June 6, 2024/FSDH Research

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The Nigerian equities market rebounded from April’s dip, underpinned by bargain hunting on some bellwether counters, particularly in the banking sector. The month started on a negative note for Nigerian equities as bearish momentum dominated the first three weeks, with investors preferring to reduce exposure to equities while increasing holdings of money market instruments. However, depressed valuations triggered interest from investors as a combination of speculative trades and bargain hunting on historically sound companies by long-term investors drove strong gains in the final week of the month. Overall, the benchmark NGX All Share Index (NGX-ASI) rose 1.1% m/m to close at 99,300.62 points, with YTD return on the index now at 32.8%.

The bullish performance across Nigerian equities reflected broad-based momentum across sectorial classifications. For context, four out of the core five sectorial classifications closed the month higher. In line with our outlook for the short-term performance of the Nigerian equity market, the Banking index recorded the biggest gain for May, rising by 3.0% m/m, as investors’ bargain hunting activities on counters like ZENITHBA (+2.8% m/m) and FIDELITY (+13.3% m/m) drove the index higher. In addition, we note that Holdco banks like GTCO (+22.3% m/m), FCMB (+12.7% m/m), and ACCESSCORP (+2.1% m/m) also delivered very solid returns in May. The Oil & Gas index trailed, gaining 2.1% m/m. The uptick in May was supported mainly by investors’ interest in SEPLAT (+3.6% m/m) and OANDO (+22.3% m/m). The interest in Seplat Energy was due to corporate events as investors attempted to increase their stake in the company following NNPC’s announcement that it had reached a settlement with Mobil Producing Nigeria Unlimited (MPNU), a step that investors consider significant in Seplat’s quest to complete its reverse takeover of MPNU. On the other hand, speculative trading on OANDO propelled the stock higher.

The Consumer and Industrial goods indices rebounded during the month, gaining 1.2% and 0.2%, respectively. The consumer goods sector rebound was aided by investors taking advantage of increasingly attractive valuations of fundamentally sound businesses in the sector. As such, we saw price increases in NESTLE (+13.7% m/m), DANGSUGA (+20.8% m/m), FLOURMILLS (+24.6% m/m), NB (+3.5% m/m) and UNILEVER (+2.0% m/m). For the Industrial goods index, the price uptick in WAPCO (+2.9% m/m) and JBERGER (+24.9% m/m) drove the positive performance. On the other hand, the Insurance sector closed May as the lone loser, closing lower by 3.3% m/m, as investors continued to take profit on major counters in the sector such as NEM (-22.7% m/m). The broad-based bullish sentiments were extended to telecoms and agriculture stocks as MTNN (+9.5% m/m), OKOMU (+10.0% m/m), and PRESCO (+27.8% m/m) recorded upbeat performances in May.

Source: Investing.com, FSDH Research

While the Nigerian equities market staged a modest rebound in May, the outlook for Nigerian equities is not overwhelmingly positive. In the short-term, we see opportunities for investors to bargain hunt on banking stocks. As highlighted in our May note, YTD, the banking sector is the lone loser across the five core sectors we track on the Nigerian Exchange. This is despite sustained growth in profitability in Q1-2024, aided by higher interest rates, FX gains, and a low base from Q1-2023. As a result, the valuation of stocks in the banking sector has cheapened, creating entry opportunities for short to medium-term investors. However, we note that the long-term outlook for the sector is hazy due to the significant dilution impact that is likely to affect holdings in banks as they raise fresh shareholder capital to comply with the CBN’s recapitalisation guidelines. Thus, we recommend investors with a “buy and hold” philosophy stay away from the banking sector.

For companies in the real sector, the business environment continues to take a toll on their operational and financial performance. Declining consumer purchasing power (amid rising prices and stagnant income levels), the rising cost of production, the impact of FX losses on FCY liabilities, and rising domestic interest rates combine to derail growth. The Q1-2024 financial results reinforce business’ struggles with several companies in the telecoms, consumer and industrial goods sectors recording losses or declining profits. We expect this sub-optimal performance to remain the narrative for businesses in the real sector in 2024, which will continue to dampen sentiments and result in persistent fund outflows from the shares of businesses in the sector. That said, we note that the oil palm businesses and the oil & gas companies (upstream & downstream) could be bright spots for investors to consider.

We are also concerned about the impact of rising interest rates. At the May Monetary Policy Committee (MPC) meeting, the committee announced a 150bps upward adjustment to the Monetary Policy Rate (MPR) to print at 26.25% as the committee focuses attention on curbing inflation and attracting FX flows. The impact of this will likely trickle down to the debt markets in the coming months. That said, we note that interest rates on government securities continue to remain very attractive for investors, while the money market appears to be enjoying a commercial paper issuance frenzy with yields greater than 25% per annum. These outlets represent attractive alternatives for investors and will continue to sustain outflows from equities in favour of money market instruments.

Source: Bloomberg, FSDH Research

All in all, we consider Nigerian equities pricey at current valuations (the NGX-ASI trades at a 7% and 18% premium to its long-run average and peer average, respectively), and current economic dynamics suggest earnings growth for businesses outside the banking sector could be subdued for the next quarters. As a result, continue to prefer the strategy of exhausting exposure to money market instruments while waiting for valuations to return to more attractive levels to resume bargain hunting activities. Nevertheless, we see opportunities for investors to exploit corporate actions as well as short-term trading in banking stocks. We particularly note that investors should be on the lookout for Seplat Energy following the agreement reached between NNPC and MPNU, which could potentially see the arbitration case dropped, paving the way for Seplat Energy to complete its acquisition of MPNU. As the company stated at the time of announcing the acquisition, it has the potential to triple the company’s production, double 2P reserves, and significantly boost cashflows and shareholder returns.

Source: Bloomberg, FSDH Research

Source: Bloomberg, FSDH Research

 Global Equities: Global equity market rebounds on monetary policy optimism

The global equities market staged a strong rebound as investors remained optimistic about the US and Europe’s inflation and monetary policy outlook. Inflation slowed in the US while sustaining a downward trajectory in Europe. In addition, macroeconomic narratives were fairly positive, strengthening investors’ belief that the global economy will remain resilient and inflation remains firmly under control. As a result, our benchmark global equity index, the MSCI All-Country World Index (MSCI ACWI), recorded a 3.8% m/m rise to close the month at 785.54 points, while YTD return is now at 8.1%.

Investors’ sentiments in the US equity market rebounded strongly in May following several perceived positive catalysts. At the start of the month, the Federal Open Market Committee (FOMC) opted to keep rates unchanged at the 5.25% – 5.50% range, broadly in line with expectations. However, the positive catalyst for investors was Jerome Powell’s comments that the Fed’s next policy direction is unlikely to be a hike despite a lack of a clear pathway towards a sustainable decline in the inflation rate towards the 2% target. This policy posture fueled a strong rally in the following days as the S&P 500 recorded positive closes in eight (8) of the next ten (10) trading days. The momentum was further supported by positive labour market data showing that non-farm payrolls showed the US economy added 175,000 jobs, lower than analysts’ expectations of 250,000. In addition, hourly wages were up but slower-than-expected while unemployment printed higher the expectations. The market interpreted these data points as positive because it reinforces expectations that the FOMC would not hike rates further, while the underperformance across the labour market data was not disastrous enough to trigger panic about the economy.

Later in the month, the Bureau of Labour Statistics (BLS) released the April inflation report showing disinflation resumed in April as headline inflation moderated to 3.4%, from 3.5% in March. In addition, core inflation moderated to 3.6% from 3.8%. Notably, the April inflation print was the first time inflation came lower than consensus expectation in the past three (3) months. The disinflation news further boosted investor sentiments, extending the rally till the end of the month. That said, we note that investors began to book some profit in the final trading days of the month. Overall, the tech-heavy NASDAQ gained 6.3% m/m, particularly driven by strong gains in NVIDIA following a positive earnings performance. Small-cap Russell 2000 (+4.9% m/m), S&P 500 (+4.8% m/m), and Dow Jones Industrial Average (+2.3% m/m) all closed the month higher.

Source: Investing.com, FSDH Research

In European markets, the rally from the end of April continued into May as the monetary policy landscape appeared to remain positive. Following the decline in inflation recorded in April, the European Central Bank (ECB) announced plans to cut interest rates in June. This sentiment was upheld throughout the month as several ECB policymakers indicated that a rate cut is likely in June, but the path afterward appears uncertain. The statement from the policymakers was further corroborated by the ECB President’s comments during an interview where she stated there is a strong likelihood that the ECB will reduce interest rates in June but guided that economic data will remain the driver of interest rate decisions. The positive momentum on monetary policy direction boosted investors’ sentiments, driving stock prices higher. The pan-European STOXX 600 gained 2.6% m/m, reflecting bullish sentiments across the region. For country-specific performance, the DAX recorded the biggest climb, up 3.2% m/m, trailed by UK FTSE 100 (+1.6% m/m) and CAC 40 (+0.1% m/m).

In our last note, we communicated our concern with the pricey valuations for US equities amid declining macroeconomic fundamentals and a downbeat outlook for monetary policy. While the US equity market staged a rebound in May, we remain bearish on US equities over the medium to long term. Equity valuations remain very pricey, indicating unfounded optimism about economic growth and monetary policy direction. For context, the S&P 500 trades at a trailing PE ratio of 24.7x, a 29% premium to its long-run average of 19.2x. Similarly, DJIA (22.1x) trades at a 28% premium to its long-run average.

Source: Bloomberg, FSDH Research

Beyond valuation multiples, the outlook for monetary policy will likely not be as straightforward as the current market posture suggests. While inflation declined in May, we struggle to see a sustainable pathway towards achieving a 2% inflation target in 2024. Furthermore, the economic growth outlook continues to worsen. While data on the ISM Services Purchasing Managers’ Index (ISM Services PMI) is yet to be released, the Institute of Supply Chain Management (ISM) released the ISM Manufacturing PMI data showing manufacturing activities contracted for the second consecutive month and is within the contractionary region in 18 of the past 19 months. The index printed at 48.7 for May-2024, lower than April’s 49.2 and below the consensus expectation of 49.6. This indicates manufacturing activities remain weak, potentially dampening the growth outlook. Another indication that the economy may be weaker than the equity market is pricing in is the downward revision to US’ Q1 2024 economic growth, as the Bureau of Economic Analysis (BEA) revised growth estimates lower to 1.3%, from 1.6% previously.

Source: YCharts, Investing.com, FSDH Research

Overall, we continue to posit that the margin of safety for investors is very limited. Current valuations do not justify the US economic growth outlook as well as monetary policy direction. We continue to recommend investors sell into the market’s highs while increasing cash holdings in their portfolios.

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