| Nigeria Economy |    896 VIEWS  |
| Nigeria Economy | |
| 896 VIEWS | |
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Tuesday, November 17, 2020 / 10:04 AM / Coronation Research /
Header Image Credit: Nigerian Stock Exchange
As of Friday, the Nigerian Stock Exchange was the
world's best-performing equity market in local currency terms and its
second-best performer in US dollar terms. The market was up 30.53% year-to-date
in Naira and up 24.60% in US dollars (translating at the NAFEX rate). Since 6
April it rose by 69.51% in Naira terms. The question is why? We explain below how this has been caused by the year-long fall in Naira fixed income rates.
FX
Last week, The Naira appreciated by 0.08% against the
US dollar to N385.61/US$1 in the NAFEX market (also known as the I&E
Window). In the parallel, or street market, the Naira fell by 1.29% to close at
an offer price of N470/US$1. Hopes of convergence between the two rates are
waning, although they are within 22% of each other. We see continuing pressure
on the parallel exchange rate.
Bonds & T-bills
Last week, the secondary market yield for an FGN Naira
bond with 10 years to maturity increased by 39 basis point (bps) to 4.70% from
4.31%, and at 7 years rose by 46 bps to 4.15% from 3.69%, while at 3 years the
yield dropped by 79 bps to 1.89% from 2.68%. The annualised yield on 307-day
T-bill fell by 24 bps to 0.15% from 0.39% while the yield on a 298-day OMO bill
remained flat at 0.28%. In the bond market demand waned as local pension funds
were asked to realign their portfolios with the four-month deadline as directed
by a PENCOM circular. The market closed the week on a bullish note, however as
average yields on all instrument declined by 5bps with significant
participation at the short and mid-end of the curve. The bullish trend is
expected to continue. As expected, activity in the T-bill secondary market was
quiet as investors focused on the primary market auction (PMA) held on
Wednesday. The Central Bank of Nigeria (CBN) offered bills worth N147.82bn
(US$378.98M) and the PMA result was strong with stop rates printing at 0.04%,
0.15%, and 0.30% on the 91- day, 182-Day, and 364-day maturities, respectively.
Oil
The price of Brent crude rose by 8.44% last week to
US$42.78/bbl. The average price, year-to-date, is US$42.39/bbl, 34% lower than
the average of US$64.17/bbl in 2019. Oil prices skyrocketed on Monday 9
November when the US pharmaceutical company, Pfizer announced that its vaccine
has an efficacy of 90% against Covid-19. However, the price steadied later in
the week on fears that sharp rises in the level of Covid-19 infection in the US
would negatively impact economic growth and on fears that the Organization of
the Petroleum Exporting Countries (OPEC) would be unable to agree sufficient
production cuts going into 2021. We expect oil prices to be range-bound and not
to exceed US$50.00/bbl for several weeks ahead.
Equities
The Nigerian Stock Exchange All-Share Index (NSE-ASI)
rose by 12.97% last week, with a gain of 30.53% year-to-date. Last week,
Oando(+48.15%), Dangote Sugar(+34.55%) and Honeywell Flour Mills (+29.29%)
closed positive, while there were no losers.
Second-best equity
market in the world
How has the Nigerian equity market become the
second-best performing equity market in the world, in US dollar terms, so far
this year? On Friday, the Nigerian Stock Exchange All-Share Index (NSE-ASI)
closed at 35,037.46 points, up 30.53% in Naira terms and up 24.60% in US
dollars, year-to-date.
The simplest explanation is probably the best.
Nigerian investors face a shortage of things to invest in. The problem comes
from the risk-free fixed income market (i.e. securities issued by the Federal
Government of Nigeria, FGN), where yields have crashed. At the beginning of the
year a 1-yr T-bill yielded 5.20%, a 7-yr FGN bond yielded 11.45% and a 10-yr
FGN bond yielded 11.40%. Inflation was 11.85% year-on-year.
By contrast, by the end of last week a 307-day T-bill
yielded 0.15%, a 7-yr FGN bond yielded 4.15% and a 10-yr FGN bond yielded
4.70%. Inflation is recorded at 14.23% year-on-year. An investor who bought a range
of FGN bonds last January would have seen significant price appreciation since
then. Bloomberg's Nigeria Local Sovereign Index (which admittedly holds very
long-dated FGN bonds, as opposed to the four-to-five-year benchmark of many of
Fixed Income Mutual Funds) is up 63.18% this year. However, an investor
starting today with a portfolio of FGN bonds with four-to-five-year maturities
cannot hope to make this much money, unless interest rates become much lower or
negative in future.
So, Nigerian investors have put more money into
equities in recent months, switching from risk-free assets (FGN securities) to
risky assets (equities). Our benchmarks for risk-taking and diversification are
described in Coronation Research, Navigating the Capital Markets: the
Investor's Dilemma, 14 July. In an era of low Naira interest rates, renewed
risk taking comes after a long period, from 2010 to 2019, when the yield of
Nigerian T-bills exceeded inflation by 2.57 percentage points, on average.
Investing used to be straightforward and now it has become complex.
Of course, the size of these returns depends on your
base currency, and the way you invest depends on how you think exchange rates
will move. The Naira began the year at N364.70/US$1 in the NAFEX market but has
since weakened to N385.61/US$1. But liquidity in that market has declined this
year and the Naira has moved to N470/US$1 in the parallel market. Foreign
investors look at the performance of the NSE-ASI completely differently from
local investors.
The equity market does not look overvalued, in our
view. Some of the major bank stocks trade at close to their average long-term
price-to-book ratios at this point, suggesting that they were undervalued
earlier in the year, but are fairly valued now. For industrial stocks it is
important to remember that the economy is likely to resume growth in the second
quarter of next year. The search for value does not end here.
Model Equity Portfolio
Last week was an extraordinary week on the NSE. At one
point the NSE implemented its circuit breaker procedure, whereby trading is
suspended for 30 minutes while traders re-set bids and offers. The market was
up 6.3% on Thursday alone. Volumes were far higher than in recent months.
Last week the Model Equity Portfolio rose by 12.69%
compared with a rise in the Nigerian Stock Exchange All-Share Index (NSE-ASI)
of 12.97%, therefore underperforming it by 27 basis points. Year-to-date it has
gained 35.69% against a gain of 30.53% in the NSE-ASI, outperforming it by
516bps.
Our underperformance last week is attributable to the
fact that there were some very high price increases in a few stocks - generally
with small index weights - in which we do not have notional positions. At the
same time, there were strong moves in several stocks with large index weights,
notably BUA Cement (+20.9% on the week), Airtel Africa (+19.4%) and Dangote
Cement (+14.6%). We are happy to have at least index-neutral positions in these
stocks.
Our overweight position in MTN Nigeria did not rise
very much last week (+7.6%) but has provided almost one third (28%, to be
precise) of our cumulative performance year-to-date.
Some of our notional positions in banks enjoyed strong
performance last week with Zenith Bank (+21.7%) providing a useful
contribution. Another significant contribution came from our notional position
in Presco (+19.4%).
We are relieved that, broadly speaking, our Model
Equity Portfolio has remained resilient in the face of significant market
volatility (upwards, on this occasion). We attribute this to not only owning
stocks that we like (such as banks, MTN Nigeria and the palm oil producers) but
also holding notional positions matching most the major index weights. We do
not plan any changes this week.
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