The Relationship between Macroeconomic Variables and Stock Market Index in Nigeria

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TITLE :           The Relationship between Macroeconomic Variables and

Stock Market Index in Nigeria

WRITER :       Ifuero Osad Osamwonyi and Esther Ikavbo Evbayiro-Osagie

A.    The background and research purposes

Economic theory and empirical studies considerstock prices and thus, market index to be one of the  best indicators of changes in economicactivity. This intellectual curiosity gained ascendancy in the last two decades due to the increasing belief that real economic activities often impact on stock prices. The Nigerian economy has experienced significant changes in its macroeconomic aggregates in the recent past. The inception of the

Structural Adjustment Programme (SAP) in 1986 came with fundamental economic reforms [a major aspect was the far-reaching liberalization of various sectors of the economy]. Similarly, the transition from a military to civilian rule in 1999 witnessed various programmes of deregulation, privatization and commercialization,

with implications for stock market index. The relationship between stock prices and the economy can be of a reversible model, viz: the stock market may influence the economy as found by Smith (1990), or the economy may influence the stock market (Amadi and Odub 2002). This is the case of macroeconomic variables and the stock market index. Fundamental analysis beliefs that stock prices are influenced by changes in money supply, interest rates, inflation and other macroeconomic indicators. It employs a general equilibrium approach, stressing the interrelations between sectors as central to the understanding of the persistence and comovement of macroeconomic time-series. This is the case of macroeconomic variablesand the stock market index. Fundamental analysis beliefs that stock prices are influenced by changes in money supply, interest rates, inflation and other macroeconomic indicators. It employs a general equilibrium approach, stressing the interrelations between sectors as central to the understanding of the persistence and comovement

of macroeconomic time-series.

B.     Method

The data requirements for this methodology include secondary information on key Nigerian macroeconomic variables such as stock prices, inflation rate, interest rate, money supply, Gross Domestic Product, exchange rate and fiscal deficit. Data on interest rate, inflation rate, exchange rate, money supply, fiscal deficit and Gross Domestic Product (GDP) were sourced from various issues of the Statistical Bulletin and Annual Report and Statement of Accounts of the Central Bank of Nigeria.

C.     The results of research and discussions

The first stage is to test for the stationarity properties of the variables by employing the Unit Root Test. The results obtained showed that four of the variables passed the unit root test in their level form, while the other four vari ables passed the test in first difference form. See Table 1 for a summary of the unit root test results. Consumer price index as proxy for inflationrate is positively related to SMI in both the short run and long run, but it is only significant in the long run (Table 4) at 1% level. The explanation for this relationship is that increasing inflation in the economy pushes the prices of stocks and thus market index upward, especially

when returns to stocks are expected to rise. On the other hand, it was expected that a high and

rising inflation rate serve to erode the real value of financial assets, stock prices inclusive. It is indicative that wealth holders would tend to shift their wealth holding in favour of real assets to the relative neglect of financial assets. GDP is not significant in the short

D.    Conclusion

This study was designed to evaluate the relationshipbetween selected macroeconomic V ariables and SMI in Nigeria . We expected a relationship between SMI as proxy for stock prices in Nigeria and selected macroeconomic variables. The model was tested using Nigerian data and we found that SMI are influenced by some macroeconomic variables. Optimal policy options are required to manage the determinants that were found significant such as M2, ER, CPI, GDP, and capital market growth. Inflation targeting has become important while adequate securities market supervision should be quickly internalized. In line with this, the results also suggest the need for policy makers to design policies that will help to curtail rapid growth in money supply. There is also the need to formulate policies that are capable of enhancing the national income of the country. Export policies should be encouraged, as they rise to the issue of balance -of- payments deficit or surplus and also responsible for the appreciation or otherwise of a nation’s foreign exchange.