Meristem Research 2020 Outlook - Finding Alpha Amidst The Haze


Wednesday, January 08, 2020 / 05:52 PM / Meristem Research / Header Image By: Meristem Research               




Global and Domestic Economy 

Global growth is set to remain fragile in 2020 as the trade tension between the two largest economies in the world weighs on demand, manufacturing, and private investments across the major economies. Monetary policies across these economies have become accommodative amidst low inflation rate and weaker economic output levels. Quantitative easing programmes have also been resumed in the U.S and the Euro to stimulate growth. The softness in global growth also impacted Emerging Markets and Developing Economies (EMDEs), although country specific risks also contributed to the growth outcomes in these economies. Political upheavals in Hong Kong and Venezuela, and sustained tensions in the Middle East hurt the fortunes of EMDEs, with commodity prices also depressed by lower global demand and oversupply.


The outlook for 2020 highlights some broad-based recovery to be driven by easing of the trade war and a clearer sky over Britain's exit from the EU. Country-specific recoveries previously beleaguered economies including Brazil, Turkey and other EMDEs is also expected to drive growth to 3.5%, although this is figure is lower than the initial expectation of 3.6%.


On the domestic front, 2019 commenced with a flurry of unconventional policies instituted by the Government to sustain the economic progress made in 2018. On the year, growth firmed up gradually from 2.10% in Q1:2019, to a moderate expansion of 2.12% in Q2 on the back of robust oil sector growth. The third quarter of the year was similarly propped up by sustained output in the oil sector and GDP growth pitched in higher at 2.28%. Some of the standout policies introduced include a review of the required Loan to Deposit Ratio of Banks, an adjustment of the Standing Deposit Facility accessible to banks and restricting accessibility to the OMO market. Clearly, the monetary end of the policy space was quite active during the year.


In the fiscal space, the 2020 budget of continuity was passed before the end of 2019, returning the budget cycle to a standard calendar year although, with rather ambitious revenue and expenditure targets. Lawmakers worked in tandem with the executive arm to expand the revenue base of the government for the 2020 fiscal year, which included an increase in the VAT, an amendment of the PSC Act, amongst other legislation.


In 2020, our expectations of consumer spending include a consistent rise in inflation and imposition of a myriad of taxes, which affirm the possibility of an erosion in consumers purchasing power during the fiscal year. Alongside this, there is a real prospect that the land borders will remain shut for the better part of 2020, further exerting pressure on food prices. In response to this, we expect a rejuvenation of activities in the agricultural sector, as domestic players work to meet the never-ending demand of foreign goods stuck at the land borders.


Mirroring the sluggish growth of the economy, the Nigerian bourse remained downbeat for the most part of 2019, save for short periods of bullish bouts triggered by corporate actions and most recently, depressing yields in the fixed income market. A review of the players allowed to partake in OMO market activities dragged primary market yields lower and in the secondary market, investors' scramble for available instruments pressured yields further. With inflation on the high on an upward trajectory, the real rate of return sank further into the negative territory, exaggerating the unattractiveness of these markets to domestic investors.


In 2020, we expect the CBN to keep up with unorthodox policies to drive its objectives. We expect inflation to remain on the high side while GDP growth stays moderate. We also project relative stability in exchange rate and do not foresee a cut in the Monetary Policy Rate (MPR) in the year.


Global Economy and Growth

Monetary Stimulus to Support Growth in Advanced Economies 

Global economic growth weakened considerably, from 3.7% in 2018 to c. 3.2% in 2019 (IMF), as geopolitical tensions heightened risks and decelerated interest in long-term business investment. Contractionary fiscal policies aimed at pegging debt levels and protectionist trade policies emerging across nations dampened growth prospects for major economies, further limiting the effectiveness of monetary policy.


In a bid to provide some extra layer of protection for the US economy in a chaotic global economy, sustain economic expansion and trigger an uptick in stubbornly low inflation rates, the US Federal Open Market Committee (FOMC) cut benchmark rates three times in 2019. Rates are now in the range of 1.5 to 1.75 percentage points. After leaving rates unchanged in December, the Committee indicated that its outlook for rates are likely to remain around current levels until the end of 2020 – an indication that the time is perhaps ripe to watch the impact of the cuts and direction of the global economy.


In the Euro Area, growth in countries like Italy, Germany and France remain subdued as data from the European Central Bank (ECB) expects a longer period of economic slowdown as against the previous estimate. Growth in the economy, especially the manufacturing sector, continues to suffer from the decline in international trade and extended global uncertainties. Also, declining economic activity continue to weigh on inflation numbers, which has been crawling below the ECB target of 2%. Consequently, the ECB has intensified its stimulus programmes, re-introducing the EUR20bn per month bond-buying programme in September to drive up inflationary pressures and support growth in the Euro Area. As at November 2019, the E.U annual inflation had inched up to 1.30%, up from 1.10% in October.


Also, in the UK, Brexit uncertainty lingered, weakening private investment and growth. In November, the Monetary Policy Committee voted 7-2 to keep the rate on hold at 0.75%, despite signs of weakness in the economy. The MPC also expects inflation to remain below its 2% target in the medium term as household spending remains tepid and business investment is kept on hold amidst Brexit uncertainties. Although the MPC held its benchmark rate at 0.75% all through 2019, we expect the stance to remain accommodative in 2020, notwithstanding the recent positive developments regarding Brexit and the elections. This would be necessary to spur recovery and growth in the near term.


The growth outlook remains weak across major advanced countries, hence, most Central Banks have become dovish, keeping interest rates low and resuming stimulus programmes to drive economic growth. However, some measure of recovery is expected on the year, and with 2019 as a base, global growth for 2020 is projected at 3.5% by the IMF.


...How far can Monetary Policies Go? 

In 2019, with weak economic growth across nations, the need for expansionary monetary policies to drive economic activities amid the rising geopolitical and trade tension was dominant. From the advanced economies, to emerging markets, Central Banks cut their interest rates at least once in the year. Yet, global economic growth slowed with the fear of a possible global recession on the horizon.


Going into 2020, the effectiveness of expansionary monetary policy in driving growth is getting weaker, especially in advanced economies. The ECB currently has its benchmark rate close to 0% while the Fed also cut rates three times this year to stimulate growth.


While accommodative monetary policy remains a key monetary tool to propel demand and employment; there is a need for fiscal stimuli to complement these policies.


This then begs the question; is there enough fiscal space left? The high debt profile in countries like Japan and the US could limit the size of fiscal stimulus while the European Union is still recovering from the sovereign debt crisis.


Global Credit Conditions Remain Weak 

Globally, expansionary monetary policies continue to support economic growth in the near term. However, the accommodative stance has increased the financial risk-taking appetite across different markets, increasing the vulnerabilities of economies to financial stress in the future. As further rate-cuts emerge, the allure of sub-prime investment increases as portfolio managers seek a higher return.


Quite a number of debt issuers with weak credit quality have seized this opportunity to raise debt instruments and to refinance earlier issued instruments in a bid to lower finance costs. Hence, the level of leveraged finance has increased significantly since the global crisis. If low rates linger for longer, the influx of leveraged debt will weaken global credit conditions further which would pose further risk to the global economy.


For the banks, the interest rate decline on investment, are affecting profitability, and in turn, the capital buffers for the bank in the face of rising macroeconomic tensions.


In the US, the economy is in its longest streak of expansion and the possibility of a cyclical recession is increasing. Given this, the US Federal Reserve has reduced the benchmark rates three (3) times in 2019 to bolster growth. However, this has lowered the borrowing cost and if it remains low for a long time, it could distress the Interest Income of lenders and insurance companies, affecting their long-run profitability. To shore up returns, some banks may take more risks which could lead to deterioration in asset quality. Also, we expect insurance firms to respond to the lower yield environment by demanding higher premiums to insure risks.


In Europe, the risks created by low monetary policy rates, Brexit, and slowing manufacturing output lingers. Concerns remain about the effectiveness of expansionary monetary policies, especially in Germany, as slow growth persist in the face of low inflation and high employment levels.


Credit risk also remains elevated in Asia, with China's debt crisis standing out. As the economy hits its slowest growth rate in over two (2) decades, its huge debt cannot be ignored. In Q1:2019, China's debt-to-GDP rose to 300%, on the back of huge corporate and household debt over the years. With China accounting for almost a third of global GDP growth, its growth performance alongside its poor credit conditions remains significant to the global credit and financial conditions.


Investment continues to slump in Latin America as the lack of broad economic reforms in key countries like Brazil, as well as political uncertainties in Mexico and Argentina continues to pull down investors' confidence in the region. Although rate cuts in advanced economies make debt instruments in emerging economies more appealing, the appetite of global investors in low-rated issuers remains subdued. Credit conditions in the region remain weak and banks' asset quality remains at risk.


In Sub-Saharan Africa, weak macroeconomic conditions pressure the credit ratings across regions. Also, most nations remain exposed to their high sovereign credit risk while the weak economic environment still pose risks to asset quality, especially in countries where policy directives and geopolitical tensions exists.


Global credit conditions are expected to remain weak in 2020, in the face of increased risk of a global economic downturn, high debt levels, high private sector leverage, and geopolitical tensions which could impact global supply chains, and investment decisions. We expect the uncertainty around trade and geopolitics to continue to impact the financial market in 2020. To moderate its effect, there will be a need to intensify the credit risk assessment for financial institutions, increase the oversight on investments made by non-financial entities and enhance the debt management practice and framework for emerging and frontier markets.


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