Sunday, January 24, 2016 3:00PM / Afrinvest
“It is during our darkest moments that we must focus to see the light” – Aristotle
The financial market is currently going through a turbulent time, reflecting the intensity of instability in the global and domestic environment. From slowing growth concerns in China and plunging commodity prices in the global market to fiscal and currency crises in the domestic economy, a dark cloud seems to overshadow the investment landscape. Notwithstanding these challenges, we analyze the performance of the Nigerian economy and financial market in 2015 while stating our expectation for 2016, paying keen attention to key events in the global and domestic economy.
Global Macroeconomic Highlights
The performance of the global economy in 2015 was largely dragged by growth concerns in China, tumbling commodity prices and monetary policy normalization in the US. The cumulative effect of these factors is expected to further dampen the activities in emerging and frontier economies in 2016 as tanking commodity prices and strengthening dollar hurt output growth. On the flipside, lower commodity prices which has propped up savings and discretionary spending, supported by easy monetary policy is anticipated to bolster output growth across advanced economies. Accordingly, the IMF projects global growth at 3.4% in 2016 from 3.1% in 2015 while highlighting slowing growth in China, lower commodity prices and policy normalization in the US as key risks to global growth.
Domestic Macroeconomic Highlights
In the domestic space, gains from a peaceful and successful conduct of the general elections was off-set by poor monetary policy responses, delayed fiscal policy pronouncements and relentless decline in oil prices. The weakness in the system was reflected in the pace of GDP growth which slowed from 6.22% in 2014 to 3.96%, 2.35% and 2.84% in Q1, Q2 and Q3:2015 respectively, dragging in its weak currency volatility, higher inflation rate and a 17.4% Y-o-Y decline of the NSE All Share Index.
As experienced in 2015, we expect adjustment to lower crude oil prices to remain a crucial theme in 2016. With lower oil prices further impeding government revenue, we believe a looming fiscal crisis (if not averted) may constitute a major threat to social stability in 2016 notwithstanding efforts to shore up revenue via diversification into non-oil sources. We are of the view that non-oil revenue projections in the proposed 2016 budget may be optimistic given the subdued outlook for consumption spending and corporate earnings amidst policy constraints in the system.
The impact of lower crude oil prices is likely to keep domestic output growth at a sub-optimal level as consumption expenditure which contributed 74.0% to GDP in Q2:2015 stays soft while private sector investment (17.0% of GDP) may be constrained by currency market challenges and the higher risk environment.
Thus, Afrinvest Research estimates GDP to grow by 3.5% in 2016 as against 3.0% in 2015 while we forecast headline inflation to average 9.6% in 2016 as pressure on FX rate lingers. In the monetary policy space, we believe the series of policy pronouncements and reversals have significantly eroded confidence in the system. As a result, we recommend policy harmonization with the fiscal team and the use of forward guidance as well as clear communications of well thought-out policy actions to reduce uncertainty in the domestic investment environment. On the basis of a bearish outlook for oil prices and the impact on Balance of Payments (BoP) and external reserves, we believe a devaluation of the naira is only a matter of time. Hence, project at least a 25.0% adjustment of the naira to N265.50/US$1.00 during H1:2016. With policy normalization in the US and increasing pressure on domestic macroeconomic variables, we also anticipate that the CBN will reverse its dovish position on interest rate which should see MPR rise by 100bps to 12.0% in the course of the year.
Nigerian Financial Market Highlights
Nigeria’s fiscal and monetary policy responses to the weaker oil price environment have only served to exacerbate the cloud of investor uncertainty, thus, amplifying the financial market rout. The local stock market depreciated 17.4% Y-o-Y in 2015 and 21.3%as at 18-Jan-2016. The key concerns affecting investor sentiment can be divided into three;
1. The revenue structure of government which is mainly skewed to oil;
2. The structure of foreign exchange earnings; and
3. Foreign exchange restrictions and policy flip-flops that have rendered the operating environment for existing businesses and large corporates decidedly negative and, tragically, increasingly hostile to the sorely needed foreign capital inflows (both FPI & FDI).
Whilst a blurry fiscal direction as well as instability in the global oil market kept investors watching, the scale and frequency of policy reversals by the apex bank have effectively doused any remaining morsel of investor optimism towards investing in Nigeria in the present time despite enticingly depressed asset prices. This has been amplified by the position to sustain an unrealistic exchange rate at the official/interbank market relative to the parallel market. In view of the observed weaknesses in the system, we envisage three possible scenarios playing out in 2016.
Our bull case scenario (20.0% probability) sees NSE-ASI at 28,981pts (+1.2% Y-o-Y), the base case scenario (50.0% probability) is projected at 26,951pts (-5.9% Y-o-Y), while the bear case scenario (30.0% probability) predicts a 25,936pts (-9.4% Y-o-Y) close for the NSE-ASI. Our overall expectation is a negative return of 5.9% for the NSE ASI in 2016 bringing the index to close at 26,951pts by yearend.
However, premised on a projected 1.0% increase in MPR to 12.0% and a volatile oil market, we expect that unstable asset prices will continue to provide opportunities for fixed income traders. Thus, we advise clients to underweight on equities and overweight on fixed income by adopting an active fixed income trading strategy in 2016. We are of the view that a carefully selected active trading strategy will help deliver alpha - with Eurobonds being our biggest investment case for the year - given the limited investment alternatives as more arbitrage opportunities emerge.
Nevertheless, we maintain that the equities market presents a huge opportunity for long term positioning at the moment despite the obvious pessimism and difficulties. Reviewing activities in the aggregate economy and reassessing opportunities in the capital market, we present our strategies for investors to play the market in Section 5 of this report, paraphrasing Aristotle that it is during these cloudy and disquieting moments that investors must focus to see the light.