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FSDH Top Picks: Domestic and Global Equities Falter in April

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May 7, 2024/FSDH Research

Nigerian Equities: March rebound proves to be a dead cat bounce; outlook is a tale of chalk and cheese
In our April note, we described the equities market rebound as a “dead cat bounce” with the expectation that the rebound would taper out. True to these expectations, the Nigerian equities market traded on a bearish note in April as investors’ upbeat mood waned significantly during the month. For context, the benchmark NGX All Share Index (NGX-ASI) opened the month with an 11-day bearish streak as domestic investors continued to reduce their equity positions. A cocktail of negatives, including persistently high interest rates, elevated valuations, and post-FY earnings season selloffs, combined to weigh on investors’ buying interest in equities. Consequently, the NGX-ASI lost 6.1% m/m to close at 98,225.63 points, bringing the YTD return on the index to 31.4%.
 
Looking at the sector performance in April, it reflected the broad-based selloffs across the local bourse as all sectors within our coverage closed the month lower. The Banking sector recorded the steepest loss as domestic institutional investors continued to reduce exposure to banking stocks, particularly at elevated valuations for the sector, with the banking sector recapitalization exercise likely to cause significant dilutions. As a result, the Banking index lost 24.8% m/m to close at 1,545.76 points, with losses in UBA (-14.6% m/m) and ZENITHBA (-27.9% m/m) leading the downturn. Banks with Holdco structures also saw steep losses as GTCO (-37.7% m/m), ACCESSCORP (-31.2% m/m), and FBNH (-32.8% m/m) all closed the month lower.
 
The Insurance and Consumer goods sectors trailed, with their respective indices losing 6.5% and 4.0% respectively during the month. Profit taking in AIICO (-12.3% m/m), MANSARD (-4.6% m/m), and CONERSTONE (-9.8% m/m) underpinned the losses in the insurance sector, while persistent downbeat financial performance for the consumer goods sector weighed, with losses in DANGSUGAR (-25.2% m/m), FLOURMILLS (-21.8% m/m), and NESTLE (-11.6% m/m) driving the index lower. Furthermore, price declines in DANGCEM (-4.4% m/m), WAPCO (-13.7% m/m), and SEPLAT (-2.3% m/m), showed a 3.2% and 2.0% decline in the Industrial goods and Oil & Gas sectors. We note that the price decline in Seplat is mainly because of the price markdown of the stock for its final dividend on 29 April. Non-indexed sectors like telecoms and agriculture also recorded sell pressures with losses in MTNN (-9.5% m/m), OKOMU (-4.3% m/m) and PRESCO (-9.7% m/m).
Source: Investing.com, FSDH Research
Our outlook for the Nigerian equities market is now a “tale of chalk and cheese”. The bearish performance in April, coupled with stellar Q1-2024 financial results from banking stocks have combined to narrow the premium valuation on Nigerian equities. The NGX-ASI now trades at a trailing PE ratio of 13.4x (previously 16.7x at the end of March), a 10% and 15% premium (previously 37% and 49% at the end of March) to its long-run average and peer average of 12.2x and 11.7x. This indicates the margin of safety for investing in Nigerian equities has increased significantly, creating entry opportunities for investors.
Source: Bloomberg, FSDH Research
Source: Bloomberg, FSDH Research
However, we do not see a broad-based opportunity scope for investors, with the opportunities likely restricted to the banking sector. As we stated earlier, the banking index lost c.25% in April (with some HoldCo banks losing as much as 37%). Combined with the outstanding financial performance across the sector in Q1-2024, this creates a sizeable window of opportunity for investors. As a result, we advise investors to exhaust their exposure to banking stocks. We think this is particularly sustainable as interest rates are expected to remain elevated through the year, with the Monetary Policy Committee (MPC) focusing on controlling inflation, while banks continue to record FX gains.
Source: Bloomberg, FSDH Research
Source: Bloomberg, FSDH Research
However, companies in the real sector of the economy (except a few downstream oil & gas companies) continued to have downbeat performances, with several of them reeling from huge FX losses, rising costs that continue to compress margins, and higher borrowing costs for working capital needs. In addition, some of these sectors/companies are trading at pricey valuations as their share prices have not declined enough to reflect the recent downturn in their financial performances. Thus, we advise investors to continue to sell down stocks in the real sector (cement, telecoms, FMCG, brewers, food processors etc.) to the minimum level required in their portfolios while rotating funds to banks, money market instruments, and trading the bond yield curve. This is supported by the current economic sentiment that investors should allocate funds to investments that benefit from higher interest rates and weaker naira.
Global Equities: Bearish sentiments dominate; outlook no longer “so positive”
The recent bullish momentum across the global equities market came to a halt in April due to a combination of factors, including weaker-than-expected economic growth outcomes in the US and upward sticky inflation data. This brought back the “higher for longer” interest rate narrative for investors, implying rate cuts by key monetary policy authorities will likely be delayed. In addition, renewed geopolitical tensions only served to deepen the bearish sentiments observed during the month. As a result, our benchmark global equity index, the MSCI All-Country World Index (MSCI ACWI), recorded a 3.4% m/m decline to close the month at 756.61 points, while YTD return is now at 4.1%.
 
In the US stock market, sentiments were broadly bearish as all major US stock indices trended downwards during the month. Underpinning the negative performance was declining hopes that the Federal Open Market Committee (FOMC) would commit to cutting rates soon. The start of the month saw the release of several macroeconomic data, including the ISM Manufacturing PMI report which indicated the manufacturing sector was now in expansion territory. In addition, labour market data came in very strong as the Non-Farm Payroll (NFP) data for March showed the US economy added 303,000 jobs, outperforming the average projection of 200,000 jobs. These data points renewed concerns that the FOMC may take longer to signal the beginning of rate cuts. Bearish sentiments were further heightened with geopolitical tensions leading the US stock market to trade southwards from the start to the middle of the month, with a six-day bearish close between 12 April and 19 April.
 
However, the Commerce Department’s Bureau of Economic Analysis released the Q1-2024 GDP report showing the US economy expanded at an annualized 1.6% rate, below consensus expectations of 2.4%. This weak GDP growth raised hopes that this may be enough to cause the US Federal Reserve to consider cutting rates in the near term. Coupled with improving narratives on geopolitical tensions in the final week of April, sentiments rebounded, and some of the losses recorded in the month were clawed back. Nevertheless, all major US stock indices under our coverage closed the month lower, with the small-cap Russell 2000 (-7.1% m/m) recording the steepest loss while the Dow Jones Industrial Average (-5.0% m/m), NASDAQ 100 (-4.5% m/m), and S&P 500 (-4.2% m/m) followed.
Source: Investing.com, FSDH Research
Similar to developments in the US stock markets, European markets recorded bearish performances in April with the London Stock Exchange (LSE) the main outlier among our coverage markets. The bearish sentiment in Europe was particularly underpinned by events outside the region with most narratives coming out of the region remaining very positive, particularly with monetary policy. For example, European equity investors were concerned with the US monetary policy developments, while concerning macroeconomic data out of China further unsettled investors. Tensions in the Middle East also did no favours to investor sentiment as this further triggered a selloff across the markets. That said, there were significant positive developments for the monetary policy story in Europe. First, headline inflation for March slowed to 2.4% (from 2.6% in February), while core inflation (which adjusts for volatile food and energy prices) decelerated to 2.9% (from 3.1% in February). This progress on inflation has led the European Central Bank (ECB) to state it may begin rate cuts in its June 2024 meeting but reiterated that it will not necessarily mean consecutive multiple cuts. These positives helped European markets rebound in the latter days of the month but were not enough to erase all the losses recorded earlier. As a result, the pan-European STOXX 600 lost 1.5% m/m, while the German DAX and French CAC 40 lost 3.0% and 2.7% respectively.
 
Contrarily, the UK FTSE 100 (+2.4% m/m) delivered modest gains for the month, rising by 2.4% m/m while also setting a new all-time high. The positive spin in the UK market was underpinned by positive economic growth developments as the UK economy expanded 0.1% m/m in Feb-2024, following a 0.3% m/m rise in Jan-2024, indicating the economy may be edging out of a technical recession. The recovery was particularly encouraging as the bulk of the growth was supported by manufacturing which expanded 1.2% m/m in Feb-2024 (compared to a 0.2% m/m contraction in Jan-2024).      
 
In our April note, we highlighted our concerns about the US stock market being too optimistic about rate cuts while requiring a near-perfect inflation and monetary policy pathway to justify the current valuation of US stock indices. Our concerns remain despite the monetary policy and geopolitical tensions inspired decline recorded in April. The S&P 500 trades at a trailing PE ratio of 24.5x compared to the long-run average of 19.2x, representing a 28% premium. Similarly, the blue-chip DJIA trades at a trailing PE ratio of 22.4x, a 30% premium to the long-run average of 17.2x, with the tech-heavy NASDAQ trading at similar premium levels. These valuations indicate the market remains overly optimistic on monetary policy and inflation pathways.
Source: Bloomberg, FSDH Research
We have previously communicated the expectation of a single rate cut in 2024, with the decision expected in the FOMC ‘s July meeting. However, recent inflation and economic growth data suggest a revision to our projections. Our base case scenario models a single rate cut for 2024, projected to happen in the FOMC’s November meeting. We also model a bearish scenario where no rate cut happens, as while we expect to see further deceleration in inflation, we see a bumpy pathway to a sustainable 2.0% inflation in 2024.
 
As we mentioned last month, we are concerned about a growth slowdown in sectors outside the technology sector. The Q1-2024 GDP growth data has raised further room for worry, while the recent ISM Manufacturing and Non-Manufacturing PMI compounds our concerns. In April, the ISM Manufacturing and Non-manufacturing PMI declined to 49.2 points (from 50.3 points in March) and 49.4 points (from 51.4 points in March), underperforming economists’ expectations. We are particularly concerned about the non-manufacturing sector, which has not only slipped into the contractionary zone for the first time since Dec-2022 but has declined for three consecutive months. We posit that the higher for longer interest rate narrative is finally weighing on the economy and the growth narrative may become that of “economic slowdown” in the next months.
Source: YCharts, Investing.com, FSDH Research
We expect the US Fed to prioritise bringing inflation down within its preferred limit and, as such, may allow some economic slowdown to achieve that target. Thus, we do not see the FOMC considering a rate cut before November.
 
Given these factors, we believe current valuations are very optimistic, and our position on US equities is quite bearish in the medium term. As a result, we reiterate our preference for defensive portfolios, minimal equity risk exposures and where possible short selling the market (and going long on volatility).
FSDH Top Stock Picks
FSDH Research

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