the US congress’ super-committee failed to reach an agreement on budget deficit cuts. In a week that capped of what is on course to be the worst November for global equities since the financial crisis in 2008; the Dow Jones Industrial Average fell 4.8%, the S&P 500 Index dropped 4.7%, the Nasdaq Composite sank 5.1%, the DAX index dipped 2.2% and the CAC 40 index declined 1.9%. In my view, global equity market performance thus far in November has been a response to the high degree of uncertainty surrounding the nearly endless array of negative outcomes that the political deadlock in western nations could impose on the global economy and markets. For the Nigerian equity market, my research shows that global uncertainty is a key drag on performance, due to increased integration with global fund flows and the continued dominance by foreign investors who appear unmoved by attractive valuations.
European Debt Crisis – a global problem
While much of the focus on the Euro debt crisis has been on Greece and its risk of defaulting, in recent weeks, that focus has shifted to a shortage of liquidity in the European debt markets. Global banks, in their struggle to maintain credit ratings, have aggressively reduced exposure to troubled European sovereign debt. This selling pressure has further compounded the problem by triggering a renewed surge in government bond yields and forcing more countries into higher debt burdens and bigger deficits. As things stand, it is clear that the measures taken thus far to stem the crisis have been insufficient and that the risk financial of contagion of global credit markets from a severe European bank deleveraging is more likely.
No silver a bullet
In my view, resolving the Euro crisis will require a variety of adjustments to the European Union treaty to give greater autonomy to the European Central Bank (ECB), as well as a write-down of significant amounts of peripheral European sovereign debt. Furthermore, I suspect that it will also require the creation of a commonly issued Euro-bond to contain the debt crisis. Thus far Germany has resisted this proposal; however there are growing indications that its tone is changing (after an unsuccessful bond auction last week and a significant spike in its borrowing cost) and that this solution may well be in the offing. Regardless of what happens with the debt crisis itself, a recession in Europe now seems to be a foregone conclusion. However, if policymakers are able to come to an effective resolution soon, the recession is likely to be moderated. I am not optimistic about this outcome and have begun to project the extent to which a European recession would impact the global markets.
Outlook: Tepid growth & increased volatility
Lost in all of the Euro debt brouhaha and US political headlines, is the fact the US economic data has shown a gradual improvement (with the notable exception of last week’s downward revision of third-quarter GDP growth) and while growth in China, India and Brazil have slowed, the fundamentals of emerging market growth remains strong. As such, I expect Q4’11 global GDP to come in at better than Q3’11’s as yearend consumer spending boosts economic growth. This should create firmer footing for stocks, however for the time being I believe global markets will remain focused on the short-term headlines, as they have all year.
What does it mean for NSEASI?
My research shows that the performance on the Nigerian Stock Exchange has increasingly mirrored trends in other major frontier markets and, to a lesser extent, patterns in developed markets. In particular, a correlation analysis shows that daily performance of the NSEASI has a 90.63% correlation with the MSCI Frontier Markets Index in 2011. Further analysis reveals that the daily performance of the NSEASI has a -0.847 correlation with the one day lag of the changes in the VIX (Chicago Board Options Exchange Market Volatility Index[1]). These statistics suggest that the Nigerian market are increasingly linked to global capital flows and is unlikely to avoid the significant headwinds likely to affect global markets in 2012.
My outlook suggests continued volatility across global markets. In fact, I have seen the VIX reach 50 during the height of the sell-off in 2010 and 2011. Compared to 2010, the VIX has traded higher in 2011 and with a longer period of heightened volatility. On balance I expect this trend to continue into 2012 and to spike as global headings emerge. In particular, a key risk to the VIX is the European Financial Stability Facility (EFSF) package which “kicked the can down the road” effectively reducing the risk of a small loss at the expense of potentially increasing the chance of a larger one later. All in all my outlook suggest the trading patterns on the Nigerian market in 2012 could resemble 2011’s as it moves in line with increasingly volatile global markets − with even greater volatility.
[1] The VIX is a popular measure of the implied volatility of S&P 500 index options. Often referred to as the fear index or the fear gauge, it represents one measure of the market's expectation of stock market volatility over the next 30 day period.
