Is The Ghana Stock Market Cooling Off?

The past three years has put a lot of smiles on the faces of investors in Ghana with index returns since 2001 reaching 632%. In fact, for the second consecutive year, Ghana's stock market is ranking as the best performing market in the world. However, in the past few weeks the market's rapid ascent has tapered off a bit leading some to question if the bubble is about to finally burst. Some of us believe the market is only pausing for breath after such a long bullish run but the recess must linger for several months if we should avoid a crash in the near future.

Let's recap what underpinned the bulls in the first place. The obvious reasons are years of under-valuation of equities on the Ghana bourse with historical earnings multiples averaging about 7x before 2001. These cheap valuations were the result of high nominal earnings growth supported by high levels of inflation and weak local investor participation in the buy side of the market. Also, the drop in interest rates and stability in the cedi over the past three years made the hitherto high returns on fixed income securities and hard currencies that Ghanaians were used to for many years no longer attractive compelling investors to look at the stock market.

The above conditions are no more prevalent and that should justifiably put the breaks on the market's bullish run. First of all, valuations are very high now compared to the historical average and to those of other emerging markets in Africa and elsewhere. The market is now trading at a very high earnings multiple of 22x which does not seem to adequately justify the potential nominal earnings growth of the listed equities and the risks in the market. One compelling reason supporting this view is that, with inflation at relatively low levels now, nominal growth in the revenues and earnings of listed companies should slow down. We have already started seeing this reflect in the half-year company results of several listed companies. A continued bullish run under such circumstances will only serve to create ripe conditions for a free fall in the near future.

Secondly, the fact that interest rates have fallen and have not climbed up again after over a year has also taken a lot of steam out of the revenue growth of the banking industry which is the sector that has led the gains in the market in the past three years. In fact, this was strongly reflected in banks half year financial statements with some banks posting negative growth in earnings while the others reported flat growth. The exception is Trust Bank of the Gambia which posted half year earnings growth of 42% largely because of high interest rates and high interest rate spreads currently prevailing in The Gambia.

Thirdly, with handsome gains made over the past few years, the market only needs a stimulus to trigger a herd profit taking behaviour as we saw in May to December 1998 and this could drive some steam out of the market. Recent IPO activities are helping to keep interest in the market for now. This is largely because the recently floated stocks appear cheaply priced relative to the market. Clydestone and Benso Oil Palm Plantation were all hugely oversubscribed during their recent IPO's and they have seen a strong rally in their share prices after listing on the stock exchange. The next IPO candidate is CAL Bank which on the basis of price earnings multiple is very favourably priced for the IPO investor.

The question is what will happen to stock prices after the IPO fever is over? A few years ago an answer to this question would not have been too difficult to answer. In those years, the environment was characterized by very high yields on treasury bills and the cedi was highly unstable- conditions that would have created a good excuse for local investors to take profits and invest in treasury bills while foreign investors sell to mitigate exchange losses. However, interest rates are relatively low now and the cedi has been very stable with little sign of a pending weakness. With this kind of situation we can realistically expect that the market is unlikely to crash but at the same time unlikely to continue to rally for a prolonged period. Another factor that could soften any sudden tumbling in prices is the fact that a local institutional fund management industry is gradually emerging in Ghana for which the size of the stock market currently is too small to support. Besides, the economy appears to be in a better shape now compared to three years ago when the bullish run began.

For now it makes very good economic sense for the market to pause for breath lest it gets a heart attack. But in all these, the long-term investor must stay focused.