Nigerian Equity Markets: Key Drivers Still Under Siege

LAGOS (Capital Markets in Africa) – Analysis of market performance in 2016 indicated that although a combination of poor corporate releases as well as weak macroeconomic fundamentals contributed to the negative return for the year, market volatility remained largely consistent with instability in the currency market. More specifically, while bearish sentiments persisted for most of 2016, equities rallied between May and July 2016 due to reforms in the Oil & Gas sector and adoption of the floating exchange rate regime. We also observed that the periods of widening exchange rate spread (between official and parallel market rates) and the imposition of currency control measures correlated with the lowest points of the index.

It is apparent that key market drivers such as exchange rate, oil prices, oil production volumes and government revenue are still under siege while policy risk remains the biggest factor to watch. Thus, our fundamental view of market performance in 2017 is bearish as uncertainties remain so long as impediments to economic expansion stay unaddressed. We expound on the determinants of performance of the local bourse in 2017 below:

1. Policy Uncertainty…. the Biggest Factor to Watch!
   At the epicentre of Nigeria’s recent economic difficulty is policy uncertainty and the major factor responsible for the unresolved crisis in the currency market is a confidence deficit. This was highlighted in our 2016 Banking Sector Report when we noted that:

   As against the oft-repeated investment case for Nigeria which had previously been predicated on the resiliency of the economy in terms of its vast and unexploited natural and human resources, attractive demographic features as well as high profit margins; confidence metrics, such as policy consistency, sound governance, regulation, and reforms, are now the new arguments being put forward by investors in making investment decisions.

Notwithstanding blunted monetary policy tools, we do not see the Apex Bank deviating from its history of policy volatility in 2017. Even so, the capacity of the fiscal policy managers to implement policies to counter the raging economic recession remains a concern in the absence of a major policy response by the Ministry of Finance since the cabinet was constituted late 2015. Thus, the direction of policy framework is still blurry. The short to medium term implication of the above is, therefore, a protracted episode of stagflation justifying a bearish outlook for equities.

2. The “Troika”: Oil Proceeds, External Reserves and Exchange Rate
   The historical trend of the Nigerian equities market indicates that performance has been tightly correlated to crude oil prices, accretion to gross external reserves and exchange rate stability. This is because capital flows into Nigeria are fundamentally driven by exchange rate stability and accretion to reserves – which is largely a function of oil proceeds.

   However, the exchange rate crisis which has lingered for more than 24 months is expected to persist in 2017 given a benign outlook on proceeds from oil as well as poor policy responses. Despite a last minute agreement by OPEC and some non-OPEC members to cut output, short to medium term outlook suggests oil prices are likely to stay at sub-US$60.00/b while militancy in the Niger Delta region will likely keep domestic production depressed. This combined with the absence of a clear-cut economic road map by the federal government to recalibrate the economy away from recession implies a blurry outlook for equities.

   Our interactions with several foreign investors with interests in Nigeria suggests that a decision to stake any position in the Nigerian market will be a function of currency liquidity and a greater certainty on their ability to repatriate capital anytime they divest. As a result, we do not see significant foreign capital flowing into Nigerian equities in the short to medium term as the discrepancy between the parallel and interbank market rates continue to deter interest in Nigeria.

   Additionally, the likelihood of a further adjustment to the current interbank market rate which remains controlled despite recent reforms by the Central Bank of Nigeria (CBN) will keep investment in Nigeria soft. Meanwhile, FX bottlenecks are expected to continue to pressure operating metrics for corporates, given the negative impact on input cost, capital expenditure and financing. On the other hand, pressure on disposable income implies a soft outlook for revenue. Therefore, improvement in operating metrics will take a medium to long-term to materialize. As such, we expect that appetite for equities will stay soft until the market has bottomed out.

3. Constrained Corporate Earnings
   In addition to the above, indications are that output contraction or subdued growth may persist in the services and industrial sectors of the economy as observed in 2016. However, the agricultural output may further improve on the back of the renewed drive to increase domestic productivity and export earnings as seen in 2016. Expectedly, growth prospects for corporates in the Consumer Goods, Industrial Goods, Health Care and Banking sectors may stay constrained in the short to medium term except for the Agric. Sector operators. Upstream Oil & Gas companies may also benefit from higher prices of crude oil if militancy is brought under control. Ultimately, market performance may be largely constrained by this uncertainty.

Where is the Bottom?
Notwithstanding the foregoing, our technical analysis indicates that a continuous downtrend in the market will trigger a rebound even in the absence of fundamental drivers as soon as market actors perceive prices to have reached its long term support level or bottomed out. As such, we are of the view that despite bearish indications from a fundamental point of view, there is a technical basis for an uptick in the index level immediately market valuation becomes ridiculously cheap (unless there is an unexpected policy misdirection from the CBN or the fiscal authorities).

To give credence to our position above, we analyze the 10-Year trend of the All Share Index (ASI) to determine the long-term support level. As shown in chart 27, the long term support level for the ASI is established at 20,000points. In the last 10 years, this support line has not been breached even during the global financial crisis of 2008 and the Eurozone market rout of 2011 both of which had the most devastating impact on financial markets around the world. Accordingly, we expect that despite a bearish outlook for equities, the index may not breach the 20,000 points support line in 2017 notwithstanding market sentiments.

A further implication of the above is that short term speculative opportunities will persist in equities regardless of the broader sentiments in the economy as active traders can swiftly long the market once the index bottoms out or near the 20,000 points support level and take profit when return targets are achieved. We also see opportunities for speculative positioning ahead of foreseeable policy pronouncements by the Apex Bank and the fiscal authorities during the year as events in 2015 and 2016 have clearly shown. The market rallied significantly during these periods, touching the short-term resistant levels in response to cheery news such as President Buhari’s victory at the poll, the announcement of the downstream oil & gas sector reforms and the initial rally that greeted the implementation of a floating exchange rate regime by the CBN.

Our Scenario Analysis in 2017
In view of the observed weaknesses in the system, our base case scenario in 2016 predicted a 5.9% Y-o-Y decline for the index if FX rate was adjusted to N265.00/ US$1.00, oil prices stabilizes above US$30.00/b, a 100bps hike in MPR to 12.0%, an appreciable performance of the 2016 budget and an improved global sentiment for equities. Although oil prices stabilized well above US$30.00/b while the CBN hiked MPR to 14.0%, initiated reforms in the FX market during the year and adjusted FX spot rate to N305.00/ US$1.00, liquidity crunch persisted in the currency market and the 2016 budget was sub-optimally implemented.

Crisis in the Niger-Delta region also escalated while policy responses to teething economic woes stayed largely insufficient. Hence, the benchmark index depreciated 6.2% Y-o-Y in 2016 (Afrinvest base case projection was – 5.9%) as macroeconomic and corporate operating metrics worsened.

In 2017, we envisage market performance to be broadly predicated on three critical economic outcomes. These include:

1. The implementation of an economic recovery plan to restore economic growth;
2. Resolution of the on-going crisis in the Niger Delta region and the impact on oil production volumes as well as revenue;
3. Apex Bank’s resolve to fix the currency market crisis and close the huge gap between official and unofficial market rates once and for all.
   

This article is featured in the March 2017 edition of INTO AFRICA Magazine, Africa’s Lions: Trust in Fundamentals.

Written by Afrinvest (West Africa) Limited Research Team, Nigeria