May 5, 2023/FSDH

Nigerian Equities: Bearish performance sustained on elevated rates and disappointing start to 2023 earnings cycle

The Nigerian equities market dropped in the month of April in line with our expectations as investors continued to book profits. The weak outturn in the Nigerian equities market was broadly driven by i) elevated interest rates and ii) weak Q1-2023 earnings performance. In the money market, despite stop rates at NT-bills auction closing the month lower, the 364-day bill remained in double-digit terrain while Fixed deposits continued to remain attractive. Meanwhile, weakening consumer income amid a high-cost operating environment is beginning to weigh on the performance of non-financial Nigerian companies. This was reflected in the Q1-2023 earnings season as major players in the consumer & industrial goods space reported weaker revenue and profit outturns. As a result, sell pressures accelerated during the month, with the benchmark NGX-All Share Index (NGX-ASI) losing 4.5% m/m to close at 52,403.51 points. YTD return on the benchmark is now at 2.2%.

Source: Bloomberg, NGX

The bearish outcomes for the Nigerian equities market are in full swing with the broadly disappointing start to the 2023 earnings cycle. In addition, while money market yields trended lower in April in line with our outlook, we expect to see a sharp upward reversal in the coming weeks which would likely extend through the rest of the year. Financial system liquidity is coming under pressure and is expected to tighten significantly in the coming months on the back of thinning liquidity versus the government’s aggressive borrowing program. As a result, we expect money market yields to surge higher, with fixed deposits likely to hit northwards of 15% while NT-bills continue to tick higher. We also anticipate persistent fund rotation from equities to money market instruments as investors look to build defensive portfolios. Thus, barring a drastic upturn in macroeconomic fortunes which would strengthen consumer demand and reduce cost pressures in the business environment, it is expected that Nigerian-listed equities will continue to turn out weak earnings, dampening risk appetite among investors.
 
But banking stocks are likely outliers in the equities market after many years of downward pressure. The rising interest rate environment is likely to result in improved interest income, with NT-bills likely to become a risk-free avenue for persistent double-digit returns. We are particularly attracted to banks with the ability to source low-cost deposits, implying favouring banks with a higher Current Account Savings Account (CASA) ratio in their deposit mix. In addition, it would be critical to focus on banks with a reliable history of asset quality, given the ever-rising risk of the Nigerian business environment, which would help reduce the impact of impairments on profitability. Thus, while we have a general bearish bias on Nigerian equities, we believe banking stocks could reward investors with decent returns through the course of the year.

Global Equities: A bullish month for global equities as macro fundamentals fall into place

As we stated in our April note, a bullish bias on US equities remained the best strategy as US-listed equities continued to deliver a strong outing during the month. In addition, our preference for a growth-heavy strategy against exposure to the “value risk factor” continues to be a masterstroke, with value-style strategies lagging growth-focused portfolios. In May’s edition of our note, we analyse events that shaped the performance of the US equities market and provide further updates on our equity strategy.

In the US, the month started on a slow note as renewed fears of a recession weighed on investors’ sentiments following some weaker-than-expected macroeconomic data points. For example, the Institute of Supply Management (ISM) survey showed that the US services sector slowed faster than projected, while new orders for manufactured goods weakened in March, showing signs of declining manufacturing activities. Furthermore, the minutes of the previous Federal Open Market Committee (FOMC) were released during the month and showed some Fed officials expect a US economic recession in 2023. However, by mid-April, the inflation report for March came in positive as headline inflation fell for the ninth consecutive month to 5.0% y/y (Feb 2023: 6.0% y/y). In addition, the Producer Price Index (PPI) rose by 2.7%, compared to 4.9% in Feb-2023. Lastly on inflation, the Fed’s preferred inflation gauge cooled in March, down to 4.2% y/y (Feb 2023: 5.1% y/y). This provided an impetus for renewed bullish sentiments as investors priced in expectations of a quick end to the Fed’s tightening cycle.

Activities in the labour market provided a further boost to monetary policy easing expectations, albeit fueled concerns of a recession. Weekly jobless claims increased during the month while available job openings fell below 10 million jobs for the first time in almost two years. Meanwhile, fears of a recession were soon allayed as data from the US Bureau of Economic Analysis (BEA) showed the US economy grew at an annualized rate of 1.1% in Q1-2023. Lastly, investors were buoyed by positive earnings announcements for Q1-2023. At the end of the month, 53% of companies in the S&P 500 released their results, with FactSet data showing 72% of companies that have released their results beat their revenue estimates. As a result of these positives, the tech-heavy NASDAQ 100 outperformed, gaining 8.4% m/m. The Dow Jones Industrial Average (DJIA) gained 2.5% m/m, with the S&P 500 gaining 1.5% m/m.

Source: Bloomberg

European equities were mostly bullish throughout April as strong macroeconomic data kept investors upbeat. At the start of the month, data on industrial production in Germany came in stronger-than-expected, expanding by 2.0% in February, against the consensus expectation of 0.1%. Similarly, industrial production data in the Euro Area showed an expansion of 2.0% against market expectations of 1.5%. On the broader economy, the services sector in the UK appeared to continue to show strength, with non-Manufacturing PMI expanding to 53.9 points (ahead of a 52.5 points expectation), with the survey indicating strong consumer spending in the services sector. However, the tale in the manufacturing sector for the UK is different as PMI figures remained uninspiring and consumers continued to cut spending on increasingly expensive commodities. Another key driver of bullish sentiments during the month was inflation figures. In France, headline inflation cooled to a six-month low of 5.7% in March (Feb-2023: 6.3% y/y). Similarly, in Germany, headline inflation fell to 7.4% for Mar-2023, against 8.7% in Feb-2023. Inflation is expected to slow further in Germany for Apr-2023.
 
Lastly, economic growth data for the European Union and the Euro Area showed slight upward momentum for Q1-2023. For context, data published by Eurostat showed a snail-speed 0.1% q/q growth for the Euro Area in Q1-2023, better than the flattish output growth on a q/q basis in Q4-2022. For the European Union (EU), economic output expanded by 0.3% q/q for the same period, better than the 0.1% q/q dip in Q4-2022. On a y/y basis, growth outturn for Q1-2023 slowed across the two zones with seasonally adjusted GDP growth of 1.3% y/y across the two zones, lower than 1.8% y/y growth (Euro Area) and 1.7% y/y growth (in EU) for Q4-2022. The weaker growth, combined with the recent financial sector turmoil gave investors hope that the European Central Bank (ECB) and other key European monetary policymakers will consider a less aggressive rate hike approach at their next meetings. This further provided a boost to investors’ appetite for stocks. As a result, the pan-European Euro STOXX 600 gained 1.9% m/m, while across our countries, the UK market led the way, with the FTSE 100 gaining 3.1% m/m. French equities followed, with the CAC 40 closing the month higher by 2.3% m/m while the German DAX gained 1.9% m/m.      
 
Our bullish bias on US equities continues to yield returns for investors as all key variables align with expectations. The biggest single factor for equity investors is the policy direction of the US Fed. At the recent FOMC meeting, Fed officials unanimously decided to raise the Fed Funds Target Rate by 25bps to 5.0% – 5.25%, broadly in line with expectations. The big positive for equity investors is that the FOMC’s statement omitted a sentence from its March statement saying, “the Committee anticipates that some additional policy firming may be appropriate”. Omitting this statement indicates the Fed may be nearing the end of its tightening cycle as inflation maintains its descent, signs of weakness emerge in the labour market, economic recession fears heighten, and banking turmoil continues. Thus, in line with our forecast at the start of the year, we believe the Fed’s May rate hike is the last for the year as we expect a pause through the rest of the year, barring any heightened inflationary pressure. Indeed, the market is aligned with our expectation as the CME FedWatch Tool indicates a 98% probability of a pause in a rate hike at the 14-June meeting. Interestingly, the CME FedWatch Tool indicates a small 2% probability of a rate cut in June, but we believe a rate cut is very unlikely. As a result, we see room for largely bullish outcomes for US equities through 2023, with occasional periods of selloffs. In addition, we recommend investors keep the focus on the earnings performance of target companies as this would likely take centre stage for investors with monetary policy direction almost certain. We also reiterate our growth-bias to constructing US equity portfolios. That said, we highlight an emerging risk of an economic recession in H2-2023. A steep downturn in economic activities will like to dampen sentiments but remains a slow-burner consideration for investors in the current landscape, particularly as leading indicators remain resilient.

Source: CME Group