February 8, 2022/Coronation Research

A month ago (10 January 2022) we wrote “Beware the January rally“ and pointed out that equity market rallies in January have a habit of unwinding later in the year. What do we have to say now? 

FX

Last week, the exchange rate at the Investors and Exporters Window (I&E Window) closed flat at N416.33/US$1. Elsewhere, the foreign exchange (FX) reserves of the Central Bank of Nigeria declined by 0.34% to US$39.98bn – the lowest level since October 2021 – as the CBN continues to intervene in the FX markets. Nonetheless, our view remains that the CBN’s position is strong as the level of FX reserves remains high in the long-term context. It seems likely that stability will be maintained in the I&E and NAFEX rates in the near and medium-term. 

Bonds & T-bills

Last week, trading in the Federal Government of Nigeria (FGN) bond secondary market was mixed with a bullish tilt as investors continued to trade cautiously over uncertainty on the direction of yields. The average benchmark yield for bonds fell by 1bp to 11.63%. The yields on the 3-year (-5bps to 8.73%), 7-year(-9bps to 11.79%) and the 10-year (-11bps to 11.98%) bonds tightened. Nevertheless, we reiterate our expectation for a rise in bond yields 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 this year. 

Activity in the Treasury Bill (T-Bill) secondary market was also mixed, albeit with a bearish bias, as the average benchmark yield for T-bills rose by 3bps to 4.37%. However, the yield on the 293-day T-bill fell by 1bp to close at 5.10%. At this week’s auction, the Debt Management Office (DMO) is expected to roll over N98.01bn (US$235.6m) worth of bills across the standard maturities. Elsewhere, the average yield for OMO bills expanded by 27bps to 5.48%;the yield on the 242-day OMO bill closed flat at 5.71%. 

Oil

Last week, the price of Brent rose to as high as US$94.00/bbl, the highest level since 3 October 2014, before settling at US$93.27/bbl (+3.60% w/w). This marked the seventh consecutive weekly gain for the commodity. Consequently, Brent is up 19.92% year-to-date and has traded at an average of US$86.40/bbl, 21.88% higher than the average of US$70.89/bbl in 2021. Oil prices continue to be supported by expectations of global supply tightening following the decision by Organisation of the Petroleum Exporting Countries and its allies (OPEC+) not to increase supply beyond the 400,000 bbl/d planned for March. This comes amidst ongoing tensions between Russia and Ukraine. 

Elsewhere, there are signs of progress on the discussion around reviving the 2015 Iran deal as the US President Biden’s administration restored several sanction waivers. The expectation is that if the US lifts sanctions on Iran, the boost in oil shipments would add to global supply significantly. However, this is yet to be reflected in oil prices which are predicted by some traders to hit US$100.00/bbl. We maintain our expectation that the price of Brent oil is likely to remain well above the US$60.00/bbl mark over the first half of this year, a level that historically been comfortable for Nigeria’s public finances.

Equities

Last week, in its fifth consecutive weekly gain, the NGX All-Share Index rose by 2.33% to settle at 47,279.92 points – the highest level since 19 September 2008. Accordingly, the index is up 10.68% year-to-date. Oando (+11.45%), Seplat Energy (+10.13%), Presco (+7.63%) and Guaranty Trust HoldCo (+7.21%) closed positive last week while International Breweries (-10.17%), Ecobank Transnational Inc (-7.63%) and FBN Holdings (-7.11%) closed negative. Across the NGX sub-indices, the NGX Oil and Gas (+7.69%) index led the gainers, followed by the NGX Industrial Goods (+3.41%), the NGX 30 (+2.92%), the NGX Pension (+2.30%) and the NGX Banking (+0.83%) indices. Conversely, the NGX Insurance (-1.93%) index fell, followed by the NGX Consumer Goods (-0.81%) index. 

Was January Extraordinary?

What is the optimum strategy for an equity portfolio, given the rally in the NGX All-Share Index in January, which has now extended into February? January’s rise of 9.15% outstripped the previous year’s entire gain of 6.07% and took the index level to heights not seen since 2008. Is this exceptional and does it point to a strong equity market for the rest of 2022? 

The first question is straightforward to answer. Over the past 12 years there have been 8 rallies in January. Five of them led to full-year rallies and three did not. If we look at the average rise during the five most recent January rallies (see line chart) it was 10.66%, so January 2022’s rise of 9.15% is not exceptional in this context.

The second question is difficult to answer. In most cases (seven out of eight) when there was a January rally over the past 12 years, it was cheaper to buy the market later in the year (see column chart). Such a simple statistical approach might suggest selling now. 

However, there is more to this than meets the eye. On two occasions (2010 and 2012) the downside was limited and holding onto shares would have paid off in terms of dividends received (assuming dividend yields in the region of 5.0%). Both years delivered handsome full-yearreturns for the NGX All-Share Index (18.9% and 35.4%,respectively). 

In two years, 2014 and 2020, there were profound, and very visible, macro-economic shocks that led to stock market losses (the oil price crash in late 2014 and the outbreak of the Covid-19 pandemic in 2020). In both cases it was possible to anticipate the effects of these on the equity market and adjust portfolios accordingly. In 2014 the NGX All-Share Index made a negative return of 16.1% and in 2020 there was a full-yearrally of 50.0%. 

In 2018 the market fell quite consistently after January, and in the second half of the year reacted negatively to rising Naira market interest rates, closing the year down 18.4%. In 2021 the market corrected in the first half of the year as Naira market interest rates rose but then rallied in the second half as the threat of further interest rate rises receded and closed up 6.1%. 

Although we think that over the course of the year market interest are likely to rise, liquidity conditions in Naira T-bill and bond markets have been strong recently, with rates trending down. So, it may be too soon to call the top of this rally (which, indeed, has extended into February). We also note that, in many cases, equity valuations are not stretched at the moment, so in these conditions, investors have incentives to pursue bargains. 

In any event, our technique – our core approach – is not to make binary calls on the direction of the market, up or down, but to buy value when we see it, and to avoid trouble (i.e., steep market declines) as much as possible. We will not call the top of the market today but will be very sensitive, given the history of January rallies, to changes in market interest rates, changes in oil prices and changes in macroeconomic conditions going forward. January rallies have a habit of not lasting. 

Model Equity Portfolio

Last week the Model Equity Portfolio rose by 2.57% compared with a rise in the NGX Exchange All-Share Index (NGXASI) of 2.33%, therefore outperforming by 24 basis points. So far this year it has gained 9.03% against a 10.68% gain in the NGX-ASI, underperforming it by 165bps. 

What went right last week? It was the strong performance from Seplat, an oil producer in which we hold a nearly-double overweight notional position. 

What has gone wrong so far this year? Our proprietary performance attribution model is our essential guide. For a start, we were not aware in advance of the listing of BUA Foods on the first trading day of the year, 4 January, with a considerable index weight but little information to go on. It has rallied 61.0% since then. Say it had a 3.5% index weight to begin with, a 61.0% rally delivers 214 basis points (bps) of performance; so, we missed out on that. Second, we have held an average cash position of close to 12.0% so far this year (we usually do hold at least some notional cash) and in a market that rallies 10.7% this is likely to cost 128bps. So, in the context of a possible level of underperformance of 342bps, perhaps our underperformance has not been too bad. All the same, we will work hard to made it up as soon as possible.

We have also seen some steep climbs this year in some mid-cap stocks like ETI Transnational, Guinness Nigeria and International Breweries, in which we do not have notional positions. Last week we asked: “Which mid-cap stock is going to rally 40.0% next week?” Our response was to begin to build positions in Guinness Nigeria and Flour Mills of Nigeria. Not for the first time, last week we were unable to execute our strategy of making a notional underweight in Airtel Africa due to liquidity constraints and we continued to delay making a notional overweight in MTN Nigeria for a while, waiting for the shares from December’s share offer in MTN Nigeria to settle. These are due to settle by 18 February 2022. We saw some liquidity in Custodian Investment and took the opportunity to add to our notional position (now 0.8%). 

This week, we will continue to lighten our notional holdings of banks, with up to 300bps of notional sales. We will lighten our notional position in MTN Nigeria, anticipating the effects of share settlement on 18 February and the potential for shares to flow into the market. We will make sufficient notional sales in Dangote Cement in order to bring this down to an index-neutral position (it is 90bps overweight at the moment). We will build up our notional position in Flour Mills of Nigeria to a neutral weight. We take any further opportunity to build up our notional position in Custodian Investment, liquidity permitting.