At times of worldwide economic stress, global markets exert a strong influence on Nigerian markets. The rise in US interest rates this year is associated with rising Federal Government of Nigeria (FGN) Eurobond yields and the FGN’s consequent reliance on Naira-denominated financing this year, causing Naira bond yields to rise. How soon the US interest rate cycle will turn is important for all classes of investors, including US equity investors and Nigerian fixed-income investors. 

Global Markets and Nigeria in Q4 2022

Should investors in Naira-denominated Nigerian markets have a view of global markets, in particular US markets? Quite apart from the fact that many Nigerians are invested in US bonds, the S&P500 and Nasdaq, as well as Bitcoin and Ethereum, there is the question of how US markets influence Nigeria. We can observe several things happening in US markets that have not occurred in a long time, and now is a good time to assess their impact.

Spot the connection 

Nigerian markets do not usually correlate with global markets (far from it), but there are some important influences which show themselves during periods of market stress. Rising US interest rates (the US 10 Government bond yield has risen from 1.51% to 4.00% this year) attract investors away from African Eurobond markets and cause the yields on Nigerian Eurobonds to rise (e.g. the yield of the Federal Government of Nigeria 2027 Eurobond has risen from 6.52% to 13.58% this year). This has a knock-on effect on Naira interest rates; the FGN finds it nigh-impossible to borrow in the US dollar Eurobond markets and needs to borrow more in Naira, forcing rates upwards (the yield of a 5-year FGN bond has risen from 12.27% to 14.27% this year). 

Are US rates going to continue rising, or have they peaked and are they about to fall? Our approach is to take a very long-term view of this issue, going back to the period immediately after 1978, the last time when US monetary authorities found it difficult to tame inflation. These data indicate to us that the US Federal Reserve is currently ‘behind the curve’ in tackling inflation (i.e. is reactive to it) which suggests more policy rate rises are on the way and the US government 10-year bond yield could rise further. Conversely, it could transpire that US inflation, for any number of reasons (to do with economic weakness and weak demand) falls soon,removing the risk of rising US rates: this is not our base case. 

Next, what are the implications for US equity markets? Several hundreds of millions of dollars are paid to a small army of US equity strategists and analysts every year to figure out the answer, so perhaps it shows chutzpah for a Nigerian research unit to address the question. Never mind, there are some important phenomenon worth noting. The first is that post-2008, US bond yields fell steadily in response to quantitative easing (QE) and cuts in the Federal Funds rate (though these were raised occasionally). Equity markets enjoyed a very long bull run and equity market gains – look at the steepness of the equity charts towards the right-hand side – got better in successive years approaching the end. Bond rates directly affect equity valuations, so a re-rating of equities is taking place.

Second, some of the great disrupters among the internet stocks are looking more ordinary today than they used to. Facebook (its price is up 234% over 10 years but is down 72% this so far this year) points to a slowdown in US advertising expenditure for its disappointing Q3 results. It looks more like a traditional advertising stock (think WPP or Publicis) than a disrupter at the moment. Other companies across a broad spectrum (from Boeing to Samsung) report data consistent with a slowdown in personal and company purchasing power. 

Some US strategists interpret these data as showing the effects of rising interest rates feeding through into an economic slowdown, which gives a degree of visibility as to when interest rates will peak and when the economic slowdown will end (perhaps in mid-2023), and which hints that equity markets may be supported (because equity markets typically anticipate economic recoveries). After three quarters of a year in a bear market, the bulls and the bears will argue the case for buying equities now, exactly when the news flow and the immediate outlook are extremely bleak. Our point is that successful long-term investors buy value when they see it and hold on :timing the market’s low point is just too difficult.

FX

Last week, the exchange rate at the Investors and Exporters Window (I&E Window) lost 0.69% w/w to close at N444.75/US$1. Elsewhere, the foreign exchange (FX) reserves of the Central Bank of Nigeria (CBN) decreased by 0.42% to US$37.49bn as the CBN continues interventions across the various FX windows. The CBN approaches the last two months of the year with both I&E rate only moderately depreciated and its FX reserves largely intact this year. It seems likely that the current I&E Window rate, or something very close to it, will be maintained for at least several months.

Bonds & T-bills

Last week, trading in the Federal Government of Nigeria (FGN) bond secondary market was bearish amidst tight system liquidity. As a result, the average benchmark yield for bonds rose 16bps to close at 14.31%. Across the curve, the yields on the 7-year (+20bps to 14.46%) and 10-year (+9bps to 14.40%) bonds expanded, while the yield on the 3-year bond remained unchanged at 14.11%. Our view remains that the combination of thin system liquidity and elevated Federal Government domestic borrowing will continue to drive yields upwards overthe coming months. 

Activity in the Treasury Bill (T-Bill) secondary market was also bearish as selloffs persisted, especially at the short segment of the curve, also in the face of tight system liquidity. As a result, the average yield for T-bills rose by 76bps to 11.04%. Conversely, the yield on the 321-day T-bill compressed by 74bps to close at 14.68%. At the T-bill primary auction, the DMO allotted N109.18bn (US$245.50m) worth of bills. The auction recorded a total subscription of N136.96bn, implying a bid-to-cover ratio of 1.25x (vs 1.69x average of the past auctions in the year). Consequently, stop rates across the 91-day (+3bp to 6.50%), 182-day (+15bps to 8.05%) and 364-day (+150bps to 14.50%, implying an 16.95% yield) bills rose. Elsewhere, the average yield for secondary market OMO bills fell by 2bps to 10.23%, while the yield on the 186-day OMO bill fell by 2bps to 11.01%

Oil

Last week, the price of Brent extended gains forthe second consecutive week, up 2.43% to settle at US$95.77/bbl. As a result, Brent is up 23.13% year-to-date and has traded at an average of US$101.69/bbl, 43.44% higherthan the average of US$70.89/bbl in 2021. 

Oil prices ended the week strong on the back of a very impressive Q3 22 earnings season, as nearly all the oil majors beat expectations, offsetting worries of demand destruction as Chinese cities doubled down on COVID-19 curbs. 

Our view is that prospects of a price cap on Russian crude pose upside for oil prices for the rest of the year. Hence, we maintain that prices are likely to remain well above the US$73.00/bbl set in Nigeria’s government budget until at least the end of the year, and quite possibly beyond it.

Equities

Last week, the NGX All-Share Index extended losses for the second consecutive week, closing down 1.09% w/w to settle at 43,912.64 points, its lowest level since 11 January. Consequently, its year-to-date return fell to 2.80%. Honeywell Flour (-11.25%), Unilever Nigeria (-10.42%) and Dangote Cement (-10.00%) closed negative while BUA Cement (+12.90%), Fidelity Bank (+7.89%) and Geregu Power (+4.55%) closed positive. Performances across the NGX sub-indices were broadly negative as the NGX Insurance (- 2.38%) led the decline, followed by NGX Pension (-1.19%), NGX-30 (-1.18%), NGX Consumer Goods (-0.36%) and NGX Oil & Gas (-0.24%) while the NGX Industrial Goods (+0.34%) and NGX Banking (+0.07%) closed higher.

Model Equity Portfolio

Last week the Model Equity Portfolio fell by 0.77% compared with a fall in the NGX All-Share Index of 1.09%, outperforming it by 32ps. It has gained 8.15% year-to-date compared with a gain in the NGX-ASI of 2.80%, outperforming it by 535bps. 

Our 2.9 percentage point underweight position in Airtel Africa relative to its index weight of 20.11% proved useful last week as the stock fell 2.8%. Our recently-created (three weeks ago) 3.0 percentage point underweight position in Dangote Cement was also useful as the fell 10.0% late last week on the back of disappointing Q3 results. 

On the other hand, we wish we had not held these two stocks at all in October. Between them they have cost 807bps over the past two weeks and destroyed the double-digit performance of the Model Equity Portfolio this year. The portfolio was up, year-to-date, by over 20.0% at the beginning of this month and was up over 22.0% year-to-date at the end of May. Airtel Africa and Dangote Cement have, however, provided 407bps of performance between them year-to-date, so it is difficult to ignore them

We have studied the index weights of the stocks in the Model Equity Portfolio, which changed a lot with the corrections in Airtel Africa and Dangote Cement. Our conclusion is to make notional sales of up to a further two percentage points in Airtel Africa this week, liquidity permitting (even though our transactions are notional we respect actually market liquidity), ditto Dangote Cement. We will also make notional sales, liquidity permitting, in Nestle Nigeria in order to bring the Model Equity Portfolio's position in it to approximately one half its neutral index weight of 3.6%. Conversely, we will take a notional position in Geregu, liquidity permitting, to create an exposure equivalent to its neutral index weight of 1.2% and likewise we will build up our notional position in BUA Cement to its neutral index weight of 9.9%.