Monday, September 18, 2023
The amazing strength of the equity market
Why is the equity market so strong? Inflation is rising, the consumer is facing a crisis, and the economic outlook is unsettled. Yet the NGX All-Share index is up 31.5% year-to-date and the total equity return, which includes the effects of reinvesting dividends, is 38.3%. How to explain this paradox?
Last week, the exchange rate at the Investors and Exporters Window (I&E Window) lost 4.56% to close at ₦756.91/US$1. In the parallel (or street) market, the Naira slipped by 2.62% to close at ₦955.00/US$1. Currently, the gap between the I&E Window and the parallel market stands at 26.17%. The gross foreign exchange (FX) reserves of the Central Bank of Nigeria (CBN) slipped by 0.08% to US$33.30bn.
Notwithstanding the current pressure on the Naira, we maintain that the reforms in the foreign currency market will lead to improvements in FX liquidity in the medium term.
BONDS & T-BILLS
In the secondary market for T-bills, performance was bearish as average yields slipped by 4bps to 7.98% pa. Average yields at the medium and long-end of the yield curve rose to 5.98% and 9.89% respectively, while the short-end tightened marginally by 1bp to 4.24%. The CBN offered ₦152.20bn (US$200.76m) at the primary T-bill auction last week; total subscription settled at ₦643.88bn, 26.48% lower than the previous auction. The bid to offer ratio was 4.23x (vs 4.08x at the previous auction). The average yield at auction rose by 81bps to 8.83% per annum.
In the FGN bond market, the Debt Management Office (DMO) offered ₦360.00bn across the April 2029, June 2033, June 2038, and June 2053 maturities with most of the demand skewed to the 30-year bonds. Demand was lower than at the last auction in August, as reflected by a total subscription of ₦290.99bn (₦312.56bn at the last auction)
and a bid-to offer ratio of 3.23x (vs 3.47x at the last auction). Yields increased across three tenors; the 10-year bond by 75bps to 15.45%, the 15-year bond up by 10bps to 15.55%, and the 30-year bond up by 55bps to 16.25% while the 6-year bond slipped by 5bps to 14.50%. A total of ₦251.49bn was eventually allotted, including non-competitive allotments of ₦65.00bn. The secondary market for FGN bonds moved in the same direction as the secondary market for T-bills. The average yield increased by 23bps to 14.40%. Average yields along the FGN bond yield curve rose: at the short end (34bps to 12.41%), mid-end (12bps to 14.66%) and long end (26bps to 15.63%).
Although demand at recent auctions has been weak and rates has moved up, the FGN bond issuance calendar appears quite light going forward, and rates could stabilise from here onwards. Much now depends on the policies of the newly appointed Governor of the CBN, Dr Yemi Cardoso, and we will need to wait to learn these in due course.
Oil prices closed strong for the third consecutive week as Brent Crude closed 3.62% stronger to settle at US$93.93/bbl. Year-to-date, it is up by 9.34% and it is trading at an average of US$81.30/bbl year-to-date which is 17.96% lower than the average of US$99.09/bbl in 2022.
On Friday, crude prices rose to a level that had not been achieved in ten months as a result of constrained supplies by Saudi Arabia and confidence in Chinese demand. Since Russia’s invasion of Ukraine in the first quarter of 2022, oil prices are on course to experience their largest quarterly spike. Note that earlier this month Saudi Arabia and Russia agreed an extension of their joint supply restriction of 1.3 million barrels per day to the end of this year.
We maintain our view that, for most of the year, prices are likely to remain above the US$75.00/bbl mark set in Nigeria’s government budget.
Last week, the NGX All-Share Index closed lower, decreasing by 1.10% to settle at 67,395.74 points. Its year-to-date return fell to 31.50%. Dangote Sugar (-10.83%), Zenith Bank (-10.01%), and FCMB Group (-9.56%) closed negative while Oando (+42.86%), United Bank for Africa (+7.87%), and Nigerian Breweries (+7.48%) closed positive. Performances across the NGX sub-indices were mostly negative as the NGX Banking (-3.24%) topped the list, followed by, NGX Oil/Gas (-2.02%), NGX Consumer Goods (-1.84%), NGX 30 (-1.09%), NGX Pension (-0.87%) and NGX Industrial Goods (-0.28%) indices closing red. On the other hand, the NGX Insurance (+0.46%) index closed in the green.
In case you missed last week’s update, click here.
What explains the equity market in 2023?
The equity market is confounding sceptics with a rise of 31.5% year-to-date while the total return (including the effects of reinvesting dividends) is 38.3%. At the beginning of the year a 1-year T-bill yielded 5.35% pa and a 10-year FGN Naira-denominated bond yielded 13.36%, so an investor who chose to take equities has done much better, year-to date, than a fixed-income investor.
An index of long-dated FGN Naira-denominated bonds has returned 4.86% year-to-date. As market interest rates have moved upwards this year (by about 120 basis points) the mark-to-market value of bonds has fallen, offsetting some of the gains delivered by coupons.
As featured in Coronation Research, Better Times in 2023, January 11, we thought that 2023 would be another good year for equities, given that the prospect for earnings growth among the top stocks was about as much as the appreciation of the market during the previous year (2022). In other words, the market was no more expensive than it had been a year earlier, and it had the potential to perform again.
The easiest way to explain 2023’s equity market performance, which indeed has exceeded our expectations, is to break it down into sectors. Each sector has responded to either a government reform, a change in economic fundamentals, or corporate action.
The bank sector has been a star performer, with the NGX Banking Index up 65.5% year-to-date. The immediate cause was the liberalisation of the foreign exchange market in June (though, some canny investors were already buying bank stocks during May) and the subsequent devaluation of the Naira/US dollar rate in the I&E Window. Many banks have substantial long US dollar positions and will record significant revaluation gains when they report results in Naira. And they are now able to trade in foreign exchange markets in ways that were closed to them previously. These factors, to a large extent, explain the rally (see Coronation Research, Investment Opportunities from FX Liberalisation, 10 July).
The abolition of fuel subsidy, announced during President Bola Tinubu’s inaugural address at the end of May, has also profoundly affected the equity market, as fuel marketers are no longer constrained by the margin imposed on them by the fuel pricing template (see Coronation Research, Investment Opportunities from Fuel Subsidy Reform, 9 June). The index of Oil & Gas stocks is up 98.7% year-to-date (we do not feature it in our chart on the opposite page: otherwise, we would have to adjust its scale).
The insurance sector is also a beneficiary of currency devaluation as many insurance companies have net long positions in US dollars and, like many banks, will be able to report revaluation gains. Individual companies have also reported strong results. The NGX Insurance Index is up 52.8% year-to-date.
The most perplexing performance this year comes from the consumer sector. After all, there can be no doubt that with inflation at 25.80% per annum and food inflation at 29.34% pa (data for August), the consumer is under pressure. The prices of several brewing stocks are down this year, with Nigerian Breweries down by a marginal 0.1%, International Breweries down by 5.3% and Guinness Nigeria down by 6.2% year-to-date (as of last Friday). Yet the shares of several food and consumer products companies have gained hugely, with BUA Foods up 72.7% and PZ Cussons Nigeria up 184.6% year-to-date.
This appears to be the result of a combination of corporate action and a rebound in earnings. BUA Foods has clearly established itself as a presence in food manufacturing and we see the recently announced merger of the listed Dangote Sugar, the listed Nascon and the unlisted Dangote Salt as a response to this. Shares in Dangote Sugar are up 255.1% year-to-date. Meanwhile, PZ Cussons Nigeria has reported both a rebound in earnings and announced a buyout of shares by its parent company (subject to ratification by the Securities and Exchange Commission). PZ Cussons Nigeria shares are up by 184.6% year-to-date.
Prospects for Q4 2023
These different factors add up to a remarkable year for NGX Exchange-listed equities, so far. What about the rest of the year? As we noted a month ago in the Nigeria Weekly Update (21 August), we think that the largest gains in the bank sector are behind us. And, overall, the market has done well so we would not be surprised to encounter profit taking the in months ahead. But that profit-taking may not be heavy because institutional investors, in particular Nigerian pension funds (see Nigerian Weekly Update, 17 July) appear to be underweight in Nigerian equities. So, it is possible that they will correct this by building positions in the major stocks if prices correct (and if sufficient volumes of stock are available for sale).
After all, Nigerian institutional investors cannot fail to notice that the NGX All-Share Index has provided a significant return since the beginning of 2020, with a price return of 151.1% and a total return or 219.9% (by reinvesting gross dividends). It has easily beaten inflation and out-performed every other Naira-denominated major asset class. 2023 is showing, once again, the case for investing in equities.
Model Equity Portfolio
Last week, the Model Equity Portfolio fell by 0.74% compared with a fall in the NGX All-Share Index of 1.10%, outperforming it by 36bps. Year-to-date it has risen by 34.34% compared with a rise of 31.50% in the NGX All-Share Index, outperforming it by 284bps.
We count ourselves fortunate with last week’s performance. If we look at our aggregate notional holding of bank stocks at the beginning of the week and discounting the fact that we sold some of it (as planned), it would have returned a positive 1.4% compared with a fall in the NGX Banking index of 3.2%. In other words, we had the right bank stocks, with both UBA and Stanbic IBTC going against the grain and rising in price. All the same, we made planned sales of our notional positions in bank stocks last week, taking the aggregate position from 21.8% to 18.8% of the portfolio, which is within 300 basis points of a neutral position.
We will continue to sell down our notional overweight position in banks this week, even though the market welcomes the appointment of Dr Yemi Cardoso as Governor of the Central Bank of Nigeria and is marking up bank stocks accordingly. We aim to reach a modest underweight position in banks this week, having announced our change in tactics in these pages on August 21.
Last week we were busy making adjustments to our notional holdings in the principal index weights of the NGX All-Share Index, making notional purchases in MTN Nigeria, Airtel Africa and BUA Cement and notional sales in Dangote Cement and BUA Foods purely, in order to bring these top-five stocks into line with their index weights.
This coming week, and observing the rise in oil prices, we will make notional purchases in Seplat Energy with a view to making it into a double overweight position. Aside from this, and our notional sales of bank stocks, we plan no further changes this week.
NB: The Coronation Research Model Equity Portfolio is an expression of opinion about Nigerian equities and does not represent an actual portfolio of stocks (though market liquidity is respected, and notional commissions are paid). It does not constitute advice to buy or sell securities. Its contents are confidential to Coronation Research up until publication. This note should be read as an integral part of the disclaimer that appears at the end of this publication.
Disclosure and Disclaimer
The analysts and Head of Research have prepared the report independently, using publicly available information. The information is believed to be accurate but not independently verified. The report is intended for the use of clients and should not be considered as a solicitation to buy or sell securities.
No liability is accepted for errors or omissions, and readers should conduct their own evaluations and consult with financial advisers before making investment decisions.
This report is not intended for individual investors and should not be distributed where prohibited by law or regulations.