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FSDH Top Picks: Global equities weaken but Nigerian equities march on in August

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Nigerian Stock Exchange Trading Floor. Image Credit: NGX

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September 8, 2023/FSDH Research

Nigerian Equities: Bullish momentum extends into fourth consecutive month
A cocktail of positive corporate actions resulted in Nigerian equities sustaining a bullish streak in August. The NGX-All Share Index (NGX-ASI) gained 3.4% in August, closing the month at 66,548.99 points, breaking the index’s all-time high, which was set in 2008. The gains in August pushed YTD gains on Nigerian equities to 29.8%.
 
The positive momentum observed in Nigerian equities was primarily supported by strong investor interest in the Consumer goods sector. The Consumer goods sector gained 24.5% m/m in August as upticks in DANGSUGAR (+103.7% m/m) and NASCON (+55.5% m/m) propelled the sector higher. Noteworthy to mention, the rally in DANGSUGAR and NASCON was due to the companies’ announcement of a proposed merger of Dangote Sugar, Nascon Allied Industries, and Dangote Rice. The Insurance sector trailed, as gains in CORNESTONE (+59.1% m/m) and SUNUASSURE (+30.3% m/m) underpinned the 3.1% m/m return in the Insurance sector. The Oil & Gas and Industrial goods sectors also gained during the month, with their respective indices gaining 0.9% and 0.6%, respectively. Persistent FX liquidity challenges continue to make SEPLAT (+10.0%) an attractive buy for investors looking to repatriate foreign currency, while modest gains in WAPCO (+9.2% m/m) and DANGCEM (+2.3% m/m) underpinned gains in the Industrial goods sector. The lone losing sector during the month was the Banking sector, which lost 3.6% during the month as steep profit-booking by investors across banking names that have rallied in recent months accounted for the decline in the broad sector index.
Source: NGX, FSDH Research
So far, 2023 has been a very profitable year for Nigerian equity investors as optimism around policy reforms and the return of foreign portfolio investors have kept investors’ risk appetite upbeat. Interestingly, indications from the first trading week in September indicate the likelihood of the momentum being sustained, as the NGX-ASI has gained 2.3% MTD (as of 7-Sep). However, we note that the gains have been broadly supported by corporate actions in DANGSUGAR (+16.7% MTD as of 7-Sep) and NASCON (+12.0% MTD as of 7-Sep) as well as the announcement of audited results for banking stocks (banking index up 10.4% MTD as of 7-Sep), thus maintaining a similar theme with August. We highlight this to caution investors that the recent momentum driver in the Nigerian equities market is largely restricted to a few tickers on the bourse, such as Dangote Sugar and several banking stocks, which were recommended in our August note. In addition, we see limited upside in those tickers following the re-rating of several of them. Thus, we cast our attention to more long-term drivers, which we think investors need to evaluate exhaustively before deciding how to reposition their portfolios for optimal returns.
 
We think that a key question is where would demand for stocks comes from? First, we evaluate the likely path of demand for foreign investors. According to the latest Domestic & Foreign Portfolio Investment Report from the NGX, foreign investors remain net sellers of Nigerian equities, with net foreign outflow from Nigerian equities printing at N21.6bn in July. Thus, FPIs appear to remain cautious as the Federal Government attempts to address FX liquidity. Interestingly, our watch on liquidity at the Investor & Exporters window (I&E window) shows status quo remains the order of the day, with average turnover at the window showing a marginal 0.9% improvement post-FX reform attempt. Clearly, the FX situation remains a critical challenge as the clearance of FX backlogs become a priority of the CBN, while alternative means of repatriating foreign currencies (such as buying fungible stocks and parallel market) have gained in value. This situation will continue to have implications for FPI interest in Nigerian equities in the near to medium term.
 
The next segment of market demand to consider is domestic investors’ demand. 2023 YTD, domestic investors have been the lifeblood of Nigerian equities, with 84.5% of total transactions done on the bourse, according to data from the NGX. The demand for Nigerian equities has particularly accelerated since May, with total transactions executed between May-23 and Jul-23 accounting for 66.5% of total equity transactions in the first seven months of 2023. Thus, it is clear that Nigerian equities demand (the majority of which was from domestic investors) was largely driven by local investors anticipating the return of FPIs. As we have established earlier, we don’t expect a sudden influx of FPI flows into Nigerian equities in 2023, ultimately leading to domestic investors unwinding their positions in Nigerian equities. In addition, we expect the full impact of weaker aggregate demand to begin to reflect in the earnings of Nigerian-listed companies from the 9M-2023 earnings announcement in October. Lastly, money market rates continue to show improvement, with the 364-day NT-bills rate now staying strongly in the double-digit terrain, providing an attractive outlet for domestic investors who want to turn defensive with their portfolios. Putting these factors together, we expect to see sell pressure outweighing buy interests in Nigerian equities in the weeks and months ahead.
Source: NGX, FSDH Research
Source: FMDQ, FSDH Research
Lastly, evaluating the technical and fundamental positions of the broad Nigerian equity index indicates that Nigerian equities are due for a decent pullback in the weeks/months ahead. On the technical side, evaluating directional indicators on the daily and monthly timeframes shows the equities market is over-extended to the positive side, indicating a greater chance of downside relative to upside potential. Similarly, the NGX-ASI is trading at a premium to its long-run average price multiples as well as peer average.
 
Following the factors evaluated, we strongly suspect the recent upward momentum in the equities market is on the verge of tapering out. Accordingly, we advise investors to adopt a bearish view of Nigerian equities. We recommend reducing equity investment exposure significantly, taking advantage of current pricey valuations. We note that specific stocks could present opportunities due to triggers such as announced corporate actions. Thus, we recommend investors have access to liquidity to take advantage of the short-term alpha such opportunities might present.
Global Equities: Bearish outcomes across US & European equities
In our August note, we highlighted profit-taking expectations as traders looked to cash in on the five-month long rally in US equities. True to those expectations, global equities faced some downward pressure in August. Mixed macroeconomic signals, various credit downgrades on regional banks and US sovereigns, as well as broadly soft earnings announcements provided a platform for investors to take profits off the table during the month. On credit downgrades, Fitch ratings downgraded US credit to AA+ from AAA. In addition, Moody’s downgraded credit ratings on several US regional banks while highlighting several big bank names that have been placed on a downgrade watchlist. This led to increased yields, negatively impacting discount rates for equity valuations on Wall Street. Meanwhile, a cocktail of mixed macroeconomic data unsettled investors during the month. The headline inflation rate edged higher by 21bps in July to 3.2%, halting an 11-month run of consecutive decline in inflation. Meanwhile, core inflation rose 4.7% y/y, 0.1ppt lower than June’s print. The broadly higher inflation numbers raised concerns that the US Fed will continue to raise rates, as comfort level on inflation appears not to be near in sight. Investors’ concerns were further reinforced by the Federal Reserve Chairman’s speech at the Jackson Hole Symposium, reiterating the Fed will continue to raise rates further “if appropriate” and “hold at more restrictive levels” as lots of ground still needs to be covered to bring inflation within the 2.0% target. Unsurprisingly, investors rode the wave of concerns to take profits off the table. The Dow Jones Industrial Average (-2.4% m/m) lost the most, with the S&P 500 (-1.8% m/m) and tech-heavy NASDAQ (-1.6% m/m) trailing.
Source: Bloomberg, FSDH Research
In Europe, sentiments were broadly similar as we saw losses across all the major indices we track within the European region. The weakness observed in European equity markets was mostly due to weaker economic growth outcomes within the region. For context, data from Eurostat showed economic growth in the Eurozone decelerated to 0.6% y/y in Q2-2023, from 1.1% y/y growth recorded in Q1-2023. The weakness in the Eurozone economic growth was underpinned by a third consecutive quarterly contraction in economic activities in Germany, the region’s largest economy. On the other hand, it gave investors optimism that the European Central Bank (ECB) may begin to consider pausing interest rate hikes as evidence of the impact of past rate hikes begins to show. Still output growth, the Hamburg Commercial Bank Eurozone Composite PMI was revised lower to 48.6 points for Jul-2023, signifying the steepest contraction in private sector activities since Nov-2022.
 
Despite the negative headlines on economic growth, inflation provided some succour for investors as headline inflation in the Euro Area slowed to 5.3% in Jul-2023 (from 5.5% in Jun-2023). Nevertheless, the Bank of England (BoE) opted to raise its benchmark policy rate by 25bps to 5.25% at its August meeting, as the battle to get inflation under control remained the policymaker’s focus. Overall, the lack of succour for investors on monetary policy tightening provided an incentive to book profits. The broad-based pan-European STOXX 600 lost 2.8% during the month. Across countries, the UK’s FTSE 100 (-3.4% m/m) lost the most, followed by Germany’s DAX (-3.0% m/m). The French CAC 40 also closed lower, losing 2.4% m/m.
 
The first key macroeconomic variable in our outlook for the US equity market is economic growth. We expect economic activities to remain strong, supported by a robust (albeit slowing) labour market. Key leading economic indicators like retail sales growth, wage growth, job creation, and business investments remain strong and indicate a worst-case scenario of a soft landing if the Fed opts to sustain restrictive rate hikes. As indicated earlier, the jobs market remains strong, as indicated in August’s Non-Farm Payrolls report, which showed Nonfarm payrolls rose by 187,000 jobs, ahead of 170,000 consensus estimates. Noteworthy to highlight, the pace of job creation remains in line with recent months and significantly below the 2022 average, indicating softness in the jobs market. Additionally, June and July estimates for nonfarm payrolls were reviewed lower. Thus, while the jobs market remains strong enough to support demand growth, a sustained pace of softening shows rate hikes may be working and doing enough to slow inflation.
 
However, we are concerned about emerging risks to inflationary pressures. The “poster boys” for rising prices post-covid have been food and energy prices, both of which are facing threats of significant uptick in prices. First, Russia announced earlier in July that it would pull out of the black sea grains deal brokered by the United Nations (UN), while several key agricultural exporters are now placing restrictive policies on the exportation of food in a bid to control rising domestic prices. These events will likely create larger food demand-supply gaps in the international market, forcing higher prices. Furthermore, Saudi Arabia and Russia have announced plans to retain their 1.3mbpd production cuts through December, forcing oil prices above $90.0/bbl. Prolonged periods of higher oil prices would imply higher energy costs and, consequently, higher inflation in the US. This holds the potential to alter the monetary policy tightening cycle over the next months.
 
In July, we stated our expectations of two 25bps hikes till the end of the year. The US Fed’s 25bps hike in July implies one more 25bps hike is likely in one of the next three Federal Open Market Committee (FOMC) meetings (September, October, December). We retain this expectation despite new information indicating more upside risks to US inflation, as the impact on monetary policy decisions will depend on the magnitude of the rebound in price, which is broadly speculative. We also note that the Fed Funds Target Rate is already at a restrictive level for economic activities. That said, we note that Jerome Powell indicated the Fed is prepared to raise interest rates and hold them at restrictive levels for as long as it is required to control inflation. In light of current evidence and risked projections over the next months, we expect the FOMC to hold its policy rate at its 20-Sep meeting, with a possible rate hike in either of the 1-Nov or 13-Dec meetings. The CME FedWatch Tool probabilities align with our expectations, predicting a 93.0% chance of maintaining the status quo. In addition, we don’t expect the Fed to begin its easing cycle at any point in the next six to nine months, indicating monetary policy will likely remain in restrictive territory till Jun-24.
Source: CME Group, FSDH Research
Combining our various positions on the key macroeconomic variables that will shape investment decisions, we believe they remain supportive of extending the 2023 bullish momentum for some time to come. In addition, recent price weakness in US equities presents attractive entry opportunities for investors with a medium to long-term horizon to resume taking positions in US stocks with solid fundamentals. Thus, we express cautious optimism on US equities and advise medium to long-term investors to gradually build positions, taking advantage of recent price weakness.

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