STOCK TRADE – MONKEY BUSINESS:
Approx. reading time: 9 minutes
© Charles Njue 2010
Paul Samuelson:
Nobel Peace Prize winner in Economics
If you replace the words 'random selection' with 'monkey selection', then you have the story I am trying to tell here.
Initial Public Offering (IPO), trade jargon that meant little to the most investment savvy Kenyan ten years ago. Now share splits and bond issues are common street talk even in downtown Nairobi. The NSE Market capitalization capped One trillion in April of 2010. In just five months the NSE 20 Share Index went up by 37% outperforming other major stock markets such as in Nigeria, Ghana and South Africa which grew by 24.7%, 14.75% and 2.49% respectively. The NSE is currently ranked as the second most vibrant stock market in the continent. The bourse largely owes this to another one of Kenyans favourite economic terms of the late 90's – Structural Adjustment Programs (SAP) which were measures taken by a hemorrhaging government facing imminent bankruptcy after years of public looting. The only feasible plan was to divest off state owned corporations. First to go was the giant electricity generating monopoly KENGEN. Soon thereafter, the government offloaded over 50 billion worth of its shareholding in the market leader Safaricom. What happened immediately after that offering? Well, let's just say that it changed forever the Nairobi Stock Exchange. That IPO was 532% oversubscribed. The writing was on the wall; Wall Street came to Kenya: Kenyans had lots of spare cash, Kenyans yearned for non conventional vehicles of investment. Multibillion blue chip multinationals rushed to this market, and like they say – the rest is history.
There's something I'll tell you about the caliber of Kenyans investing in the NSE; this is not your average Godfather hat wearing, double breasted, safariboot clad Kikuyu wheeler-dealer. NO! These are highly intuitive, intelligent, educated individuals with big titles in gold letterings on glitzy biz cards from lush offices in blue chip companies. These are people who have done their due diligence, have sought the opinions of their equally as brilliant financial planners; they know market fundamentals and have tucked in between their dark-wood bookshelves the best investment guide books. Ask what a yield curve is and you're likely to end up humiliated by the very limited scope of your own knowledge. If it's any consolation, and I bet it is, there's a good measure of certainty that their money is safe – these are mostly reputable companies with strong balance sheets and good prospects for the future. No one is likely to be loosing their money – but as for the expectation of making a quick buck? Well, that's a different thing all together.
Let's Separate Fact From Fiction:
Here are two facts about stocks: (1) stocks are bought and sold with the future in mind – speculative trade and (2) people act quickly on information about the future performance of a corporation whose stock is traded. Taking the two facts together we conclude that stock prices quickly reflect the most recently acquired information about the future of the corporation that issued the stock. Traditional vehicles of investment; by this I mean (a) manufacturing and distribution, (b) housing and real estate, (c) contracts and orders (d) service industry, may be somewhat less dynamic, inflexible and capital intensive, but they are more predictable and comfortable for people not wishing to have self induced cardiac arrests. Consider a restaurant owner who has just printed new menus. If demand falls it is unlikely that he will immediately try to sell his restaurant, he'll not even flinch over the fact that he just put untenable prices for meals, he is unlikely to do as little as discard the menus. He is likely to sit it out for a while, considering the costs of printing new menus, annoying his clients with erratic prices, and worry little about loosing his investment. But what's the scenario with securities? Prices can change by the minute. And I am not kidding; the stocks market is as volatile as quick sand.
But What Makes the Stock Markets so Volatile?
That's like asking why people don't ever get enough! The answer is simple – GREED - the all time human super motivator. People want more all the time. Greed for a quick buck sets up speculation; people are no longer interested in buying into companies for dividends, NO! 99.9% of people who buy stocks do so for speculative purposes. I guess the question here then is "How does speculation result in changing share prices? Especially if the fundamentals have not changed?" Once again the answer is simple:-Insider Trading: more economic jargon, which when paraphrased means gossip. What you pay your investment manager for, what makes one stock trader better than the other is his ability to acquire gossip. The faster a trader can acquire information that is not yet public, the better his chances of minting money – I say minting here because he churns money out of nothing other than information that is only known to a small group of people called insiders.
I'll give a hypothetical example; the Safaricom mobile phone money transfer service M-Pesa is a major factor in determining consumer preference. Jack, a business editor with a major daily, has a contact at the treasury, a clerk called Emma, who has a friend called Tom who works in high places at the treasury. One day Tom tells Emma that they have received a request from Safaricom's main rival Zain, to run a similar money transfer service. The next morning Jack's privy to that info. What happens next clearly demonstrates the distortions likely to happen for greed's sake. Does jack print the story? No! He instead calls Jim - the CEO of Grapevine Stock Brokers. The next morning as the trading bell rings on the floor, Grapevine offloads three million Safaricom shares at 6/- for a total sum 18 Million. Jack runs the Zain licensing story three days later, and all other stock brokers rush to sell their Safaricom shares. The share drops to 3/-. At this juncture, Grapevine starts buying back the share. With the 18 million they got, they can now buy twice as many shares – 6 million.
Why are they buying? Because Jack printed only half the story- the other half was that the Central Bank had expressed concerns over mobile based money transfer schemes and the Zain application had little chance of approval. When people eventually learn that there never was an actual threat to Safaricom's dominance, the share climbs to 8/- higher than it was initially. So Jim's 6 million shares are now worth 48 Million. How much has Grapevine made? They started off with 18 million; a few days later they have stocks worth 48 million – 30 million out of nothing? Well, not exactly nothing; could money have changed hands? Could Jack have induced Emma in anyway? And could Jack have sold this info to Jim?
Here comes the coin flip: (see the other side)
Let's change the scene; exit the investment manager, enters the monkey. Is one more competent than the other in choosing stocks within broad classes? I've heard many things said by very learned persons about our closest cousins. It's been said, for instance that a thousand Columbus monkeys, hitting randomly on keyboard keys for a thousand years would eventually type the encyclopedia Britannica, and immediately lapse back to utter nonsensical chatter. Get my drift? Writing the Britannica is no normal fete by any standards, but then neither is trading the markets. Stock traders, business editors and investment managers will say everything they need to say, after all they are chasing a portfolio, but the fact is that making money out of stocks is nothing but pure monkey business – you stand no better chance than an ape throwing darts at the charts or a rodent dashing from one bar graph to another. Here's the indisputable proof:
The truth is that in the absence of insider information, stock trading is nothing short of utter guess work. Consider two stocks each trading at 100/=. Company ABC just got a large government contract, while company XYZ just recalled thousands of defective products. We would expect the stock of ABC to be bid up, and that of XYZ to fall. At the end of the day, ABC stock will be selling at 100 + and XYZ at 100 -. Many economists predict that the price of ABC stock will rise sufficiently (and the price of XYZ will fall sufficiently) so that after the price adjustments have taken place, the ABC stock is no better and no worse a buy for the price than the XYZ stock. Lost? Let me explain. Why is XYZ stock now cheaper than ABC stock? Because XYZ represents a less valuable item. Should its value appreciate, so will its price, and should the two be of equal value, so will be their prices. They will ALWAYS be at equilibrium when their values are compared. 10kgs silver are worth the same as 1kg gold; so are you better off buying 10kg's silver or 1kg gold? What all this suggests is that there are no uniquely good or bad buys in the stock market. Distortions come in only when there's insider trading. Maybe you should be asking "Is insider trading legal?" Do you think it should?
Breaths or Bubbles?
Caution's what's needed, especially in pubescent markets like the NSE; there are no precedents here. There's a huge possibility for instance, that the NSE may be experiencing a 'stock market bubble' like the 'dot.com bubble' in USA bourses during the late 90's, where prices of stocks shot up without any substantial reason. A stocks market bubble is a massive rise in stock prices caused by a wave of public enthusiasm and mass behavior that gives rise to an exaggerated bull market. Generally, stock market bubbles are followed by stock market crashes, like the great crash of October 29, 1929, prior to the great depression in northern America. Surprisingly, none of the crashes has ever been forecasted even by great economists. Just 14 days before the great crash of October 29, Irving Fisher, a distinguished economist, said that in a few months he expected the market to be much higher, only for it to collapse in less than a month.
The NSE market index has hit an historic high of 5,654.46, which is comparable to the United States NASDAQ (National Association of Securities Dealers Automated Quotations) index of 5,048.62 in July 2000 just before the 'dot-com bubble' burst. The market index has never been this high and the probability of it dropping is more likely. Besides, there's a curiosity about most of the stocks; they have a P/E (Price/Earnings) ratio of more than 22, meaning that, an investor will take 22 years or more to double his investment. This is simply unrealistic and clearly reflects the existence of a bubble in the market. 'Is the NSE trading in a bubble?' Nobody has ever predicted the 'when' and 'how' of bursts. Just before the burst, the market will always look so promising and attract some late comers. Unfortunately, they are hit the most, and the Kenyan scenario would be worse; investors buy the over valued shares using borrowed money. Let's all just hope that the bull run at the bourse is just a breath and not a bubble.
References :
- Roger A. Arnold – 'Economics' second edition 1992 pg 478
- Paul Samuelson - "proof that properly discounted present values of assets vibrate randomly," Bell Journal of Economics and Management science 4 (Autumn 1973): 369-74
Other Economics Related Essays:
- Poverty; the facts you may not have known
- Economising fate
wolf of wall street - banned in Kenya, but clearly demonstrates this point
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