The Return of the Equity Market

Wednesday, October 14, 2020 / 08:29 AM / ByCoronation Research / Header Image Credit: Orange FM

During the two weeks to 9 October, the Nigerian StockExchange All-Share Index (NSEASI) rose by 7.96%, bringing its year-to-datereturn to 5.86%. To what can we attribute the popularity of equities during arecession? The answer, we believe, was the cut in the monetary policy rate on22 September, signaling that we are not returning to a high-rate environment.Nigerian investors are learning to diversify. See page 2 for details.

Last week the foreign exchange rate held essentiallyflat, with the Naira up by just 0.01% against the US dollar at N385.81/US$1.This was the situation in the NAFEX market (also known as the I&E Window).In the parallel, or street market, the Naira gained 1.72% to close at an offerprice of N457/US$1. The two rates are now within 19% of each other. Weattribute recent strength in the parallel market rate to the Central Bank ofNigeria's (CBN) supply of US dollars to Bureaux de Change (BDC). The result isto support the parallel exchange rate, but we doubt that this action alone willunify the two exchange rates soon. At the same time, the two rates are not asfar apart as they were in early 2017, for example, so a resolution may be mucheasier to achieve today than it was then.

Bonds & T-bills

Last week the secondary market yield for an FGN Nairabond with 10 years to maturity decreased by 63 basis points (bps) to 7.23%, andat 7 years fell by 149bps to 5.76%, while at 3 years the yield declined by 3bpsto 3.10%. Very significant levels of redemption from the Open Market Operation(OMO) market are due this month and downward moves in bond yields reflectreinvestment of these funds, in our view. The annualised yield on 342-day Tbillfell by 100bps to 2.14% while the yield on a OMO bill with similar tenure roseby 23bps to 2.20%. Our sense is that liquidity in the money markets remainshigh and is likely to exert further downward pressure on rates over the comingweeks.

Oil

The price of Brent crude rose by 9.14% last week toUS$42.85/bbl and we attribute this to the shock of Hurricane Delta causingdisruption to rigs in the Gulf of Mexico. The average price, year-to-date, isUS$42.50/bbl, 33.79% lower than the average of US$64.20/bbl in 2019. TheOrganization of the Petroleum Exporting Countries (OPEC) is meeting nextMonday, and the cartel appears unsure as to how soon global oil demand willrecover to 2019 levels. We think that oil prices will remain in a range betweenUS$40.00/bbl and US$46.00/bbl over the coming weeks.

Equities

The Nigerian Stock Exchange All-Share Index (NSE-ASI)rose by 5.30% last week, with a gain of 5.86% year-to-date, as Nigerianinstitutional investors returned to the equity market in high volumes. Lastweek International Breweries (+21.03%), FBN Holdings (+19.23%) and Access Bank(+16.24%) closed positive, while Oando (-2.62%), Nigerian Breweries (-0.82%)and Unilever Nigeria (-0.74%) closed down.

The Return of the EquityMarket

Last week, the Nigerian Stock Exchange All-Share Index(NSE-ASI) rose by 5.30% to bring its year-to-date return up to 5.86%. From itslow point this year on 6 April ,the equity market has risen 37.48%. Hightrading volumes have returned thanks to the return of Nigerian institutionalinvestors, notably funds managed by Pension Fund Advisers (PFA).

The factor that prompted Nigerian institutionalinvestors finally to return to the equity market, in our view, was the cut inthe Monetary Policy Rate (MPR) on 22 September, from 12.50% to 11.50%. As weexplained last week, the Monetary Policy Council's communique opined that interestrates are not the means to lowering inflation (August: 13.22% y/y). In otherwords, do not expect the CBN to increase market interest rates to a level equalto or above inflation.

In reality, the CBN's stance on inflation has beenevident for much of this year, but institutions continued to buy Treasury billsand government bonds rather than equities until very recently.

Proshare Nigeria Pvt. Ltd.

On our part, we have been running a Model EquityPortfolio and publishing it (on page 3 of this weekly), forewarning our readersof changes we are about to make.

Most of the time we avoid timing the market, i.e. weavoid predicting when the market is going to go up or down. It is just toodifficult. What we do is make notional purchases (this is a model and not areal portfolio) of stocks when they are cheap relative to their valuationhistory and when their earnings prospects are either good or likely to returnto trend over the medium term (two years). We try to keep it as simple as that.

The exception to these rules came in early March whenour underperformance (see chart) prompted us to make notional sales of most ofour positions in banks, taking our notional cash position from 15.4% to ahighly defensive 64.8%. It worked. Note that most funds, in the real world,cannot do anything so radical.

What of the Nigerian equity market's prospects? As weexplained in Coronation Research, Navigating the Capital Markets, 14 July,there are at least some stocks with adequate long-term return on equity thatare worth holding. And, as we explain in Shifting the Appetite of NigerianInvestors: From Savings to Mutual Funds, 2 October, investors need to diversifytheir holdings when inflation-beating Treasury bills are no longer available.

Model Equity Portfolio

Lastweek, the Model Equity Portfolio rose by 6.18% compared with rise in theNigerian Stock Exchange All-Share Index (NSE-ASI) of 5.30%, thereforeoutperforming it by 88 basis points. Year-todate it has gained 12.16% against again of 5.86% in the NSE-ASI, outperforming it by 630bps. The past two weekshave seen exceptional outperformance from the Model Equity Portfolio, with atotal 167bps gain ahead of the market. However, this needs to be set againstour total 143bps underperformance against the market in the six weeks prior tothat. There is something to be said for not panicking when things are goingwrong.

Proshare Nigeria Pvt. Ltd.

Threeweeks ago we made a significant change to the portfolio by selling off most thenotional position in Nestle Nigeria and trimming Airtel Africa and DangoteCement in order to have enough cash to make notional purchases of banks. Ourreasoning was that, despite the fact we like bank stocks (or some of them), weonly had a neutral weight. Our performance attribution model tells us that, ifwe had not done this, the Model Equity Portfolio would be up 11.45%year-to-date with 45bps outperformance last week.

Oursense is that Nigerian institutional investors have come back into the equitymarket and that they may provide a degree of support going forward. Although wedo not like to make market calls - we could not have predicted the 7.96% rallyover the past two weeks - we are not minded to make radical changes in theportfolio now and plan no changes this week.