The Nigerian equities market has continued its losing streak as negative sentiments against the market persist. Reactions to regulatory headwinds have amplified, and the pricing of equities falls short of their fundamentals valuations. On the heels of uncertainties in the global economy, monetary policy tightening and political tensions, the recent depression in the market may not be unexpected, however, the magnitude and duration of the loss was largely unanticipated.
The equities market has lost (6.2%), which is a far cry from what was obtainable in February 2013, where market had gained 18.45 percent, owing to the large fund inflows into the Nigerian capital market.
Widespread impact of tapering on emerging market
QE tapering has dragged most African markets as they have underperformed consensus expectation for Q1:2014. The exceptions are the Ghanaian and South African markets with 12.97 percent and 0.95 percent returns YtD.
Emerging markets: BRICS and MINT have also been adversely affected, save for Indonesia, which has gained 5.47 percent, South Africa and China that have marginally returned 0.02 percent above 2013 level. Brazil is the most affected, shedding 6.98 percent, while Russia, India, Mexico, Nigeria and Turkey are all in the red zone shedding 0.47 percent and 3.61 percent, 5.62 percent, 6.2 percent, and 4.73 percent, respectively.
Nigerian market still relatively cheap amid peers
Trailing P/E and ROE have pegged at 13.63x and 19.76 percent, respectively, more attractive in comparison with other African countries – South Africa (P/E 20.31x, ROE 10.47%), Ghana (P/E 24.78x, ROE -8.93%), and Kenya (P/E 14.13x, ROE 18.76.
Nigerian equities market: Time to take position?
Equities’ pricing (P/E ratio) has dropped to 13.63x from 14.50x in December 2013. Although some of the stocks in the market have rich valuation, current market sentiments seem to have jettisoned value. Banking stocks are mostly affected by the developments in the economy as they have the highest exposure to monetary tightening.
With the anticipated further hike in CRR on public sector deposits to 100 percent and the need for fresh capital by most banks to meet the Basel II and III requirements coupled with the further tapering by the US Fed, the current investors’ negative sentiments may not be out of place.
The banks will still thrive to grow earnings via better cost management, increasing focus on non-interest income, and growth in loan books, especially to real sector. While the banking stocks may still be bearish in the coming weeks due to Investors’ negative reactions to the current realities, we believe position taking for 2013FY results and dividend declarations will be the major catalyst for the next market rally.
Capital flows, perceived future FX depreciation and asset returns
Portfolio rebalancing theory conjectures that, shocks to emerging market equity market prices can trigger capital outflows and currency depreciation as a result of portfolio reassessment by foreign investors in a bid to reduce exchange rate risk exposure and vice-versa. However, Bank of International Settlement (BIS) research shows that, although exchange rate (FX) intervention such as a managed floating regime as operational in Nigeria, but has the capacity to reduce FX volatility and counter the impact of capital flight, this policy cannot shield such economies against portfolio rebalancing by foreign investors, hence the pressure on the currency.
An assessment of historical data on FX and performance of the NSE ASI suggests that despite a managed floating FX regime, FX depreciation remains consistent with market downturn and both variables showed similar trend following market stability. This development was sequel to the global financial crisis that resulted in massive capital flight from the Nigerian market, which was overweight on foreign investors.
There is likelihood that foreign investors may continue rebalancing their portfolio to reduce FX risk exposure given expectation of further depreciation of the naira. With 50 percent foreign participation in the Nigerian equities market, this trend may also imply that the pressure on the naira may intensify further, given the forward guidance given during the week by the new Fed chair to stick to reduction in stimulus. However, attractive equities market fundamentals, MSCI frontier and emerging market indices rebalancing and significant positive interest rate differential in the fixed income space may possibly sustain some inflows to the market.
In search of alpha?
In the last three weeks, we have seen only 19 stocks appreciate while 73 stocks declined and 89 traded flat resulting in the 6.20 percent YtD loss of the market. As investors re-adjust their portfolios in search of ‘value in the mire’, we highlight two of our proprietary portfolios which we believe will guide investors searching for alpha or at least capital preservation.
Our “defensive” and “high return” portfolios have consistently outperformed the Equities market returning 1.72 percent and 0.70 percent YtD, respectively, against the -6.20 percent return of the market. The portfolios consists of stocks with low-to-mild volatility, high five-year average ROE greater than 20 percent and modest five-year earnings growth.
We are of the opinion that the stocks in the High Return Portfolio have good fundamentals and are properly positioned to sustain their competitive edge in the industries they belong. This portfolio is recommended for risk-loving investors and is expected to return 25.34 percent for the year.
The defensive portfolio on the other hand was designed given the “bumpy” outlook on equities in 2014, and is focused on capital preservation.