The strong positive correlation between the Nigerian Stock Exchange (NSE) All share Index (ASI) and crude oil prices finally broke this year as investors sentiment turned bearish in the Nigerian stock market despite a rally in oil prices.
The divergence began to emerge in early March as volatility hit Emerging Markets as traders worry about trade war tensions between the world’s two biggest economies (USA and China) and a scenario of accelerated tightening by the Federal Reserve.
Crude oil prices have rallied this year by around 12 percent off the back of supply disruptions in Libya and Venezuela. However, the ASI which initially rallied in early January is now down -0.73 percent year to date. Traditionally, the Brent crude oil price has been a signal for predicting future changes in the stock market performance in Nigeria.
This is because rising oil prices leads to strong economic growth in oil dependent Nigeria and oil export earnings contribute the largest chunk to foreign reserves in the country. A larger foreign exchange (FX) reserves position usually boosts investors’ confidence in Nigerian equities and the external reserves provide security for foreign investors who may be worried about the difficulty of exiting the market at will.
In 2017 while crude oil prices doubled from its 2016 levels, Nigeria attracted about $3 billion in foreign portfolio investments (more than 100 percent its 2016 level). These huge investments in Nigerian securities enabled the market to return as much as 42 percent, making it the 3rd best performing market in the world in 2017.
This trend showing the correlation between crude oil prices and stock market performance can also be observed in previous years. In August 2014 when oil prices reached a record $114 per barrel, the Nigerian Stock Exchange All Share Index rallied to 43,031 points, its highest level since the market crash of 2008. Coincidentally, both stock prices and crude oil prices collapsed in 2008.
Again, when the oil prices fell below $30 per barrel in January 2016, the All Share Index was at 22,456 points which was its lowest in 5 years. However, 2018 appears to be very different from previous years. As oil prices rose from $69 per barrel and hit a year high of $80 per barrel in May 2018, the stock market has had a correction, shedding over 6,300 points or 15 percent since a peak in earlier in the year.
It dropped from a peak of 44,460 at the start of February to 38,104 at the end of May. The selloff has been broad based from industrials like Dangote Cement which has given up gains for the year, Financials such as Union Bank down -18 percent, Nigerian Breweries -19 percent and downstream oil and gas firm Forte Oil that has returned -21 percent year to date.
If the stock market is already bearish during a crude oil price rally, the market may just get from bad to worse for equity investors if the OPEC fails to renew the supply quota agreement that pushed crude oil prices back above the $70 per barrel region. Despite the improved outlook for the overall sector from higher oil prices, challenges remain for firms in the country, according to Moody’s.
“Nigerian corporates continue to see electricity followed by high interest rates as the biggest inhibiters to business activity. According to Central Bank Nigeria data, prime lending rates remain very high at 17.78% as of the end of December 2017, while maximum lending rates exceeded 30%. These two considerations will continue to weigh negatively on corporates’,” Moody’s said in May 9 note on the Nigerian economy.
Henry Ogbuaku, group head asset management at GDL Asset Management told BusinessDay by phone that the downward trend observed in equity prices this year is as a result of foreign investors exiting the local market due to fears of insecurity and rising political tensions in the country. He explained that the equity investors are currently not responding to the rally in oil prices because they are distracted by the election risk and negative news appearing in the press on civil unrest in the North East and Central Nigeria.
Henry also added that he does not expect stock prices to recover until after the general elections next year regardless of any improvement in company fundamentals or other positive macro news.
According to Robert Omotunde, head of research at Afrinvest Securities Ltd, the correlation between crude oil prices and stock prices is an indirect positive correlation through reserves accretion and positive impact on exchange rates.
“The three factors that have driven equity prices lower are the interest rate normalization in America and Europe, the polity risk as the general elections draw closer and the slow pace of economic growth could each have been responsible for the poor performance in stock prices since January,” he added.
