Monday, September 21, 2020
05:00 AM / by Proshare Research/ Header Image Credit: EcoGraphics
Global stock markets are going to have difficulties breaking the glass ceilings erected over the twin problems of a global health pandemic and a disrupted world economy. Slow global economic growth will likely mix with huge fiscal deficits amidst rising healthcare expenditure to create the worst of all worlds.
Myths: Counting on Self-correction
The average economist loves the idea of a self-correcting market, but the pains of a self-correcting market are either too severe or the time too long to be practical. This explains why most governments prefer to dodge the bullet either partially or totally. Following this argument (which many people would contest) the development of Nigeria's equity market must involve a clever set of collaborative actions amongst a network of market stakeholders. Analysts observe that to expect the local stock market to take off on the strength of its organizational force is like waiting for a pregnant woman to give birth to a child unaided, this is possible but risky.
A few local equity traders note that the domestic stock market requires support whether solicited or unsolicited since the consequence of unfettered market action could prove damaging to the stability of society. The NSE, therefore, needs to build upon its progress in the last two decades to reach the next level of its evolution where more instruments of bellwether industries are listed on the Exchange and more sophisticated trading activities take place. The Growth Board creation is a step in the right direction, but it must move from the realm of the drawing board to the realm of action.
Also, the demutualization of the NSE needs to be concluded quickly to bring the market to the contemporary standards of equity trading platforms in Europe, Asia and the United States of America (USA). The demutualization of the Exchange would move it from being a broker-dominated Exchange to an investor-oriented Exchange with higher governance standards.
The derivative market has been an area that the Onyema-led NSE has shown a keen interest in initiating and developing but stockbrokers have been reticent. According to one broker, "you build a derivative market on a fundamental understanding of asset classes and the pricing of their spin-offs; traders in Nigeria still have a knowledge gap that would need to be closed if they desire to trade in this neck of the woods" he said. However, the trader further noted that "derivatives can be very risky and require high technical competence. As things stand today local market traders have neither the risk appetite nor the basic skill sets to handle such sophistication. This is where I think less is more, and for now, we should continue to dip our feet in a slow-moving river rather than take a dive into a deep blue sea".
This may be true, but by not filling the "white spaces" open in the domestic financial market, traders would be allowing for inefficiencies in asset pricing and limiting the breadth of asset categories. An improvement in asset classes could likely increase capital importation and strengthen the country's foreign exchange rate. Besides, with more tradeable assets available on the NSE, the market would become more attractive to both local and foreign investors and lead to domestic asset deepening (see illustration 4).
Illustration 4: COVID-19 and Opportunities; Surfing A Pandemic
Political Risks, A Matter for Concern?
Should investors be worried about Nigeria's domestic political risks? Certainly. The recent Standards & Poor (S&P) credit rating for Nigeria was B-/B long-term and Short-term, the country's long- and short-term national scale ratings were at 'ngBBB/ngA-2.
The recent ratings reflect major country risk concerns that have political risk as a chief component. The relatively weak security situation in the country, especially in the Northeast and Northcentral parts has stirred international and domestic investor anxiety around the county's economic stability and sustainability, especially its harried agriculture, minerals and mining belts. Food inflation of the country for July 2020 was put by the national statistics office (NBS) at +15.48% as against the broader headline inflation rate of +12.82%.
Economic analysts have observed that the incessant farmer/herder conflicts, rural and urban banditry, highway kidnappings and killings by individuals allegedly associated with a local insurgency group, Boko Haram, have cost the country a major drop in agricultural productivity, especially in the breadbasket states of Benue, Plateau, Adamawa, Taraba, Bauchi, Gombe and Yobe (see illustration 5).
Illustration 5: Map of Nigeria, Inside the Breadbasket
Source: Proshare Research, Ecographics
The push of insurgents towards the Southwest draws a dark picture of a sinister move to take over one of the most economically, industrially, socially and politically developed parts of the country. Places in Oke Ogun, Oyo State like Shaki and Iseyin are already under the onslaught of armed herdsmen believed to have ties with major Sahel region terror organizations. The same anxiety reoccurs within the country's machine manufacturing and industrial fabrication belts in the Southeast and South-south.
Fears of widespread sociopolitical and economic troubles ahead have become a dominant theme spoken softly amongst the country's elites and have worsened the country's credit risk rating amongst international credit agencies and heightened the risk factors associated with Nigeria's political and socio-economic stability.
The relative weakness of the market in respect of asset classes and the number of corporations listed on the Exchange may create opportunities for the market to leapfrog ahead of expectations. Contrary to most popular perspectives, the COVID-19 pandemic reinforces opportunities just as much as it poses threats.
The limited tradeable assets within the equities market mean that local investors must find other ways of making money after adjusting for inflation. With the recent 2020 inflation rate at +12.82%, and bond yields at between 1% and 1.3% in the secondary market and about 6.7% for ten-year bonds with a coupon of 12.5%, there is minimal wriggle room for those with cash to put away. The Nigerian Eurobond market has become increasingly attractive to investors with a coupon of 6.75% and a yield of 3.79% for maturity in January 2021 but as quoted on August 31, 2020. Diaspora bonds with maturity in January 2022 traded on August 31, 2020, at a coupon of 5.63% and a marginal yield of 4.56%. Within the context of a COVID-19-depressed economy, Eurobonds appear to be a bright torch, even if a flickering one. Eurobonds seem to be some of the best-in-class investment vehicles in 2020 featuring low risk and modest inflation-adjusted returns (see illustration 6).
Illustration 6: Where Will the Next Investment Honeypot Come From?
Source: Proshare Research, Ecographics
On the other hand, real estate, by some judgment, is a low-risk asset with the possibility of relatively high returns. The challenge, however, is that the sector's presumed risk status could be much higher than acceptable thresholds for risk-averse investors. Analysts note that the COVID-19-induced recession which worsened as a result of a fall in international oil prices and federal revenues would likely cut disposable incomes and hurt analyst's economic outlook for Q4 2020 as investors foreclose on their appetites for fixed assets with indeterminable cash flows.
Precious metals such as gold and silver have gone up in the last few months but these assets are essentially countercyclical, when strong global currencies weaken investors tend to seek solace in assets that are tangible like precious metals but with global supply chains being reestablished and factories coming back on line several countries will likely see a reversal of falling GDP growth rates and a strengthening of their currencies which would lead to investors dumping hard metals and returning to more liquid assets denominated in hard currencies. Going long on major currencies seems to be a smart money move, but some currencies would be more volatile than others, therefore, currency hedges and stop-loss arrangements may prove useful, especially between Q4 2020 and Q2 2021.
Soft commodities will still have a hard time into 2021 but as manufacturing picks up and the coronavirus abates some commodities should experience price recoveries and rise above even pre-COVID-19 levels.
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