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March 7, 2023/FSDH Research
What impact did Nigerian elections have on its financial markets, and what can investors expect?
A week ago, Nigerians headed to the polls to elect a new President. Interestingly, this coincided with a period of synchronized rally across several of the country’s financial instruments in the fixed-income and equities market. This has raised speculation that optimism regarding the emergence of the ruling party’s Bola Ahmed Tinubu drove the rally across these instruments. As a result, it becomes imperative to provide clarity on the bullish momentum, its drivers and what the investor community can expect under the Tinubu-led administration.
In the run-up to the general elections, the Nigerian equities market, sovereign bonds, and Eurobonds market were on a bullish streak. For context, in the week before the general elections, the average yield across Nigerian sovereign bonds compressed by 12bps. Similarly, average yield across Nigerian Eurobonds compressed 30bps during the week, as equities gained 2.1% in the same week ending 24-Feb. As a result, it was unsurprising that sentiments remained upbeat even as the election results poured in, indicating an early lead for the eventual winner, Bola Tinubu. On the back of the announcement of the election results, momentum on Nigerian sovereign instruments dissipated as the average yield on domestic bonds and Eurobonds inched higher by 7bps and 2bps, respectively (1-March vs. 24-February). However, the equities market remained on course, as the NGX-ASI gained 1.0% (1-March vs. 24-February).
That said, it is imperative to state that the observed movement across these key financial instruments was not indicative of investors’ perception of the outcome of the elections. First, in the Eurobonds market, the rally was broadly driven by improved demand by investors as they sought to reinvest coupons earned during the month. For proper context, investors in Nigerian Eurobonds received the sum of $151.8m in coupon payments across three Eurobond instruments in the week leading up to the elections, which some investors sought to reinvest, driving demand. In addition, the rally was broad-based across SSA Eurobonds, reflecting bargain hunting by investors following weeks of persistent losses across these instruments due to elevated debt risk concerns (such as Nigeria’s credit rating downgrade). For domestic bonds, improved demand from coupon payments during the week leading up to the elections (summing up to c.N66.8bn) and attractive pricing following recent downward price pressures underpinned the rally observed in the country’s domestic bonds. Lastly, for the equities market, several large-cap corporates, in an attempt to meet the NGX deadline for filing results, released their FY-2022 numbers in the lead-up to the elections, sparking improved risk-on sentiments among domestic equity investors as they chased attractive dividend yields in light of weak momentum in money market yields.
Source: FMDQ, FSDH Research
Source: FMDQ, FSDH Research
The outcome of the election will begin to play a key role in investors’ decision-making and strategy outlook in the months ahead. Despite the President-elect emerging from the ruling party, he is perceived to have a more pro-business stance within his overall economic management style, as evidenced during his time as Governor of Lagos state. We see room for more private sector participation which would lead to a conscious attempt to ease the operational bottlenecks of the business environment, particularly as it relates to infrastructure, foreign exchange, and security. This will likely bode well for companies listed on the Nigerian equities market, but evidence of such impact, in our opinion, remains inconclusive, hinged on concerns around political willingness and implementation capacity to see through these key reforms.
Nevertheless, it is likely that addressing the fiscal imbalance, in particular, rising debt levels will be done over a protracted period, and therefore macroeconomic fundamentals will continue to affect investment decision-making as investors remain cautious. Overall, we expect the current fiscal policy stance will remain unfavourable for fixed-income investors as it would involve aggressive borrowing and spending, a recipe for higher yields. It is expected that tax reforms and revenue generation measures will form an important pillar of the incoming administration in addition to ensuring monetary policy consistency. Getting coordinated fiscal and monetary policy right is expected to be a key signal to investors.
Nigerian Equities: Depressed money market yields extend bullish momentum
The local bourse continued its bullish run into the fourth consecutive month as sustained weakness in money market yields drove renewed interest in Nigerian equities from local institutional investors. During the month, at the CBN’s NT-bills auction, the stop rate on the 364-day bill plunged to as low as 2.24% before firming up at the end of the month on tighter system liquidity. Furthermore, earnings announcements by a number of the big corporates across the industrial, agriculture, consumer goods, and oil & gas sectors provided a decent boost for investors’ appetite, spurring buying interest. Some of the large-cap tickers that drove the market during the week include MTNN (+8.8% m/m), DANGCEM (+4.2% m/m), SEPLAT (+20.5% m/m), BUAFOODS (+20.8% m/m), and GEREGU (+46.7% m/m). As a result, the benchmark NGX-All Share Index (NGX-ASI) climbed by 4.8% m/m to close at 55,806.3 points. Consequently, YTD return improved to 8.9%, from January’s 3.9% print, with market capitalisation settling at N30.4tn.
Source: Bloomberg, NGX
From a sectorial viewpoint, market activities were broadly bullish, as four of the five (5) major sectors under our coverage closed in the green. The Oil & Gas sector (+16.0% m/m) led the gainers as investors took an interest in oil-related stocks largely down to above-market expectations earnings announcement, reflected in large gains for SEPLAT (+20.5% m/m), and CONOIL (+76.8% m/m). Trailing were the Consumer Goods (+8.2% m/m) and Banking sectors (+4.0% m/m), on account of price appreciation in BUAFOODS (+20.8% m/m), FLOURMIL (+6.7% m/m), ZENITHBA (+6.0% m/m) and UBA (+6.1% m/m). The Industrial Goods sector followed, gaining 2.6% m/m due to bargain hunting in DANGCEM (+4.2% m/m) and WAPCO (+9.2% m/m). On the flip side, the Insurance (-2.3 % m/m) sector closed the month as the lone loser as price depreciation in MBENEFIT (-15.4% m/m), and AIICO (-4.8% m/m) weighed on the sector.
As noted in our last note, the rally in the market has been driven by a depressed yield environment (particularly in the money market) amidst elevated system liquidity, forcing big-money investors such as PFAs to focus on investing in stocks with strong earnings performance and dividend yield. Our views on the domestic equities market remain unchanged as we continue to see room for low money market rates into April (despite the recent spike in NT-bills rate), as the elevated level of debt maturities and coupon payments will keep the financial system liquid. We note that the CBN’s CRR debit tool remains a risk to our projections. In addition, we note that the relative stability in the political environment has significantly diminished any political risks that could weigh on investors’ risk appetite. Lastly, the earnings season has continued to see major listed corporates deliver solid earnings releases, supporting buying interest.
However, technical indicators (across all timeframes) indicate the Nigerian equities market is stretched and is due a pullback. As a result, we see room for profit taking in the coming weeks as investors attempt to lock profits earned, particularly as the earnings season drifts to an end. Post-Q1, we see a greater probability for bearish equity market performance premised on several reasons. First, we note that most banks are yet to release their audited FY-2022 numbers as they wait for the outcome of the Ghana debt renegotiation deal, which could have a significant negative impact on their profitability for the exposed banks. In addition, we expect yields to reverse higher by mid-Q2, improving the attractiveness of money market alternatives. When we combine these risks with the current overbought state of the equities market, we reiterate our belief that the probability of downside in the current market landscape outweighs the upside probability. As a result, we reckon the Nigerian equities market is hovering around its peak with limited upside, justifying the need to reduce portfolio exposure to Nigerian equities.
Global Equities: Mixed sentiments across global equities
February was a month of mixed sentiments across the global equities market as investors sought direction amidst a cocktail of conflicting market-moving events. In the United States (US), equities retreated as investors weighed the possibility of a more aggressive Fed in the coming months. At the start of the month, the Fed’s decision to raise the Fed Funds Target Rate by 25bps was met with good cheer by investors but was soon cut short by robust labour market data, which raised fears the Fed may reverse course at its next meeting. Depressed earnings from the big tech companies posed further pain points for investors during the month. The big news in February was the first inflation data of the year which delivered a negative surprise for investors as the Consumer Price Index (CPI) rose 0.5% m/m and 6.4% y/y, both ahead of consensus expectations of 0.4% m/m and 6.2% y/y. Furthermore, the Fed’s preferred inflation gauge, the Personal Consumption Expenditure (PCE) index rose 0.6% m/m and 4.7% y/y (vs. consensus expectation of 4.3%), representing the first y/y uptick since Sep-2022. That said, we note that US equities clawed back some losses at the end of the month as investors that trade on technical analysis took advantage of the short-term sell pressure that had weakened the markets. Overall, all major US equity indices closed the month lower, with the DJIA (-4.2% m/m) leading the way, trailed by the S&P 500 (-2.6% m/m) and NASDAQ Composite (-1.1% m/m).
Source: Bloomberg
European markets under our coverage witnessed diverging sentiments from the US equity market as positive inflation numbers, and the absence of negative monetary policy surprises provided a decent base for European equities to eke out modest gains during the month. First, in line with investors’ expectations, the European Central Bank (ECB) raised its benchmark policy rate by 50bps to 2.5%, with the Bank of England (BoE) taking a similar decision to raise its policy rate by 50bps to 4.0%. Furthermore, Euro area inflation fell to 8.5% y/y in January (from 9.2% in December), reflecting weaker price growth in Germany (where inflation fell 40bps to 9.2% in January). Despite the seeming positives, European markets were not left without pressure points as concerns of contraction in the UK economy, the impact of Russia’s production cut on prices, and concerns around monetary policymakers remaining hawkish longer than investors anticipate provided a reality check for investors. Nevertheless, European equities eked out decent gains as broad-based pan-European STOXX 600 closed the month with a gain of 1.7%. Across individual countries, the French CAC 40 (+2.6% m/m) led, trailed by the German DAX (+1.6% m/m) and the UK’s FTSE 100 (+1.3% m/m).
In line with our expectations from last month, growth stocks have begun to outperform value stocks, represented by the smaller decline in the NASDAQ composite compared with the DJIA. However, the inflation outlook is now broadly uncertain, putting investors’ expectations regarding monetary policy “up in the air.” Nevertheless, we see significant value amidst the hubris of uncertainties. We expect the US Fed to retain its hawkish policy stance by raising rates at its next meeting. The magnitude of the increase will be dependent on inflation numbers for February as sustained above-expectation inflation print could force the Fed to consider increasing its magnitude of hikes. However, we expect the Fed to retain a 25bps hike, supported by the CME FedWatch Tool, which indicates a 72.3% probability of a 25bps hike. That said, we note that it is significantly lower than the 96.7% probability from a month ago, indicating aggressive inflation numbers sway the Fed’s decision. Nevertheless, we retain our preference for a gradual increase in exposure to US equities as we expect inflation to resume its descent in the coming months and would likely spur the Fed to halt its rate hikes by H2-2023. In addition, we expect economic activities and retail consumption to remain robust to support earnings growth across key listed companies.
Source: CME Group
Conclusion
Overall, we advise investors to take advantage of price dips in the market to build positions with a bias for growth tilt in equity allocation. In addition, we recommend cautionary portfolio increases ahead of the next FOMC meeting on 22-March, where further clarity will be gleaned on the Fed’s posture of future policy decisions. Lastly, it would allow investors to evaluate February inflation numbers due in a week from the Bureau of Labour Statistics.
