With negative expectations already priced in, earnings did better than expected, spurring investor interest across Cement and Tier I bank stocks and driving the market to a positive close (+0.9%) for the month of July.
July 29, 2020/Cordros Report
The U.S Federal Open Market Committee (FOMC) is expected to decide on its benchmark interest rate later today. Of all economic indices competing for attention, we believe measures to stimulate economic growth from the COVID-19 pandemic will take centre stage. The Fed projects the U.S economy will shrink by 6.5% in 2020. While growth is expected to rebound strongly by 5.0% y/y in 2021, the renewed surge in COVID-19 cases is now posing a remote threat to the expected recovery. Meanwhile, in its last policy meeting, the committee elected to leave the rate near zero (0% – 0.25%) for the third consecutive time in the year. This was as a result of the current global pandemic which has crippled growth. We note the U.S economy contracted sharply in March, erasing the gains of January and February and turned real GDP for Q1-20 negative (-5.0% y/y on an annualised basis). We believe additional loosening policy actions to, at best, reassure the market of its commitment to a dovish monetary policy stance, will be central to the committee’s consideration and as such, influence its decision. Thus, while we expect the Fed to leave rate unchanged, we do not rule out an additional bond-buying announcement.
Elsewhere, the Bank of Japan (BOJ), in its latest Monetary Policy Meeting, kept its key short-term interest rate at -0.1%, while also maintaining the 10-year Japanese Government Bonds (JGBs) yields at 0.0%. The BOJ expects the Japanese economy to improve gradually, albeit slowly in H2-20 (Q1-20: -2.2%), while also enunciating its resolve to closely monitor the impact of the pandemic on activities over the medium to long term. The BOJ further expects the Japanese consumer prices to remain in deflationary territory for the time being, mainly due to the global pandemic and the past decline in crude oil prices. The Japanese economy contracted by 0.6% q/q in Q1-20, with inflation rate printing -0.1% in June-20 mainly from the weakness in external demand. We expect interest rates to remain at present levels in the medium term as the bank’s monetary policy authorities focus on growth.
As at mid-week, performance across global equities was flat to moderately positive, as investors assessed a batch of mixed earnings reports while holding out for more U.S. stimulus to limit the economic damage of COVID-19. Consequently, US (DJIA: -0.3%; S&P: +0.1%) and European (STOXX Europe: +0.1%; FTSE 100: +0.1%) stocks were down WTD. Asian markets have been mixed — Japanese (Nikkei 225: -1.6%) stocks are down so far this week as a stronger yen and dismal earnings reports have hurt sentiments, while Chinese (SSE: +3.1%) stocks are up on investor bargain-buying, after recent slumps. Emerging (MSCI EM: +2.0%) and frontier markets (MSCI FM: +2.0%) stocks are also up in the week, with rising bets of a dovish stance from the U.S. Federal Reserve to support the world’s biggest economy.
According to the National Bureau of Statistics, a total of NGN651.80 billion was generated as Value Added Tax (VAT) in H1-20. Relative to the same period from a year ago, the achieved VAT is 8.5% higher. However, at this run-rate, total VAT receipts are trailing the FGN’s 2020 budget. For better context, at NGN651.8 billion over H1-20, the reported VAT is 36% lower relative to the FGN half-year target of NGN1.02 trillion in the revised 2020 budget. Meanwhile, on a quarterly breakdown, VAT receipts in Q2-20 grew marginally by 0.81% q/q to NGN327.10 billion (Q1-20: NGN324.60 billion), benefitting from the implementation of the VAT hike in February 2020, even as the COVID-19 pandemic disrupted economic activities in the period. Notably, collection rates were lower across key sectors such as Federal Ministries & Parastatals (-22.90% y/y), Building and Construction (-2.21% y/y), and Offshore Operations (-9.37% y/y). On our estimate, the FGN will face the hurdle of generating c. NGN689 billion per quarter to, at least, meet its 2020 target. The foregoing is a tall order in our view, given the low level of activities from the onset of the COVID-19 outbreak, together with the COVID relief packages for small businesses which includes VAT exemptions.
The Budget Office recently released the 2021-2023 Medium Term Expenditure Framework (MTEF) which we understand is in line with the provisions of the Fiscal Responsibility Act (FRA) 2007, a guide for the policy thrust behind the public finances of the FGN. In the document, the Nigerian economy is forecasted to contract by 4.2% y/y in 2020 (Cordros estimate: -3.4%) on the expectation that oil GDP will contract by 12.96% y/y, together with a slower contraction in non-oil GDP growth (-3.6% y/y). Beyond 2020, the economy is expected to gradually recover with GDP expected to grow by 3.0% y/y, 4.7% y/y, and 3.9% y/y, in 2021, 2022, and 2023, respectively. Oil revenue was also forecast to grow by c. 96% in 2021 (2020 estimate: NGN1.01 trillion) on oil production assumption of 1.86mb/d and an average oil price of USD42.00/barrel. Overall, the aggregate FGN revenue for 2021 is projected at NGN7.50 billion, while aggregate expenditure is estimated to be NGN12.66 trillion (2020 revised budget estimate: NGN10.81 trillion), leading to a fiscal deficit of NGN5.16 trillion. On a percentage of GDP basis, the expected deficit is 3.63% of GDP, which is well above the 3% limit set by the FRA 2007. In our view, until the FGN implements strategies to unlock new revenue sources, we believe it will not be feasible to keep the deficits within the 3% target.
With negative expectations already priced in, earnings did better than expected, spurring investor interest across Cement and Tier I bank stocks and driving the market to a positive close (+0.9%) for the month of July. For the holiday-shortened trading week, the All-Share index rose 1.1% WTD to 24,693.73 points, closing in the green in 2 of 3 trading sessions, and reducing the YTD loss to -8.0%. On sectors, the Industrial Goods (+3.6%) index sustained last week’s gains, with the Banking (+3.0%) index joining the leaders’ list. Conversely, the Oil & Gas (-6.5%) and Consumer Goods (-0.4%) indices closed in the red. The Insurance index was flat.
Our view continues to favour cautious trading as risks remain on the horizon due to a combination of the increasing number of COVID-19 cases in Nigeria and weak economic conditions. Thus, we continue to advise investors to seek trading opportunities in only fundamentally justified stocks.
Money market and Fixed income
The overnight (OVN) rate contracted 10bps, WTD, to 2.2%, as inflows from the prior week and FGN bond coupon payments (NGN49.33 billion) kept liquidity in the system afloat.
In the absence of any significant inflows to the system next week, we expect the OVN to expand, and as the CBN may mop up liquidity from the system.
Trading in the Treasury bills secondary market was bullish, on the back of the still buoyant system liquidity. Thus, the average yield across all instruments contracted by 29bps to 3.5%. Across the segments, average yield at the OMO segment contracted by 41bps to 4.2% whereas they expanded slightly by 1bp to 1.7% at the NTB segment, as market participants shifted focus to this week’s PMA. At the PMA, the CBN offered to investors maturing bills worth NGN265.95 billion. The auction closed with the CBN rolling over NGN49.84 billion of the 91-day, NGN54.59 billion of the 182-day and NGN161.52 billion of the 364-day – at respective stop rates of 1.20% (previously 1.30%), 1.50% (previously 1.80%), and 3.40% (previously 3.35%).
For next week, the tight liquidity expected in the system should cause reduced demand for instruments in the space.
The Treasury bonds secondary market continued to trade with bullish sentiments, as the healthy liquidity in the system sustained local participation, and as investors reinvested coupon payments. Consequently, average yield contracted by 20bps to 7.1%. Across the curve, yield contracted at the short (-30bps) and mid (-44bps) segments, as investors demanded the MAR-2024 (-66bps) and MAR-2027 (-125bps) bonds, respectively, while they expanded at the long (+6bps) end, following sell-off of the JUL-2034 (+31bps) bond.
We expect investors to continue to cherry-pick attractive yields, notwithstanding the expected strain in system liquidity.
The CBN’s foreign reserves sustained its descent as FX outflows continue to outpace inflows, thus dipping by USD59.86 million w/w to USD35.92 billion. Consequently, the naira appreciated marginally against the US dollar by 0.06% w/w to NGN389.25/USD at the I&E window but weakened by 0.7% to NGN475.00/USD at the parallel market. In the forwards market, the naira appreciated against the US dollar across the 1-month (+0.2% to NGN390.47/USD), 3-month (+0.4% to NGN393.45/USD), 6-month (+0.4% to NGN398.7/USD) and 1-year (+1.5% to NGN412/USD) contracts.
Despite the CBN’s stronger commitment towards exchange rate unification, we still see legroom for the currency to depreciate further, at least towards its REER derived fair value. Our prognosis is hinged on (1) the widening current account (CA) position, (2) currency mispricing, which could induce speculative attacks on the naira, and (3) the resumption of FX sales to the BDC segment of the market which should place an additional layer of pressure on the reserves as the CBN funds the backlog of unmet FX demand.