MON, AUG 10 2020-theG&BJournal– EFG Hermes has suggested Financial system distortions are partly to blame (interest rates do not make much sense), and valuations have not been a good guide to future returns in Nigeria but are equally surprised that so little local liquidity is going into stocks.
‘’We remain Underweight on Nigeria. We have no visibility on when we will see changes in economic policy that are necessary for a rally in stocks. GTB is our preferred Nigeria name,’’ EFG Hermes said as explainer to the disappointing market performance which has seen volumes collapse and foreigners cut back on net selling because of the FX backlog (USD2.0-2.5bn for portfolio investors).
EFG Hermes argued in their latest Macro Strategy Report seen by theG&BJournal that Local investors should be piling into Nigerian stocks because risk-free rates have fallen sharply since access to CBN’s OMOs was barred in October 2019, valuations are at post-GFC lows, and downside risks to NGN continue to build (stocks should be a natural hedge).
The closing of the OMO window led to a rapid shift in local liquidity in late 2019 – stock market ADVT rose and local pension funds allocated cash to equities for the first time in several years. Dividends payable in early 2020 were an additional incentive, and the NGN devaluation in March 2020 stimulated heavy retail net buying in the face of foreign selling.
‘’However, recent data shows how little local money has flowed into equities since October. We estimate that pension funds have allocated just cNGN56bn (USD16mn) to stocks since end-September 2019 – their holdings of FGN bonds are up NGN1,500bn (USD3.2bn) over the same period. Meanwhile, we estimate disappointing flows into equity mutual funds of just NGN0.6bn since the OMO decision.’’
Money market funds, which offer negative real returns, have grown by NGN173bn over the same period. Bond mutual funds – some of which offer FX exposure – have grown by NGN153bn, while the local gold ETF is seeing strong inflows.
According to EFG Hermes: Locals may be shy about equity investment for several reasons: pension fund managers are not rewarded for taking a long-term view; the macro outlook is poor given the COVID-19 and oil price shocks; locals still seem to have access to OMOs, with NGN3.2trn (USD8.2bn) owned by local non-banks in June 2020; latent local liquidity is poor (demand deposits grew 6% Y-o-Y in June,); and locals are nervous about NGN shocks. Moreover, available data suggests that low valuation multiples are no guarantee of decent medium-term returns in Nigeria.
‘’We look at various multiples (trailing and fwd P/E, DY, P/B) and find a relative low correlation between these and 1, 2 & 3-year index performance. We compare this with Pakistan, a more cyclical market where the interest rate policy is clearer, which has a far stronger correlation between valuation and future returns. Local liquidity has flooded back to Pakistan in 2020.’’
Why does valuation not provide a sound investment basis for Nigerian stocks? ‘’We think Nigerian authorities have shown a greater willingness than FEM peers to accept long periods of low growth and distorted market signals as the cost of currency stability and import substitution.’’
The effect is that Nigeria markets can stay cheap for longer, putting off all but the most patient investors. The oil price and COVID-19 shocks have so far been insufficient to force a change in direction.
Indeed, the distortions have worsened, with base money growing rapidly as the CBN retains bank reserves.
Meanwhile, FX reserve burn appears to have slowed. There is little to suggest that a shift to unified exchange and interest rates is imminent, though the parallel rate has recently moved out.
‘’We think that local funds with LT liabilities should increase their equity allocations, but believe that foreigners can generate better returns elsewhere.’’
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