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June 6, 2023/FSDH Research
Nigerian Equities: Deja vu as hope for PBAT-led economic reforms triggers market rally
The Nigerian equities market closed May on a blockbuster note as investors began to price in hope for the biggest set of economic policy reforms since the Investors & Exporters window creation in 2017. To understand the newfound momentum in Nigerian equities in May, we take a look back at 2015, the Nigerian equities market had recorded losses for three consecutive years as dwindling foreign exchange earnings (due to the oil price crash) triggered foreign investor outflows while domestic investor interest plummeted to record lows amid high-yielding money market assets. However, in April-2017, the Central Bank of Nigeria introduced the Investor & Exporters Window (I&E window), which provided fair amounts of transparency in the FX market, with transactions dominated by market participants other than the CBN. This piece of FX policy reform reignited FPI interest in Nigeria and drove one of the best rallies in recent years. This was short-lived, with capital flow reversals in 2018 worsened by the Covid-19 pandemic of 2020 that resulted in subdued foreign investor interest in Nigerian equities as concerns of FX policy and dollar crunch lingered.
Source: NGX
Thus, the announcement of fuel subsidy removal and exchange rate unification by Nigeria’s newly elected President, Bola Ahmed Tinubu (BAT), roused investor sentiments triggering the highest daily gain on the local bourse since Nov-2020. For proper context, the local bourse was headed for a modest 1.1% gain for May before the policy announcements by the President during his inaugural speech. Following the announcement, investors’ interest increased as they hoped for an improvement in fortunes at the FX market, which is expected to trigger foreign investor interest in Nigerian equities. As a result, the benchmark NGX-ASI rallied 6.4% to close the month of May at 55,769.28pts while YTD return surged to 8.8%.
Source: Bloomberg, NGX
Interestingly, while the rally was broad-based, the two sectors expected to be the biggest beneficiaries of the policy reforms outperformed. The banking sector led the sectoral gainers for the week, rising by 19.5% for the month. The demand for banking stocks reflects the consideration that “when” and “if” foreign investors return, they would be the first point of buying spree among them, particularly as the sector’s valuation remains at a steep discount relative to EM peer’s pricing. The Oil & Gas sector followed, gaining 18.7% m/m, as news of the removal of fuel subsidy created an expectation that the profit margin of the downstream oil & gas sector will likely rebound, thus triggering a buying spree on downstream oil & gas stocks. Other sectors benefitted from the broad-based bullish sentiment as the Consumer Goods sector gained 15.2%, trailed by the Insurance sector, which gained 13.4%. Investors were less enthusiastic about the Industrial sector due to the recent decline in volume growth and the rising cost pressures. Nevertheless, the sector eked out a 1.7% m/m gain in May.
Source: Bloomberg
Today’s key concern for investors is whether the momentum will be sustained or the bullish charge is a false start. We seek to analyse the facts in this month’s note and provide our perspective on expectations as we review market performance. From our standpoint, we are cautious about the likely return of FPIs to the Nigerian market, despite the recent policy announcements. First, removing fuel subsidies is unlikely to improve the FX situation. Nigerian National Petroleum Company Limited (NNPCL) remains the sole importer of PMS and will continue to rely on crude oil dollar proceeds to fund importation. Thus, while NNPCL recovers the full cost of importing PMS in naira terms, its FX obligation remains unchanged, removing any hope for net FX gains.
The most impactful of the new policy announcements will be the decision to unify the exchange rates. It remains unclear what the timeline for accomplishing this would be, but we suspect the unification will likely occur in the N600/$ – N680/$ range. This will introduce much-needed transparency in the FX market and improve liquidity. However, the policy’s degree of success would depend on a culture change among individuals that prefer to hold wealth in foreign currencies. Ultimately, while we see a case for improved FX liquidity after the exchange rate unification, we are cautious about attracting adequate FX to provide confidence for foreign investors that their dollar demand will be met whenever they need to repatriate funds. Bearing in mind the backlog of FX Payments to investors that still need to be cleared.
On a brighter note, we regard the policy announcements from the FG as ‘positive body language’ on willingness to push through tough economic policy reforms. This will eventually encourage foreign investors to return to the Nigerian financial market.
We believe the current bullish momentum built on expectations of FPI return will fizzle out. That said, we note that investors focused on investing in long-term value-delivering companies can continue to build positions for long-term value creation. However, investors who want to bank on the likelihood of foreign investors returning to the Nigerian equities market should remain underweight to domestic equities and avoid what we term a “bull trap”.
In addition to the factors discussed earlier, we retain expectations of higher money market yields as we head into the second half of the year due to tightening liquidity and large borrowings by the FG, thus reducing attraction for equity instruments. We also reiterate that we are particularly attracted to banks with the ability to source low-cost deposits, implying favouring banks with 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.
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Global Equities: Mixed outcomes across US & European markets
Last month, growth stocks in the United States (US) continued to outperform value stocks as investors continued to bet on a pause in Fed’s rate hikes despite conflicting economic evidence. It was a topsy-turvy month for investors as a cocktail of conflicting economic data had to be processed. First, inflation data for April showed a further deceleration in inflation outcomes as the headline inflation rate fell to 4.9% (previously 5.0%), with core inflation falling similarly to 5.5%. In addition, the Producer Price Index (PPI) rose at a slower pace of 2.3% (previously 2.7%) as weaker commodity prices and easing supply chain issues continue to favour production costs. This gave investors hope that although the Federal Open Market Committee (FOMC) would raise rates in its May meeting, it would likely pause the hikes by July. Truly, the FOMC raised its Fed Funds Target Rate by 25bps in its May meeting and indicated that it would pause rate hikes from its next meeting. The expectations of a slowdown in rate hikes led to selloffs on traditional value stocks, reflected in steep losses for the Dow Jones Industrial Average (DJIA) in May. Interestingly, retail sales data for April-2023 came in weak, particularly after adjusting for inflation. In addition, the manufacturing PMI slumped to 48.5 points, falling into a contractionary region. These data points corroborated postulations that the Fed’s tightening program is beginning to impact the economy and would force the Fed to refrain from further hikes through 2023.
However, we note that economic data on the US economy continues to show mixed signals of weakness and strength. For context, while manufacturing PMI dipped, the services sector PMI expanded to 55.1 points in May-2023. In addition, US GDP growth for Q1-2023 was revised higher by 0.2ppt to 1.3%. Furthermore, the jobs market rebounded significantly in May, with the US economy creating 339,000 jobs in May, beating the consensus expectation of 180,000 jobs. On the downside, the unemployment rate rose to 3.7%, from 3.4%. Despite these conflicting data points, investors continue to price in a pause in rate hikes, evidenced by the rotation out of value stocks to growth stocks. In other market-moving news, the chaos created by the debt ceiling negotiations unnerved investors during the month. However, strong earnings performance from APPLE and NVIDIA provided a strong boost for mega-cap tech stocks. Overall, the tech-heavy NASDAQ led the way, gaining 7.6% m/m, while the DJIA lost 3.5% for the month. The S&P 500, which gives a fairer view of aggregate market performance, returned a measly 0.2% gain, as losses on value names and financial stocks erased most gains from mega-cap tech and growth-tilt stocks.
Source: Bloomberg
In Europe, sentiments were broadly weak during the month as bearish sentiments dominated the continent’s key financial centres. The bearish sentiment was triggered by an unabating monetary policy tightening campaign, persistently high inflation, and weak economic growth outcomes. On policy tightening, the European Central Bank (ECB) raised its benchmark rate by 25bps while the Bank of England (BoE) followed suit, raising its benchmark rate by the same magnitude. Interestingly, both policymakers signalled no intention to halt rate hikes in the near term as inflation remains stubbornly high. Truly, inflation remains in sticking point for European economic managers despite Eurozone headline inflation falling to 6.1% in May (previously 7.0%), lower than the 6.3% consensus forecast, but remains far from the ECB’s 2.0% target. In the UK, economic activities expanded at the smallest pace since 2021, growing by 0.2% in Q1-2023, reflecting weakness in manufacturing. In Germany, the economy slipped into a technical recession after the economy contracted 0.3% q/q and 0.5% y/y in Q1-2023, following a similar downturn in Q4-2022. The economic weakness in Germany has been underlined by persistent weakness in consumer spending and government spending, broadly down to the impact of inflation on purchasing power. Overall, the weakness observed in economic outcomes, coupled with the expectations of further rate hikes, the pan-European STOXX 600 lost 3.2% for the month. Across specific countries, the UK FTSE 100 was the biggest loser, down 5.4% m/m, trailed by the French CAC 40 (-5.2% m/m), and the German DAX (-1.6% m/m).
The outlook for the US equity market appears to have been muddled by the recent conflicting data on inflation, economic activities, and the jobs market. While some data points indicate the economy may be slowing, others indicate that the US economy remains resilient, despite the aggressive rate hikes. This makes the 14-June FOMC meeting the most important meeting in recent months as it would provide an opportunity to gauge how the Fed officials interpret these data points. We note that the recent OPEC+ decision to cut oil production will likely trigger fears of an increase in energy prices which could play on the minds of the fed officials as they make their interest rate decision. Lower oil output will likely trigger higher energy prices, a pain many consumers were hoping is beginning to subside, with a huge impact on inflation. From our viewpoint, the expectation for a pause in rate hikes is no longer as clear-cut as initially forecasted. However, we retain our expectation for a pause in rate hikes as we reckon the recent consecutive downward pressure on the inflation rate will encourage most fed officials to adopt a wait-and-see approach. The CME FedWatch tool aligns with our postulations. From a previously overwhelming 99% probability of a pause in rate hikes after the May meeting, the probability now stands at 78%. In addition, instead of the 2% probability of a rate cut from the end of the May meeting, c.22% probability is now assigned to a 25bps rate hike.
Other major market worries, such as the debt ceiling concern and recession fears, are no longer paramount for investors as these fears have been eased. Thus, the outcome of the 14-June FOMC meeting will likely shape the outlook of the US equity market. We advise investors to maintain their exposures to US equities, particularly with a growth tilt, as we expect the US Fed to pause its rate hikes. However, should the committee opt for the contrary by raising rates, we recommend it would be a good time for investors to take some profits off the table with a plan to buy back on any potential dip post-FOMC meeting. For investors looking to make fresh exposures, we advise a wait-and-see approach until after the FOMC meeting when clarity on the Fed’s position is achieved. A decision to hike could represent an opportunity to establish long positions in favoured equities at attractive prices should investors sell off exposures. Ultimately, we retain our perspective that the US equity market is on a medium to long-term bullish trajectory.
Source: CME Group
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