March 5, 2024/FSDH Research
Nigerian Equities: Stocks retreat in February as monetary policy landscape changes
Following the strong start to 2024, Nigerian equities retreated in February despite racing to record highs at the start of the month. In February, the benchmark NGX-All Share Index (NGX-ASI) rose to an all-time high of 105,722.78 points but soon fell lower as interest rate dynamics changed in line with our projections in the February FSDH top picks note. In our February note, we alluded to the likely impact of a hawkish monetary policy stance with rate hikes and liquidity mop-ups being implemented to ensure price stability. The market began to price in this risk later in the month, leading to selloffs across counters ahead of the Monetary Policy Committee (MPC) meeting. The negative performance was further magnified by profit-taking across large-cap counters in the Industrial goods sector. Overall, the benchmark NGX-ASI lost 1.2% m/m to close at 99,980.30 points, with YTD return on the benchmark moderating to 33.7%.
Across sectors, the Industrial goods index closed the month as the worst performer, losing 13.3% m/m to close at 4,886.13 points. The decline in the Industrial goods sector was mainly due to profit taking in DANGCEM (-10.0% m/m), as investors capitalized on the stocks’ record high price following significant investment from Femi Otedola. The Insurance sector followed, losing 6.1% m/m to close at 367.57 points, following profit-taking activities in NEM (-19.5% m/m) and MANSARD (-14.7% m/m). Furthermore, the Banking index lost for the second consecutive month, closing lower by 2.0% as investors continued to sell banking stocks, with UBA (-7.6% m/m) and Zenith (-0.3% m/m) leading the downward pressure on the index. We note that the selloff on banking stocks extended to banks with Holdco structures (not included in the banking index), with ACCESSCORP (-15.6% m/m) and FCMB (-11.7% m/m) closing downwards. The Consumer goods and Oil & Gas sectors were bright sparks in the month as they closed higher by 16.5% m/m and 4.1% m/m, respectively. In the Consumer goods sector, the bullish performance was driven by buy interest in BUA FOODS (+39.8% m/m), limiting the impact of losses in NESTLE (-17.4% m/m), UNILEVER (-18.5% m/m), GUINNESS (-19.9% m/m), and NB (-12.2% m/m).
Source: Investing.com, FSDH Research
In line with our expectations, the Nigerian equities market is beginning to show signs of weakness. Nigerian equity valuations remain very stretched compared to historical average and peer pricing. The benchmark NGX-ASI currently trades at a PE ratio of 14.6x, a 10% premium to the peer average of 13.2x (including South Africa, Brazil, and Egypt). In addition, the NGX-ASI PE ratio of 14.6x is a 20% premium to its long-run average of 12.1x. This indicates Nigerian equities continue to trade at a premium to both frontier market peers and the long-run average.
Source: Bloomberg, FSDH Research
Source: Bloomberg, FSDH Research
In the coming months, we mostly see negative triggers for Nigerian equities. Investors’ sentiment towards Nigerian equities will be shaped by monetary policy, interest rates (NT-bills & bonds), earnings outlook, and FPI investment decisions. In our February note, we stated the expectation of an outsized rate hike combined with an increase in the Cash Reserve Ratio (CRR) to curb money supply growth. True to this expectation, at the February Monetary Policy Committee (MPC) meeting, the CBN governor announced a 400-bps hike in MPR to 22.75%, raised CRR to 45.0% (from 32.5%), adjusted the asymmetric corridor around the MPR to +100/-700 bps, and retained the liquidity ratio at 30%. The CBN governor followed these policy decisions by stating the apex bank’s plans to increase the frequency and size of OMO auctions to ensure sustained liquidity mop-ups and create an attractive avenue for FPIs to bring in dollar flows. We expect the CBN’s contractionary monetary policy approach to be sustained over the next 12 months as they attempt to bring inflation under control, attract FPI flows, and mop up liquidity to prevent currency speculation.
The CBN’s monetary policy tightening over the next months will trigger a surge in interest rates across the curve. Evidence of this is already being played out in the money market as well as the bonds market. At the most recent OMO auction, the CBN sold N1.1tn worth of OMO bills with the stop rate across the short, mid, and long tenors closing at 19.0%, 19.5% and 21.5% (compared to 10.0%, 13.5%, and 17.0% at the last OMO auction in January). In the secondary market, the average NT-bills rate has risen 687bps to 15.4% at the end of February (January: 8.6%), while the average bond yield at the end of February was 17.2% (January: 14.5%). We expect these rates to surge further in the coming months. Higher yields on these fixed-income instruments will trigger outflows from the equities market as domestic investors (who have been the primary drivers of the recent rally) look to take advantage of the investor-friendly interest rate environment.
Source: FMDQ, FSDH Research
Outlook for the earnings season will dictate investor sentiments to a lesser degree. Primarily, we believe the high-yield environment will see the equities market fall into a lull, with limited activities and a general downward price movement. Thus, while there may be some bright spots in terms of earnings outlook, investors are likely to be risk-averse to those opportunities. Specifically, on the earnings outlook, we expect the interest rate environment to be favourable for companies operating in the financial services sector (banking, insurance, and other financial services). Periods of higher interest rates coincide with healthier returns on investments for other financial services and insurance companies as they majorly invest in fixed-income instruments. For deposit money banks, higher interest rates will support higher interest income via investment securities and loans. That said, we note that higher interest rates could dampen loan growth for the banking sector as real sector players become reluctant to borrow at higher interest rates. In addition, the devaluation of the naira in the early parts of the year would be positive for deposit money banks. However, the gains from that will be capped for banks without international subsidiaries, following CBN’s policy announcement on Net Open Positions (NOP). That said, we advise investors to do a company-by-company analysis before deciding to invest, as performance will be shaped by several other factors outside of interest rates.
On the other hand, we expect companies in the real sector to continue to grapple with the impacts of high-interest rates, surging inflation, weakening currency, and tighter consumer pockets. While consumer goods companies who deal in essential products can raise prices to pass on higher costs to consumers, weakness in the naira will see many players in the sector record further FX losses in 2024. Cement producers are likely to be bright spots due to their ability to dictate price, thus allowing them to pass through higher costs fully to the consumer. In addition, their strong balance sheets and limited exposure to foreign-denominated loans stand them in good stead against the impacts of naira devaluation. However, as we highlighted earlier, elevated valuations and a broad lack of interest in the equities market will likely outweigh the positive financial performance of these cement companies.
Lastly, we expect foreign investors to retain their standoffish approach towards Nigerian equities despite improvement in FX inflows into the country. The CBN’s drive to improve FX flows and drive activity levels at the NAFEM window is yielding results. Attractive OMO and NT-bill rates will continue to attract foreign investors interested in the carry trade opportunity in the Nigerian money market. Factually, the average turnover at the NAFEM window in 2024 is $211.9mn, 86.1% higher than 2023’s average. This is indicative of improved FX liquidity and an influx of FPI flows. However, despite this improvement, we do not expect these flows to get to the equities market because of i) attractive OMO rates would likely keep FPIs focused on enjoying the carry trade opportunity on higher naira yields, ii) the elevated valuation of Nigerian equities could be a deterrent to interested investors.
Source: FMDQ, FSDH Research
We expect steady outflows from the Nigerian equities market as investors rebalance their portfolios towards money market instruments and bonds, except for equity-focused players who will likely hold just enough to stay within policy limits. In our last few notes, we have advised investors to sell into the market highs, and we continue to encourage investors to reduce their exposures in favour of very attractive options in the money market.
Global Equities: Upbeat performance in US and European equities market
Last month, the global equities market extended the positive start in 2024 into February as the global monetary policy landscape continued to improve while macroeconomic data out of Europe and the US remained positive. As a result, the MSCI All-Country World Index (MSCI ACWI) gained 4.2% m/m, closing at 761.28 points.
In the US stock market, equities recorded a bullish performance, with small-cap stocks rebounding from a disappointing start to the year while mega-cap tech stocks extended their bullish 2024 performance. The bullish performance across US equities remains anchored on investors’ optimism that the Federal Open Market Committee (FOMC) will begin to cut rates as early as its May meeting. Positive earnings outturns during the month further fueled buying interest, with investors adopting a risk-on approach to managing their portfolios. Specific to data points, headline inflation surprised to the upside but printed lower than December’s figures as prices rose 3.1% y/y in January, compared to 3.4% in December. However, the inflation print exceeded the analyst estimate of 2.9% y/y. On the other hand, January’s core inflation printed in line with December’s 3.9% y/y. We note that investors reacted negatively to the inflation report, as the S&P 500 lost 0.4% in the week of the inflation release. However, the inflation concerns were soon allayed as the commerce department of the Bureau of Economic Analysis (BEA) released the headline Personal Consumption Expenditure (PCE) index, showing it rose 0.3% m/m and 2.4% y/y compared to December’s 0.1% m/m and 2.6% y/y print. Similarly, the core PCE index (excludes volatile food and energy costs) rose 0.4% m/m and 2.8% y/y as against 0.1% m/m and 2.9% y/y increase in December. The y/y moderation in these key inflation data points helped to raise optimism that the FOMC will implement its first rate cut in H1 2024.
Although the fairly positive inflation numbers were key to the northward momentum in US equities, positive earnings performance from mega-cap tech companies greatly boosted investors’ buying appetite. Key names like Nvidia, Apple, Alphabet, Meta Platforms etc. beat consensus expectations on earnings. Another major positive to highlight in February was the sustained expansion in economic activities as the S&P Global US Services Purchasing Managers’ Index (PMI) rose to 52.5 points in Jan-2024 from 51.4 points in Dec-2023, while the S&P Global US Manufacturing Purchasing Managers’ Index (PMI) was revised upward to 52.2points in Feb-2024, surpassing a preliminary estimate of 51.5points and January’s print of 50.7points. These positive drivers underpinned the broad-based gains in US equities as the S&P 500 (+5.1% m/m), NASDAQ 100 (+5.3% m/m), Dow Jones Industrial Average (+2.2% m/m), and Russell 2000 (+5.5% m/m) all closed higher for the month.
Source: Investing.com, FSDH Research
European markets recorded a similar bullish performance in February, underpinned by positive inflation performance, which raised hopes of the European Central Bank (ECB) implementing a rate cut in 2024. According to Eurostat data, headline inflation in the Euro Area fell to 2.6% y/y in February from 2.8% y/y in January, indicating persistent disinflation in Europe with a pathway to the ECB’s 2.0% target. Investors were also buoyed by improvement in the HCOB Eurozone Composite PMI data, which printed at an eight-month high of 48.9 points in February, from 47.9 points in January, indicating the Eurozone economy may be recovering from the recent slump in economic growth, albeit still in contractionary territory. As a result, the pan-European STOXX 600 gained 1.8% during the month. Similarly, the German DAX (+4.6% m/m) and French CAC 40 (+3.5% m/m) both closed the month higher. That said, the UK FTSE traded flat for the month as the Bank of England’s policymakers indicated interest rates will remain high for longer. While the BOE Deputy Governor, Sarah Breeden stated that there is a shift in focus to how long rates should stay at current levels rather than planning further increases, the BOEs Chief Economist stated that the first rate hike “is a long way off”. In addition, the UK economy entered a technical recession in Q4 2023, further stoking concerns about the strength of the UK macroeconomic plot.
The long-term outlook for the US equity market remains positive, albeit with emerging near-term risks. All key macroeconomic fundamentals that have been of concern to equity investors have remained positive, guiding the market that the US Fed will achieve its objectives of a soft landing for the US economy. As highlighted in our prior notes, the primary catalysts for US-focused equity investors are FOMC’s monetary policy direction and corporate earnings performance.
On monetary policy, the FOMC will hold its second meeting for 2024 on 20-March with the market pricing just a 3.0% chance of a rate cut with consensus expectation of a hold, in line with our forecast for 2024. We believe the landscape (inflation, labour market, and economic growth) continues favouring a rate cut in 2024. First, the Fed’s preferred inflation gauge is the core PCE index, which rose 2.8% y/y in January, lower than the 2.9% recorded in December. Thus, while inflation continues to decline, it remains well above the Fed’s 2.0% preferred level. As a result, we think the Fed will remain standoffish on rate cuts until it is sure inflation is on a sustainable pathway towards 2.0%. This position was echoed in the minutes of the FOMC’s January meeting with members stating they will not be comfortable cutting rates until they have greater confidence that inflation is still declining while highlighting the risk of moving too quickly on rate cuts. In addition, we believe the jobs market remains very hot, with the Labour Department reporting the US economy added 353,000 jobs in January, representing the first back-to-back months of the US economy adding more than 300,000 jobs (in December and January), since June and July 2022. With the labour market showing strength, we see the Fed being reluctant to cut rates until there appears to be a slowdown in job creation. Overall, as we have stated in our prior notes, we remain firm on our expectations of a first FOMC rate cut in June-2024 with consensus expectation now adjusting to our forecasts (the CME FedWatch tool now predicts a 54.2% probability of a first rate cut in June compared to the previous estimation of a 62.3% probability of a first rate cut in May).
The outlook for corporate earnings also remains mildly upbeat. The consensus growth estimate for the S&P 500 earnings is 3.9% y/y in Q1-2024 and 9.0% y/y in Q2-2024, indicating investors are optimistic about healthy earnings growth in the year’s first half. However, we are concerned that the bulk of the earnings growth is expected to be driven by the mega-cap technology stocks, implying most sectors outside of the technology sector are likely to witness slower growth or possibly decline. In addition, the US economy is expected to remain on the growth path in 2024, albeit at a slower pace. As a result, while the growth story is positive, we see signs of a slowdown emerging, making it imperative that the Fed consider a rate cut in the coming months.
All that said, we are concerned that major US equity indices are trading at all-time highs while valuations are significantly stretched. The S&P 500 is trading at a PE ratio of 24.4x, a 28% premium to its long-run average of 19.1x. At the current valuation, key positive catalysts (a June rate cut, steady economic growth, corporate earnings outperformance) must be on-the-money in the coming months to sustain the pace of the rally recorded in the first two months of the year.
At current prices, we advise investors to reduce their exposure to US equities to lock in some profit while adopting a wait-and-see approach to increasing positions. Our recommendation is based on our expectation for the market to pull back in the near term as current prices are stretched, at least in the short term. Major US equity indices are trading close to the overbought region, while also consistently trading at the end point of their Bollinger bands in recent weeks, a technical trading position which is not sustainable in the long term. Subsequently, we advise investors to hold their cash and keep a watch on inflation and labour market data in the coming months, as they would be primary determinants of achieving expectations of the FOMC beginning its expansionary monetary policy cycle in June. A persistent decline in the core PCE index for February and March would indicate a sustainable path toward disinflation and strengthen the case for a rate cut in the June FOMC meeting. This would improve our outlook and suggest a re-entry around April. The commencement of rate cuts in June will be positive for growth via business investment and consumer spending, strengthening the earnings growth outlook for US-based businesses. This would, subsequently, validate premium valuation above long-run average price multiples for US equities.
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