Equity Markets: Seeing Past the Corrections

By Coronation Research

January has seen investors across the world take fright, with equity markets as diverse as the US Nasdaq and those of Russia, Korea and Denmark all correcting.

So much for the fear factor. We know that successful investors are not easily scared and that they buy value patiently over time. It appears this has been happening with FGN US dollar Eurobonds recently.

FX

Last week, the exchange rate at the Investors and Exporters Window (I&E Window) weakened by 0.08% to close at N416.33/US$1. Elsewhere, the foreign exchange (FX) reserves of the Central Bank of Nigeria declined by 0.41% to US$40.15bn, as the CBN continues to intervene in the FX markets. Our view remains that the CBN’s position is strong as the level of FX reserves remains high in the long-term context. Hence, it seems likely 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 amidst buoyant liquidity from the January 2022 bond maturity, coupon payments, and Federation Accounts Allocation Committee (FAAC) inflows. Consequently, the average benchmark yield for bonds fell by 29bps to 11.64%. Accordingly, the yields on the 3-year (- 25bps to 8.78%), 7-year (-50bps to 11.88%) and the 10-year (-53bps to 12.09%) bonds tightened. Nevertheless, as liquidity thins out, we reiterate our expectation for 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 similarly bullish, as the average benchmark yield for T-bills fell by 6bps to 4.35%. The yield on the 300-day T-bill fell by 11bps to close at 5.11%. At the T-bills primary auction, the DMO allotted N223.75bn (US$537.87m) worth of bills across all tenors. The stop rates on the 91-day (-2bps to 2.48%), 182-day (-14bps to 3.30%) bills tightened. Notably, the rate on the 364-day bill reversed the trend of the last auction, falling by 10bps to 5.40% (annualised yield: 5.71%). Demand was strong, as a total subscription of N475.63bn was recorded – the highest since 11 November 2021 – implying a bid-to-offer ratio of 3.67x). Elsewhere, the average yield for OMO bills fell by 59bps to 5.21%; the yield on the 249-day OMO bill declined by 1bp to 5.71%. At the OMO auction, the Central Bank of Nigeria (CBN) sold N40bn worth of bills and maintained stop rates across the three tenors.

Oil

Last week, the price of Brent rose by 2.43%, its fourth consecutive weekly gain in the month, to settle at US$90.03/bbl, its the highest level since 10 October 2014. Consequently, Brent is up 15.75% year-to-date and has traded at an average of US$85.29/bbl, 20.31% higherthan the average of US$70.89/bbl in 2021. Oil prices continue to be supported by geopolitical tensions between Russia and Ukraine and the threat to infrastructure in the United Arab Emirates by Yemen’s Houthi group. Elsewhere, the Organisation of the Petroleum Exporting Countries and its allies (OPEC+) is expected to meet on Wednesday and will likely ratify a 400,000 bbl/d increase for March, in line with its declared schedule. Nevertheless, we maintain our expectation that the price of Brent oil is likely to remain well above the US$60.00/bbl mark overthe first half of this year

Equities

Last week, the NGX All-Share Index rose by 0.54% to settle at 46,205.05 points, the fourth consecutive weekly gain in the month. Accordingly, the index is up 8.17% year-to-date. International Breweries (+18.00%), Guinness Nigeria (+13.98%), Airtel Africa (+10.00%) and Honeywell Flour Mills (+9.38%) closed positive last week while Dangote Cement (-8.53%), Cadbury Nigeria (-8.42%) and Oando (-2.94%) closed negative. Across the NGX sub-indices, the NGX Banking (+4.84%) index led the gainers, followed by the NGX Oil and Gas (+3.53%) and NGX Consumer Goods (+2.04%) indices. Conversely, the NGX Industrial Goods (-5.12%) fell, followed by the NGX Insurance (-3.12%) – which declined for the fourth consecutive week – and the NGX 30 (-1.13%) indices.

Seeing Past the Corrections

Last week, we showed the connection between US inflation, the rise in US Government bond yields and the rise in Federal Government of Nigeria (FGN) US dollar Eurobond yields. US Government bond yields were going up; so too were those of FGN Eurobonds. We wrote that the FGN Eurobond yields looked ‘generous’ and, “investors may look at these yields in a favourable light.”

Evidently, they did. Last week, the yield of the FGN US dollar 6.500% 2027 Eurobond fell and so too did that of the FGN US dollar 7.696% 2038 Eurobond. In essence the yield of the 2027 bond fell from over 7.0% per annum to just underit; the yield of the 2038 bond fell from over 9.0% pa to just underit. Some investors found the yields tempting enough to buy.

This is not to showboat our opinions but to show something else, namely that at least some investors are looking though the current round of market corrections and are buying high US dollar yields when they can. Successful investors, in our view, are not easily scared: instead, they consistently buy value when they see it. If they sell, they wait until the market is in a confident mood before doing so.

At this point, we need to be careful with our language. A market correction is defined as a fall of 10.0% or more. The broad-based US equity market, the S&P500 Index, fell by 9.80% between 3 January and 27 January, just shy of a correction. The principal European indices have not, for the most part, corrected, while the principal Japanese index, the Nikkei-225 Stock Average, did correct (by 10.78%) between its highest and lowest points in January (so far).

The big correction has been seen in the US tech-orientated Nasdaq Composite Index which fell 15.66% between 3 January and 27 January, at which point it was down 16.84% from its high point in November last year. However, to find many other equity markets that have reported similarly bad performance during January (i.e., a fall of more than 10.00%) would be difficult. One has to look far and wide: Korea, Russia and Denmark all qualify.

In the case of the FGN’s US dollar 2038 Eurobond, its price fell by 7.57% between 4 January and 19 January, and it fell by 11.94% between 8 November and 19 January.

What US institutional investors appear to be doing – in fact, what many have already done – is to rotate portfolios out of growthorientated tech stocks (particularly companies that do not yet make profits) and into traditional value stocks such as established chemical, industrial and basic material manufacturers (which typically show strong free cash flows). This does not just reflect the high valuations of tech stocks. It also reflects the danger that the US government may seek to increase its oversight of certain large tech companies. And, at the same time, it reflects the fact that the US economy is growing quite quickly with strong wage growth that feeds through into high consumer confidence.

This is not to say that we are calling the US equity markets on these pages. There remains the issue of elevated US inflation, though corporate productivity gains may solve it. There is also the possibility, however remote, that falling US equity markets themselves negatively impact upon savers and dent confidence, though wage growth may compensate for this over time. It is easy to see why market strategists and commentators need to be careful with their choice of words at this time.

It seems that wobbles in US and global markets are likely to continue for a while at least, perhaps with most concerns affecting tech stocks and cryptocurrencies. For FGN Eurobonds, however, it appears that value-seekers have already been persuaded to see through the corrections.

Model Equity Portfolio

In the last full week of January 2022, the Model Equity Portfolio rose by 0.20% compared with a rise in the NGX Exchange All-Share Index (NGX-ASI) of 0.54%, therefore underperforming by a significant 34 basis points. So far this year it has gained 6.30% against an 8.17% gain in the NGX-ASI, underperforming it by 187bps.

Last week the problem was easy to identify. The stock of Ecobank Transnational, which forms 0.95% of the NGX AllShare Index, rose by 44.75%. If you do not own this stock, you underperformed by 43bps last week. On the other hand, why would a serious buyer of a stock (i.e., someone trying to build a meaningful position in it) allow it to rally by 44.75% in a week? One is tempted to ask:”Which mid-cap stock is going to rally 40.0% next week?”

Movements like this have not been uncommon during January, starting off with the day-one listing of BUA Foods (4.9% ofthe index) which rallied 61.0% between 4 January and 28 January.

Again, last week, we were unable to execute our strategy of making a notional underweight in Airtel Africa due to liquidity constraints (we made a notional sale of just 200,000 shares) and we continued to delay making a notional overweight in MTN Nigeria for a while, waiting for the shares from December’s N97.0bn share offer in MTN Nigeria to settle. This was fortunate as Airtel Africa rallied 10.0% last week.

As earlier advised, we began to take some weight away from our notional position in banks last week and we will continue this week. In the light of the weak Stanbic IBTC results over the weekend this seems sensible. We made a notional purchase of Custodian Investment last week, the strategy being to do so whenever liquidity permits. We will build a small notional position in Flour Mills of Nigeria this week as well as Guinness Nigeria