Outlook 2018 - On Thin Ice; Charting a Course to Solid Grounds

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Thursday, January 18, 2018 /10:48AM / Meristem Research 

Investment Précis 
Continuing its path of a gradual recovery, global growth strengthened steadily in 2017 on the back of increased trading activities across countries as well as central banks’ interventions. Improved consumer spending and business investments in the US and Euro area and firmer net export and production in China were the major drivers of global growth. In the UK, however, the economy continues to weather the Brexit storm in the face of declining consumption and real wage growth. 

With business investment and net trade growing faster than envisaged in Britain, the Bank of England hiked rate for the first time in 10 years. This is expected to mitigate Brexit-related constraints on investment and labour supply and also to diminish the obvious slowdown in the economy.  The US Fed also implemented its rate hikes in the year, as expected, alongside launching its balance normalization strategy, to ensure that interest rate remain a viable tool to be employed in the economy. 
 

Asides the growth in China and its expected contribution to global growth, Other emerging Asian countries witnessed growth in 2017 which stemmed from improvement in investment, manufacturing and trade. While we witnessed strong growth in domestic demand, similar growth was also witnessed in net exports, owing to the growth in high-tech sectors. Consequently, Bangladesh and India are expected to be amongst the top growing emerging Asia economies 

In Sub-Saharan Africa, improved commodity prices anchored growth in 2017 and are expected to continue to do so in 2018. Increased global oil demand from the OECD region and the OPEC output cut were the major drivers of the increase in oil price witnessed in H2:2017, which significantly benefitted major oil exporting countries.  
 

The growth expectation for emerging markets (specifically African countries) has been the major driver of investments to these countries. According to the IMF, growth in Sub-Saharan Africa is expected to rebound to 2.50% in 2017 from 1.40% recorded in 2016, similarly Foreign Direct Investment (FDI) to the region improved significantly over the same period. Based on growth expectations, strengths, weaknesses and size, countries like Angola, South African, Kenya, Mauritius, Cote d’Ivoire, Tunisia, Rwanda, Botswana and Nigeria have been identified as possible top FDI destinations in 2018. 
 

In a bid to continue to attract foreign investments and foster economic growth, the Nigerian government has put in place several policies and taken steps to address pressing issues in the economy, like the Economic Recovery and Growth Plan (ERGP), Voluntary Assets and Income Declaration Scheme (VAID), Appropriation Bill, Debt restructuring etc. Given the uncertainties that still lie ahead, we believe the economy is still on thin ice but it is charting a course to solid grounds. 

In November 2017, the 2018 appropriation bill, which was an improvement over the 2017 bill, was presented, and we have mixed opinions on the feasibility of stated underlying assumptions. While we believe that targets like USD47.00pb oil price are attainable and quite realistic, we do not repose same faith in some others like the 12.42% average inflation rate and NGN305/USD exchange rate as we consider then being stretched on the optimistic side considering the uncertainties surrounding them.  

While the Presidency expects a GDP growth rate of 3.5%, we forecast a real GDP growth of 1.77% in 2018. We expect the improved oil production and price, which triggered the end of the 2016/2017 recession, and the subsisting policies on agriculture as well as the strength of government expenditure to be the major drivers of growth in 2018. 
 


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On the inflation side, despite the inflationary pressures prevalent in 2017, the introduction of the I&E FX window (which moderated external cost pressures), coupled with the high base effect, were a few of the factors responsible for the downward trend witnessed. Given our expectations of an expansionary fiscal policy, a relaxation of the hawkish monetary stance as early as the first quarter of this year, and campaign spending ahead of the 2019 General Elections, we do not expect a significant drop in inflation rate.
 

While keeping inflation rate in check remains one of the major objectives of the Monetary Policy Committee (MPC), supporting growth and ensuring economic stability are also important objectives of the committee. To support foreign inflows and ease the pressure on the currency, the committee maintained the MPR at 14% all through 2017, even as the CBN also made several modifications to the FX system. This saw exchange rate stable at NGN363/USD at the I&E FX window and parallel market. 

Furthermore, the CBN reinforced its ban on importation of 42 items, which led to the increased production of some basic agricultural produce in the country. Rice is one of the most important food items in Nigeria and a favorite staple in all regions of the country. Given this demand, and the estimated supply shortfall of 2.5MMT, we see legitimate avenue for investors to make profit in rice cultivation. Similarly, oil palm processing has also been identified as a viable sector for investment. 
 

A major investment hub for 2017 was the Nigerian Equities market, as the NSEASI gained 42.30% at the end of the year, representing the highest return recorded since 2013. The increased buying pressures witnessed may be attributed to the introduction of the I&E FX window by the CBN, the MSCI’s decision to retain and increase the weighting of Nigerian stocks in its Frontier Market Indexes and the impressive financial scorecards churned out by the listed companies.
 

In 2018, we envisage a continuation of the current upward trend albeit at a much slower pace. Whilst we expect sectors such as the consumer goods and industrial goods sectors to consolidate on the gains from the economic recovery, we posit that the banking sector will post a moderate return on the back of our modest earnings growth expectations for the sector’s heavyweights.
 

Also, we don’t expect the insurance and the oil and gas sectors to be left out on the recovery. Using the fundamental and neural network methodologies, we arrived at an expected 2018 return of 14% for the market.
 

In the Fixed income space also, investors benefitted from the stable FX and high yield environment, resulting in significant participation in the market. Following the government’s intent to substitute high-rates short-term domestic debt with long-term foreign loans, we had more Eurobond auctions in 2017. Similarly, there was a further deepening of the debt market, as the government introduced the FGN Savings bond, Diaspora bond and the Sukuk, which were all oversubscribed.
 

Despite our expectation of a plausible rate cut in 2018, we do not expect a significant moderation in yields because of this. Nonetheless, we still expect market yields to gradually trend downwards, as market participants re-price assets in the light of the cut in policy rate.
 

Also, we expect some periods of declines, depending on the conditions in the OMO market and the settlement of maturing T-bills with foreign loan. 
 

Given our outlook on several economic variables, we provide a guide for our investors to earn alpha, even as the economy charts its course to solid grounds. 

 

Proshare Nigeria Pvt. Ltd.


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