……….But Upside Remain in Nigerian Stocks amid Heightened Risks
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July 8, 2022/FSDH Research
Global Equities Succumb to Pressure…Outlook remains gloomy
Investors across the global equities market were in for a bumpy H1-2022 as several risks ranging from persistent inflation to rising recession fears weighed on investor sentiments. The dismal performance of the global equities market was reflected when the iShares MSCI World ETF (an ETF of global equities) lost 21.0% in H1-2022. It should be noted that no market category was left out of the rout as developed, emerging and frontier market equities all faced the brunt of investor panic. That said, investors in commodity-focused companies (metals and energy) were on the defensive side of the market as rallying crude oil and metal prices supported momentum in their share prices. In this month’s note, we examine the factors that have influenced market performance as well as provide guidance for investors with exposure to the US and European equities market.
In the US, the primary concern for investors was the surge in inflation and the subsequent policy response of the US Federal Reserve (US Fed). According to data from the Bureau of Labour Statistics, headline inflation rate surged to 8.6% in May-2022, from 7.0% at the end of Dec-2021. Thus, indicating the broad based price pressures from the Fed’s prior over-extended accommodative stance, higher energy cost and elevated food prices. In response, the Fed initiated its policy normalisation attempts by raising the Fed Funds Target Rate by 150bps to 1.5%. The resultant impact was a surge in yields and subsequent asset rotation from equities. Later in the quarter, inversion of the yield curve raised fears that the Fed’s policy normalization posture and surging inflation (which was hurting consumer pockets) could push the US economy into a recession. This was corroborated by downbeat growth revisions by major global economic institutions, downward revision of earnings guidance, headcount downsizing by major corporates and negative commentary from top listed companies’ CEOs. Overall, the first half of the year was filled with mainly negative headlines for equity investors, leading to broad based losses with growth stocks taking the worst hit as evidenced by the 29.5% loss in the tech-heavy NASDAQ. Similarly, the S&P 500 (down 20.6% YTD) and DJIA (down 15.3% YTD) closed H1-2022 negatively, as the S&P 500 slipped into bear market territory.
In Europe, the narrative was similar to developments in the US equities. Inflation in the Eurozone surged to multi-year levels with major economies like England (surging 370bps to 9.1%) and Germany (surging 230bps to 7.6%) leading the way. Interestingly, the European Central Bank (ECB) has been fairly accommodative relative to other major policymakers in combating record level inflation. Nevertheless, this was inadequate to bolster sentiments as the onslaught of the Russian-Ukraine crisis outweighed other events within the European equity markets. Following the invasion of Ukraine by Russia, significant growth concerns emerged, as the impact of surging inflation on consumer pockets and supply-side bottlenecks on corporate’s earnings performance caused trepidation for European equity investors. Overall, the bearish performance posted by European equities was reflected in the slump in the pan-European STOXX 600 index (down 16.5% YTD). Similarly, the performance across the major European equities markets was a synchronised downturn as the German XETRA DAX (-19.5% YTD), French CAC 40 (-17.2% YTD) and UK’s FTSE 100 (-2.9% YTD) all closed lower.
A question for investors as we approach the second half of the year: “Is the worst over for global equities?”. To answer this, we examine a number of factors including; Inflation, Policy Normalisation, Likelihood of a Recession and Corporate Earnings Outlook. First, inflation in the US and across European economies is expected to continue to remain broadly elevated on high energy cost, unabating food price pressures and lingering impact of the prior prolonged accommodative monetary policy stance. We expect rate hikes to remain a domineering headline in the second half of the year with the US Fed and ECB stating their inclination to maintain a hawkish policy approach. This will continue to impact negatively on stocks in two ways. In addition, hawkish policies would continue to drive fixed income yields higher fueling sustained asset rotation from equities. Finally, higher interest rate implies it becomes more expensive for consumers to take mortgages and service credit card debts, causing a slowdown in general economic activities.
Another concern for US and European equity investors in H2-2022 is recession fears. As earlier highlighted, rising interest rates will continue to dent the ability and willingness for consumers to take on more debt for consumption while surging inflation (without commensurate increase in wages) will pile more pressure on purchasing power. The effect of this is a negative domino on economic activities, significantly raising probability of a recession. In addition, a recession raises the risk of further depressing corporate earnings performance. That said, the positive of a recession is the likelihood that the US Fed and other major policymakers may consider slowing down on rate hikes to allow consumer and corporate spending to recover, a potential sweetener for equities.
Overall, as our position has been since the start of the year, we continue to remain bearish on US and European equities. Hawkish monetary policy, possible prolonged period of recession fears and weaker corporate earnings are all factors that we expect to weigh on investors’ sentiments in H2-2022. As a result, we see further downside for US and European stocks and advise investors to continue to remain patient before taking positions.
Nigerian equities record strong H1-2022 performance…But is there still value in the market?
Nigerian equities recorded a strong outing in the first half of the year as the benchmark NGX-All Share Index (NGX-ASI) gained 21.3%, outperforming the MSCI Frontier Market index (-19.5% in H1-2022) and MSCI Emerging Market index (-18.8% in H1-2022). The healthy performance of Nigerian equities in H1-2022 was underpinned by several factors. First, corporate earnings performance remained very strong as listed Nigerian corporates continued to defy the hostile operating conditions. For context, the weighted average growth of Net Profit of the top 10 most capitalised stocks on the NGX (accounting for 83.4% of total market capitalisation) printed at 36.3% y/y in Q1-2022. In addition, the interest rate environment was broadly accommodative for equity investors as the CBN defaulted to being interest rate defensive in H1-2022. Thus, despite implementing a 150bps hike in its benchmark policy rate, the CBN contained the direct impact on interest rates via budget support for the government, interest rate repressive policies and moral suasion of banks. As a result, average yield across the yield curve has declined 21bps YTD. This accommodative yield environment provided a boost for Nigerian equities performance.
In analysing the performance of the different sectors of the Nigerian equities market in H1-2022 reflects the strength of solid corporate performances. The Oil & Gas sector led gaining 58.1% as strong gains in oil price fed buy interest in SEPLAT (+100.0% YTD) while CONOIL’s (+30.9% YTD) outstanding FY-2021 performance and dividend announcement drove further gains. The Telecoms sector also delivered outstanding price appreciation following gains in AIRTEL AFRICA (+81.4% YTD) and MTNN (+16.8% YTD). The Industrial goods (+7.2% YTD) and Consumer goods (+5.9% YTD) sectors also delivered a decent outing in the first half of the year as most companies in the sector benefitted from being able to raise prices amidst the high inflation environment. On the flipside, the Insurance (-10.0% YTD) and Banking Sectors (-2.0% YTD) delivered no value to investors as regulatory bottlenecks and rising competition from fintech alternatives continue to weigh.
Following the relatively strong outing for Nigerian equities in H1-2022, the question on the mind of investors is; “Is there still value in Nigerian equities?”. To answer this question, we examined the current valuation of Nigerian equities relative to historical pricing and peer pricing. At the end of H1-2022, the NGX-ASI traded at a PE ratio of 10.5x, a 14.5% discount to its five-year average and the MSCI FM. Interestingly, Nigerian equities have continued to deliver above historical average earnings growth, implying they should be trading at a premium to five-year average PE ratio of 12.3x. Thus, we estimate the fair pricing of Nigerian equities at 14.0x – 15.0x PE ratio, implying an c.40.0% upside in value for Nigerian equities. Despite the existence of this value, concerns border around if the value will be realized amidst various headwinds including Pre-election jitters and Hawkish Monetary Policy.
The first concern for us is the hawkish monetary policy environment which historically has proved to be a concern for investors in the equities market. Since the Emefiele CBN-led Monetary Policy Committee (MPC) took office, the MPR has been raised thrice, with the benchmark NGX-ASI losing an average of 2.3% within the first month of the rate hike but going on to gain 4.7% and 0.5% in the subsequent 3-month and 6-month period. Thus, we establish a clear pattern of an initial negative reaction to rate hikes but subsequent correction in the long run due to lack of immediate impact on the yield curve. In H2-2022, we expect the MPC to maintain its new-found hawkish policy tilt in an attempt to rain in on inflation. However, we expect the CBN will continue to contain any impact on yields, making fixed income instruments unattractive despite rising MPR, a move it successfully deployed in H1-2022. Thus, we believe the prospects of additional rate hikes would not have significant negative impact on equities unless the CBN finally lifts the lid on interest rate.
Another factor to evaluate is the upcoming 2023 general elections, a critical factor for the equities market in the final six months before the election year. Taking a cue from history, in second half of a pre-election year, the NGX-ASI has lost an average of 2.9% over the past five pre-election years (2002, 2006, 2010 and 2014). Interestingly, the NGX-ASI has lost in four of such periods out of the previous five. In addition to the dismal performance of Nigerian equities during the period, investors have historically shown uneasiness during the second half of a pre-election year as foreign investors have always exited Nigerian equities aggressively with local institutionals following suit. In today’s context, foreign investors no longer play an active role in trading Nigerian equities as they control less than 25.0% of market activities, thus we do not expect any significant selloffs from them due to current subdued presence in the Nigerian market. Consequently, local institutional investors may have more incentive to remain in the market as long as election activities don’t turn violent.
It is however critical to examine the activities of foreign investors in H2-2022. The foreign investor activity remains subdued as the scarcity of FX continues to remain a deterrent for any form of investment. The situation has been worsened by hawkish monetary policy by the US Fed and other Advanced Market monetary policy makers. Looking ahead to the rest of the year, foreign equity investors are likely to continue shunning Nigerian equities as the FX crunch is expected to persist (on declining crude oil production and lack of access to international debt markets) while the pre-election environment would further raise the risk premium for foreign investors. In our view, we recommend this equity investment strategy tilt for foreign investors due to inability to repatriate funds as well as elevated devaluation risks.
For domestic investors, we see a situation where the CBN is able to keep domestic interest rates in check despite pursuing a tighter monetary policy while pre-election activities will only trigger a broad-based market selloff if it turns broadly violent. On the other hand, we expect Nigerian corporates (particularly FMCGs, Brewers, Upstream Oil & Gas, Oil Palm and Cement companies) to continue to deliver strong corporate earnings despite the tight operating environment. As a result, we recommend domestic investors continue to explore opportunities in the previously highlighted sectors for capital gains in the equities market. That said, risks to this expectation are a decision by CBN to lift the lid off bond yields & treasury bills and a sudden violent turn in the 2023 elections.
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