Interest Rate and Equities in 2022


Tuesday, January 18, 2021 / 9:04 AM / by Coronation Research / Header Image Credit: primeimages;iStock


Which way will the equity market go in 2022? Our answer is that Nigerian investors are influenced by interest rates and that market interest rates may rise in 2022. The appropriate equity market strategy, in that case, is to look for secular growth stories (like telecommunications) and earnings growth, rather than relying on a positive rerating of the market as a whole.



Last week, the exchange rate at the Investors and Exporters Window (I&E Window) weakened by 0.12% to close at N416.50/US$1. Elsewhere, the Central Bank of Nigeria's foreign exchange (FX) reserves were unchanged at US$40.50bn. In our view, the CBN's position remains strong as the level of FX reserves remains high in the long-term context. Hence, as liquidity rises in the official FX markets, it seems possible that stability will be maintained in the I&E and NAFEX rates in the near term.


Bonds & T-bills

Last week, trading in the Federal Government of Nigeria (FGN) bond secondary market was bullish as the average benchmark yield for bonds fell by 3bps to 11.51%. Notably, the yield on the 3-year (-7bps to 9.07%) and 7-year (-16bps to 12.27%) bonds tightened, while the yield on the 10-year (+1bp to 12.61%) bond expanded. On Wednesday, the Debt Management Office (DMO) released its Q1 2022 bond issuance calendar and is expected to offer between N420bn - N480bn (US$1.01bn to US$1.15bn) across the January 2026 (reopening) and January 2042 (new issue) maturities. In addition, at the primary auction this week, the DMO plans to offer N150bn worth of bonds across the earlier listed tenors. We expect a rise in bond yields over the medium term owing to an expected increase in domestic borrowing by the FGN to finance the budget deficit and tight domestic monetary policy amidst global monetary policy normalisation this year.


Activity in the Treasury Bill (T-Bill) secondary market was also bullish last week, as the average benchmark yield for T-bills fell by 4bps to 4.39%. The yield on the 314-day T-bill was down by 1bp to close at 5.22%. In its first primary market auction (PMA) of the year, the DMO allotted N57.54bn (US$138.16m) worth of bills across all tenors. Accordingly, the stop rates rose by 1bp apiece on the 91-day (2.50%) and the 182-day (3.44%) bills. Surprisingly, the rate on the 364-day bill reversed its recent trend, rising by 60bps, the highest jump since 28 April 2021, to 5.50% (annualised yield 5.82%). Notably, demand was weak, as a total subscription of N113.06bn was recorded, implying a bid-to-offer ratio of 1.46x (vs an average of 3.73x over the auctions in 2021). Elsewhere, the average yield for OMO bills rose by 12bps to 5.61%; the yield on the 263-day OMO bill gained 21bps to 5.73%. At the OMO auction, the Central Bank of Nigeria (CBN) sold N20bn worth of bills and maintained stop rates across the three tenors.



Last week, the price of Brent rose by 5.27%, it's second consecutive weekly gain, to US$86.06/bbl - the highest level since 26 October 2021. Oil prices continue to be supported by tight supply from the Organisation of the Petroleum Exporting Countries and its allies (OPEC+) as global demand remains strong despite worries around the Omicron coronavirus variant. Consequently, Brent is up 10.65% year-to-date and has traded at an average of US$82.33/bbl, 16.14% higher than the average of US$70.89/bbl in 2021. Elsewhere, China suspended some international flights to manage the virus outbreak at Tianjin and the city of Dalian. In addition, data from the US Energy Department showed that US crude stockpiles declined by 4.55 million barrels as of 12 January 2022 against a consensus estimate of 1.90 million barrels, further supporting prices. We maintain our expectation that the price of Brent oil is likely to remain well above the US$60.00/bbl mark over the first half of this year.



The NGX All-Share Index rose 1.37% last week, crossing the 44,000-point mark to close at 44,454.67 points, its highest level since 5 February 2018. Accordingly, the index is up 4.07% year-to-date. BUA Foods (+24.06%), MRS (+9.72%), Dangote Cement (+8.00%) and PZ Cussons (+6.72%) closed positive last week while Nestle Nigeria (-7.81%), Unilever Nigeria (-5.71%) and Nigerian Breweries (-4.17%) closed negative. Across the NGX subindices, the NGX Industrial Goods (+3.56%) index led the gainers, followed by the NGX Oil and Gas (+1.74%), NGX Banking (+0.75%), NGX 30 (+0.47%) and NGX Pension (+0.14%) indices. Conversely, the NGX Consumer Goods (-4.35%) fell, followed by the NGX Insurance (-1.54%) index, which lost for the second consecutive week.


Interest Rate and Equities in 2022

Which way for the equity market in 2022? At Coronation Research we shun such questions, preferring to show how investing in stocks with high and consistent profitability creates wealth over the long term, as we demonstrated in 'Equities for a Superior Return' (15 November 2021). Nevertheless, the question about the market's direction comes up at the beginning of every year.


We consistently make the point that, for Naira-denominated investors, the past two years have been very different from the eight years prior to that. For most of the period between 2012 and 2020 it was possible to earn a risk-free return in Tbills above the rate of inflation. The difference, on average, was 4.0 percentage points. Why take risks in the equity market, or elsewhere, when the Federal Government of Nigeria's bills beat inflation anyway?


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Before 2020, when T-bills rates crashed, it took a lot to move the Nigerian equity market. In 2012 and 2013 the driver was the re-inflation of the Nigerian banking sector after the establishment of the Asset Management Company of Nigeria (AMCON) in 2010, combined with the conviction on the part of foreign institutional investors that they could make money from investing in Nigerian consumers' wallets as represented by listed consumer stocks.


Three years of equity index losses followed (2014, 2015 and 2016) as oil prices dropped and pressure mounted on the Naira in the foreign exchange markets. The resolution of those pressures - basically the final in a series of exchange rate adjustments - in 2017, combined with a resurgence in commodity prices, saw the equity market make a 42.8% gain that year.


During the next phase, after 2017 and up until the present day, we doubt that foreign institutional investors play a significant part in driving the equity market. Domestic investors are in the driving seat and domestic investors are influenced by Naira interest rates. From mid-2018 rates started rising again (the authorities wished to maintain interest in the Naira in the foreign exchange markets) and money moved into T-bills and fixed income. Equities fared poorly, as indeed they did in 2019.


Then monetary policy changed. From October 2019, low interest rates were the order of the day. Naira interest rates crashed in the final quarter of 2019 and throughout 2020. The result, despite the economic devastation brought by the Covid-19 pandemic, was a 50.0% rise in the equity market. In 2021 T-bill rates began to rise again, but when it became apparent that T-bill and FGN bond rates would rise no further after May, the equity market (with a considerable delay) rallied during the second half of the year.


What do we think about interest rates in 2022? Our forecast is that there will be a steady and significant rise throughout the year, with 182-day T-bill rates forecast to average 5.2% in Q1 2022f, rising to an average of 8.5% in Q4 2022f. This does not mean that risk-free T-bill rates will exceed inflation again: but it does mean that gap is likely to narrow, meaning that Money Market and Fixed Income instruments are likely to become more attractive to investors than they are today.


For the equity market this does not spell doom, but it does suggest that investors will become increasingly cautious as the year progresses. In terms of equity market strategy, this points to holding stocks with strong secular growth (telecommunication stocks are good examples) and growing earnings. By contract, we believe the market is unlikely to accord higher ratings (higher ratings than today) for stocks that lack earnings growth.


Model Equity Portfolio

In the second week of 2022 the Model Equity Portfolio rose by 0.67% compared with a rise in the NGX Exchange AllShare Index (NGX-ASI) of 1.27%, therefore underperforming by a significant 60 basis points. So far this year it has gained 2.42% against a 4.07% gain in the NGX-ASI, underperforming it by 165bps. In other words, the past two weeks have undone roughly half the 328bps outperformance we carefully achieved last year. This is not a happy situation.


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In a word, the problem is BUA Foods. This stock was listed on the first trading day of the year, 4 January, at N40.0/share and has appreciated 65.0% to N66.0/s. It makes up 4.9% of the index. Last week it appreciated by 24.1% from N53.2/s to N66.0/share. If you do not own a stock that makes up 4.9% of the index and that stock appreciates by 24.1%, you are missing out on 118bps of index performance in a week. That is the problem.


Therefore, we may be quite pleased to have underperformed by 60bps under the circumstances. This does not tell us, however, what to do about our lack of notional ownership of BUA Foods. We are under the impression that there is not much information or research on the stock (the company will hold a conference call for investors tomorrow), and we do not like taking positions in stocks without a certain amount of research. On the other hand, sometimes one has to take the attitude that if you cannot beat them, you join them. We will weigh up the situation this week.


An important point is not to be distracted by what is going wrong. Some things are going right. Our overweight notional position in Seplat earned a useful 11bps last week. Our notional and very slightly overweight position in Dangote Cement earned 151bps.


As forewarned last week, we began to create an underweight position in Airtel Africa and an overweight position in MTN Nigeria, following our recent Nigerian telecom sector report 'Delivering a Digital Future' in which we recommend a Buy for MTN Nigeria with target price of N266.17/share and a Sell for Airtel Africa with a target price of N793.84/share. We are experiencing two issues. The first that liquidity in both stocks is low, and it is difficult to transact (even though our trades are notional, we respect actual market liquidity). The second is that, as far as we understand, allocations of shares from December's offer of N97.0bn-worth of MTN Nigeria shares have not been made yet. When the allocations of stock are made, we expect there to be at least some flow of stock onto the market, so it is probably best to wait for this to happen in order to make significant notional purchases.


Last week we noticed that a broker downgraded Custodian Investment from a Buy to Hold, causing the price to slip. We took the opportunity to make notional purchases of the stock. The stock is not liquid, and it is taking time to build up a meaningful position. We shall continue to do this.


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