The Nairobi Securities Exchange (NSE) 20 Share Index is seriously lagging behind the broader stock market.
Beginning January and up to August 18, the key benchmark has dropped 12 per cent while the NSE All Share Index (NASI) has climbed up some 2.8 per cent.
Naturally, you would think that such a wide divergence would grab investors’ attention, but you would be wrong.
Besides a handful of analysts and market journalists, few people are focussing on this divergence that began last May and even fewer are aware of it.
But should they? Does the growing divergence hold any value for the enterprising investor? Honestly, I do not think so. Investors are better off keeping the status quo. Here’s why.
First of all, if you have been paying attention, by now you should have noticed that the key benchmark has been dancing ‘off-beat’ compared to its peers.
In the past eight months, the NSE-20 Share index has traded down while the FTSE NSE 25 Index and FTSE NSE Kenya 15 Index have held up pretty well at 0.33 per cent and -3.14 per cent respectively over the same period.
So, why the steep divergence? Research shows that while the popular index is more reliable than the NASI, the NASI is found to be more accurate and more representative of the underlying market position.
The NASI enjoys a higher correlation (0.96) with the underlying market capitalisation compared to NSE-20 Share index (0.65). This goes to show why it is pointless to try to find any meaning to the divergence.
Having said that, investors who are eager to improve their market visibility through study of divergences should instead focus on intermarket divergence (bonds vs stocks).
Historically, stocks tend to follow bonds. Rising or plummeting bond yields tell us that it is an important time to start buying or selling equities.
Year-to-date, secondary bond yields have increased (the FTSE NSE Government Bond Index is down three per cent to 87.92 basis points as of August 18, 2016)), which signals increasing optimism about the outlook for growth — an important sign that the share market is set to accelerate in the next seven to 12 months.
The catch-up trade should eventually drive up the NSE 20 Share index.
Another good reason why investors should focus on the NASI is its relative sensitivity. Although the NASI suffered from negative momentum last year just like its large-cap counterparts, it traditionally has had greater sensitivity to the broader market than its counterpart.
As a result, its ongoing resilience suggests better times could lead both for the economy and for the market as a whole.
On the contrary, though the blue chips tend to perform better on profitability and stability, their performance is affected by the fact that their stocks have a very high price and hence not affordable to retail investors.
As a result, the benchmark index is “limited” in its representation.
Lastly, the NASI simply covers a significant part of the market including small and mid-cap stocks compared to the NSE-20 Share, which mostly covers large caps — by close of Monday, average market cap was Sh33.3 billion which is 2.7 times the average market cap of the overall market — and represents roughly a third of the market.
For these few reasons, please save your time, keep your eyes where it matters — the NASI.
This investment opinion feature was first published in the Business Daily.