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The Markets in Review: Global Market and Nigeria II – Coronation Research

Aug 23, 2022   •   by Coronation Research   •   Source: Coronation   •   eye-icon 383 views

Earlier this year we explained how US markets underwent an attack of nerves in the first half, with rising inflation, monetary policy tightening and the still ongoing war in Ukraine discouraging investors, while the Nigerian market enjoyed its disconnection from global markets and rallied. However, the tables appear to have turned since the end of June

Global Market and Nigeria II

On these pages, we have highlighted several times that global markets, including US stock markets, have no correlation with Nigeria's NGX Exchange. We explained how US markets underwent an attack of nerves in the first half of the year with rising inflation, monetary policy tightening and the still ongoing war in Ukraine, while the Nigerian market enjoyed its disconnection from global markets. Locally, growth was driven by low short-term market yields, the rally in oil prices and foreign investors taking positions in fungible stocks.


However, the tables appear to have turned as US markets began to rally after June this year while Nigeria’s equity market began to slide. After notching their worst first half since 1970, the S&P 500 (+11.71%) and the NASDAQ Composite (+15.20%) indexes rebounded, fueled by stronger-than-expected corporate earnings and hopes the economy could avoid a recession even as the Federal Reserve continued to hike rates. According to Refinitiv, analysts expected aggregate annual S&P earnings growth of 5.7% in Q2 2022. Instead, however, S&P 500 companies reported an average earnings growth of 6.7%. In addition, July saw a slew of positive macroeconomic indicators such as strong US Non-Farm Payrolls and a slowdown in US headline inflation. US Non-Farm Payrolls were up 528,000 against consensus estimates of 258,000. According to the US Bureau of Labor Statistics, the US consumer price index (CPI) rose by 8.5% y/y in July, a slower-than-expected increase compared with June (9.1% y/y) following easing of inflationary pressures

 


On the other hand, Nigeria's NGX All-Share Index has shed 4.69% since the start of H2 2022, following profit-taking prompted by tightening domestic monetary policy and a rise in fixed-income yields. The consequence of the Central Bank of Nigeria's 100bps hike in the Monetary Policy Rate (MPR) to 14.00% and the resultant squeeze in banking system liquidity caused an upward shift of the Naira yield curve and a reallocation of funds to fixed income securities. The recently concluded FGN bond auction saw yields rise by an average of 75bps. In addition, the Q2 2022 earnings season failed to improve sentiment as some large-cap stocks recorded weak earnings growth. 

However, we expect that support for the US equity market is likely to taper in the light fears of a possible global recession and the prospect of continued interest rate hikes by the US Federal Reserve to combat decade-high inflation. As can be seen in the inversion between 2-year and 10-year US Treasury yields, a factor which is frequently cited as a harbinger of a recession, we expect continued upward movement in yields as market participants position ahead for more policy rate hikes while the valuation of growth and tech stocks continue to face downward pressure. 

 For Nigeria, we maintain that fixed income yields are likely to continue to rise over the medium term owing to an expected increase in domestic borrowing by the FGN to finance the budget deficit and tight domestic monetary policy. Nonetheless, the results for Tier I banks (c. 8% of the benchmark index by market cap) are due to be released by the end of August and may give some support to the market if earning expectations are realised.

 

FX

Last week, the exchange rate at the Investors and Exporters Window (I&E Window) strengthened by 0.14% to N429.05/US$1. Elsewhere, the foreign exchange (FX) reserves of the Central Bank of Nigeria (CBN) gained 0.06% to US$38.91bn, the highest level since 9 August, improving the ability of the CBN to continue intervention efforts across the various FX windows.

Given the strength of the FX reserve position we believe that the CBN will be able to maintain this rate in the I&E Window, or something close to it, for several months.


Bonds & T-bills

Last week, trading in the Federal Government of Nigeria (FGN) bond secondary market was bearish amidst tight system liquidity. As a result, the average benchmark yield for bonds rose 13bps to close at 12.82%. Across the curve, the yields on the 7-year (+13bps to 12.68%) and 10-year (+6bps to 13.00%) bonds expanded, while the yield on the 3-year bond (-1bp to 12.11%) declined. At the FGN bond auction, the Debt Management Office (DMO) allotted a total of N200.58bn (US467.55m). However, demand was weak, as reflected by a total subscription of N247.08bn (y-t-d average: N451.58bn) and a bid-to-offer ratio of 1.10x (y-t-d average: 2.48x). Consequently, yields across the March 2025 (+150bps to 12.50%), April 2032 (+50bps to 13.50%) and January 2042 (+25bps to 14.00%) bonds expanded. Our view remains that the combination of thin system liquidity and elevated Federal Government domestic borrowing will continue to drive yields upwards over the coming months. 

Activity in the Treasury Bill (T-Bill) secondary market was mixed as the average yield for Tbills shed 1bp to 7.86%. Notably, the yield on the 293-day T-bill compressed by 1bp to close at 6.80%. At the T-bill primary auction this week, the DMO is expected to offer N295.53bn worth of bills. Elsewhere, the average yield for secondary market OMO bills rose by 5bps to 11.16%, with the yield on the 256-day OMO bill rising by 36bps to 11.25%. At the OMO auction, the CBN offered N50.00bn worth of bills: however, no sale was recorded.

 

Oil

Last week, the price of Brent relapsed, falling by 1.46% w/w to settle at US$96.72/bbl. Nevertheless, Brent is up 24.35% year-to-date and has traded at an average of US$104.24/bbl, 47.04% higher than the average of US$70.89/bbl in 2021. 

Weak economic data from China and increased speculation that the Iran nuclear deal could come to fruition added bearish pressure to oil markets at the start of the week. Later a larger-than-expected drawdown in US crude inventories helped ease concerns about the level of demand, leading to a slight rebound in oil prices towards the end of the week. 

In this exceptional year for oil prices, we maintain that prices are likely to remain well above the US$73.00/bbl set in Nigeria’s government budget


Equities

The NGX All-Share Index succumbed to a second consecutive weekly loss last week and the fourth loss in five weeks, falling by 0.59% w/w to settle at 49,370.62 points, the lowest level since 9 August. Consequently, its year-to-date return fell to 15.58%. PZ Cussons (-17.07%), Honeywell Flour Mills (-14.49%) and Cadbury Nigeria (-11.04%) closed negative, while Zenith Bank (+3.29%), BUA Cement (+1.70%) and United Bank for Africa (+0.71%) closed positive. The results across the NGX sub-indices were broadly negative, with the NGX Insurance (-1.40%), NGX Consumer Goods (-1.30%), NGX Oil & Gas (-0.87%), NGX Pension (-0.75%), and NGX-30 (-0.64%) indices declining. Conversely, the NGX Banking (+0.65%) and NGX Industrial Goods (+0.28%) indices closed positive. 


Model Equity Portfolio

Last week the Model Equity Portfolio lost 0.35% compared with a fall in the NGX All-Share Index of 0.59%, outperforming it by 24bps. It has gained 19.47% year-to-date compared with a gain in the NGX-ASI of 15.58%, outperforming it by 389bps.

Our outperformance over the past month surprises us. After all, when we last announced a re-positioning of the portfolio, five weeks ago, we decided to overweight MTN Nigeria and Dangote Cement, each by two percentage points over their index weights. While the market is down 5.0% over the past month, MTN Nigeria is down 14.4% and Dangote Cement is down 2.3%, which suggests that underperformance was on the cards. MTN Nigeria's Q2 results were good, though the growth rates in top-line Sales and Net Profits were a little lower than in the previous quarter: nevertheless the market has turned against the stock. Dangote Cement's Q2 results disappointed the market, with production levels falling due to shortages of gas, top-line Sales rising by less that the rate of inflation, and Net Profits negatively affected by high energy costs and foreign exchange translations. 

So, why did we not underperform the market? The reason is that many mid-cap stocks, in which we do not have positions, fell – for example, see how PZ Cussons, Honeywell Flour Mills and Cadbury Nigeria fared last week (page1 of this report). And three mid-cap stocks fell; namely Flour Mills of Nigeria (down 12.0% over the past month), Stanbic IBTC (down 11.3%) and Guinness Nigeria (down 7.2%), in which we have underweight positions relative to the index. And one large-cap stock fell; namely Nestle Nigeria (down 7.1% over the past month), in which we hold an underweight position. So the market fell by more (a loss of 5.0%) than our Model Equity Portfolio (down 4.72%). 

Of course, relative performance is a relative matter (albeit a source of pride, or of vanity, for portfolio managers). What matters is the absolute return and in absolute terms the Model Equity Portfolio has been losing value and slipped under the threshold of a 20.0% gain year-to-date. This kind of performance is not good news. So, what do we do next? 

To begin with, we set out to perform better than the market by choosing stocks. Some of our selections have delivered handsomely so far this year, notably Okomu Oil, Presco and Seplat, though we have lowered our exposure to Okomu Oil and Presco in recent months as international palm oil prices have faltered. We permit ourselves to hold a lot of cash (the highest level was 18.8% of the portfolio this year) if we think the market is likely to correct. But predicting the direction of the market as a whole is very difficult, and we try not to rely on our overall market judgment too much. 

For now, we continue to believe that MTN Nigeria represents good value and we also intend to stick with our overweight in Dangote Cement for the time being. We concede that we need to refresh our ideas - merely allowing the market to fall and trusting that we do not hold the worst-affected stocks is not good enough - and we will study and report back. Meanwhile, we plan no changes this week.

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