Inflation erodes stock returns amid rate hikes
Nigeria’s inflation rate, which has surged to its highest level in more than 16 years, is putting a damper on stock returns as interest rate hikes brightens prospects of the fixed income market.
The country’s monetary policymakers have since been more hawkish in recent months as their major dilemma is to curtail inflation. The nation’s headline inflation raced to 19.64 percent in July, the highest since September 2005, from 18.60 percent in June, according to the National Bureau of Statistics (NBS).
The Monetary Policy Committee of the Central Bank of Nigeria has raised the Monetary Policy Rate, the key interest rate, twice this year, with analysts saying another hike looks likely in September.
Nigeria’s high-interest rate environment aimed at reducing inflation continues to make fixed income securities more attractive at the expense of stocks.
The NGX 30, which tracks the top 30 companies in terms of market capitalisation and liquidity, has decreased this month by 2.33 percent and its 3.22 percent return this year underperforms the entire market, which has advanced by 16.37 percent.
‘Another rate hike looms… it’s negative for equities’
“In our view, another rate hike in September is not far-fetched. The MPC is scheduled to hold its next meeting on the 26th and 27th of September 2022,” Chinwe Egwim, chief economist at Coronation Research, said in a note after the NBS inflation report was released on Monday.
The Damilare Ojo-led team of investment research analysts at Meristem expect yields in the fixed income market to trend upwards, “backed by tighter monetary policy and lower system liquidity.”
They said: “Also, the government’s suspension of the proposed Eurobond issuance will increase demand for local currency debt, further supporting our prognosis of higher yields.
“Rising inflation, heightened insecurity and low capital inflows remain major pain points in the country.”
They noted that the domestic equities market was predominantly bullish during the first half of the year.
“The positive mood on the NGX was influenced by impressive corporate performance, dividend declarations, numerous corporate actions during the period and the depressed yield environment,” Meristem analysts said.
They said a rebound in fixed income yields remained a downside to their expectation of bullishness for the rest of the year.
“The interest rate environment will remain the main determinant in the movement of equities going forward. We expect the bear market to persist as the impact of the increased benchmark interest rate continues to weigh down equity markets. However, investors are expected to continue cherry-picking stocks with solid underlying fundamentals,” said United Capital research analysts in their August 15 note.
Recently, the International Monetary Fund (IMF) released its July 2022 World Economic Outlook update, highlighting the downward revision of global and regional growth forecasts in its baseline scenario.
The IMF estimates that global growth would be 3.2 percent in 2022 and then moderate to 2.9 percent in 2023. This is a 40 basis points (bps) and 70bps downward revision from its April forecasts.
The primary driver identified by the IMF for the downward revisions include the increase in energy costs, unabating inflation pressures (due to rising food and energy prices) and the economic cost of reducing inflation.
Coming into the year, the major concern for global economic growth was the emergence of new strains of the pandemic. However, the war between Russia and Ukraine posed new supply constraints and further restrained growth.
At July’s Monetary Policy Committee (MPC) meeting, the authorities further raised the MPR by 100bps to 14 percent from 13 percent. The committee believed that a hold stance would mean that the CBN was not responding sufficiently to the global and domestic price developments.
Judging by the MPC’s posture at July meeting, CSL Research analysts believe that the CBN is more likely to stick on the path of a rate hike, “especially at a time when election spending is partially fuelling add-on inflationary pressures.”
They said a further rise in the MPR, if it translates to an increase in market rates, will narrow the interest rate gap and make naira bonds more attractive, which may be negative for the stock market.
The domestic equities market reversed its bullish momentum last week, losing over N570 billion compared to the preceding week as investors book profits off half-year 2022 earnings results, and the fixed income market remains attractive. The stock market opened this new week on a negative note. Its positive return year-to-date (YtD) printed higher at +16.37 percent at the close of trading session on Tuesday.
With inflationary pressure pushing yields higher in the fixed income space, market watchers expect the stock market to see mixed trends with a more cautious/bearish tone, as large-cap names continue to dictate market direction.
Here are 30 most capitalised stocks and how they have performed year-to-date
As at August 16, Access Holdings stocks recorded negative return of 8.6 percent YtD, Custodian Investment (-13.9 percent), Dangote Sugar Refinery (-8 percent), ETI (+21.8 percent), FCMB Group (+15.1 percent), Dangote Cement (+0.7 percent), United Capital (+21.2 percent), Unilever (-6.9 percent), MTNN (+2 percent), Seplat Energy (+118.4 percent), UBA (-13 percent), Zenith Bank (-13.3 percent) and Okomu Oil (+52.7 percent).
Presco share price has risen by 62.4 percent YtD, while Stanbic IBTC Holdings has decreased by 22.1 percent. Year-to-date performance of other large-cap stocks show: Total (+5.7 percent), Transcorp (+12.5 percent), Union Bank (+1.7 percent), Nigerian Breweries (-5.7 percent), Nestle (-16.5 percent), Lafarge Africa (+4.2 percent), Airtel Africa (+99.5 percent), BUA Cement (-18.6 percent), Oando (+10.9 percent), FBN Holdings (-5.7 percent), Fidelity Bank (+19.6 percent), Flour Mills (+8.1 percent), GTCO (-21.9 percent), Guinness (+115.4 percent) and International Breweries (+1 percent).
Domestic investors controlling equities transactions
The June 2022 domestic and foreign portfolio investment report released by the Nigerian Exchange Limited (NGX) shows that foreign investors accounted for only N243.48 billion or 14.65 percent of the half-year 2022 equities transaction as against N221.96 billion or 21.46 percent in H1’21. In the review period, foreign inflow into Nigeria’s equities market was N120.51 billion while foreign outflow was N122.97 billion as against foreign inflow of N105.24billion and outflow of N116.72billion in H1’21.
Also, in H1’2022 domestic investors’ equities transactions were valued at N1.418 billion or 85.35 percent of the total transaction as against H1’21 low of N812.46 billion or 78.54 percent of the total transactions in H1’21. Transactions by domestic retail investors in H1’22 were valued at N452.14 billion as against N335.29 billion in H1’21 while their institutional counters accounted for transactions worth N966.43 billion in H1’22 as against N477.17 billion in H1’21.
DMO’s bond auction
The Debt Management Office (DMO) conducted a bond auction on August 15, offering N225 billion and allotted N196.57 billion across the 3-year, 10-year, and 20-year tenors at respective stop rates of 12.50percent (+150 bps), 13.50 percent (+50bps) and 14 percent (+25bps).
Analysts at Vetiva Research said they expect the bearish sentiments to persist in the bond market as players react to the rate increase at Monday’s auction “as well as the uptick in inflation”.
Interest rate policy and the need to protect those who save in Naira
Bode Agusto, founder of Nigeria’s first indigenous credit rating agency, Agusto & Co, said in his recent note: “Setting the risk-free rate at a level significantly below the rate of inflation reduces confidence in the Nigerian naira because savers are unable to earn a positive return in real terms. It also fuels speculative demand for foreign exchange as savers seek solace in currencies that can store value better.
“A significant portion of pension assets are held in fixed income securities in Nigerian naira and the current situation is resulting in a significant erosion in the purchasing power of these assets. If this situation continues, the defined contribution system of pensions will be at grave risk.
“It is important for policy makers to review Nigeria’s interest rate policy to ensure that those who save in Nigerian naira do not lose purchasing power. This will reverse the erosion of the value of pension assets and reduce speculative demand for hard currencies. If interest rates are uncompetitive, demand for government securities wanes and savers will seek solace in hard currencies putting pressure on exchange rates.”
In line with market expectation of continued uptick in the yield environment of the sovereign bonds market, marginal rates across the 2025s, 2032s, and 2042s climbed 1.5 percentage points, 50bps, and 25bps, to print at 12.5 percent, 13.5 percent and 14 percent, respectively, according to Lagos-based analysts at United Capital.
They said investors are “retaining standoffish sentiments in a bid to drive yields further upwards, amidst a generally illiquid financial system.”
“That said, a blend of inflation expectations, climbing interest rates in the fixed income market, and political risks as we approach the electioneering season, remained the significant driving factors of investors’ standoffish stance in August’s auction,” the analysts added.
According to them, to attract fund managers’ interest, the DMO will most likely succumb to higher rates on all subsequent offerings.
They said: “Also, we maintain that the hawkish stance of the CBN in its last two MPC meetings, hiking MPR by a total of 250bps, will continue to drive investors’ appetite for higher rates for their funds.
“Also, we maintain that a blend of the not-so-significant expected coupon payment of N66.8 billion in August, and the FG’s persistent need to rely on the domestic market to fund its fiscal imbalance, as the external debt market conditions remain unfavourable, will further shove pricing power away from the FGN/DMO and into the hands of the private sector asset managers.”