October 19, 2021/Coronation Research
The international financial press is full of the inflation story. What happens if inflation takes root in the US and puts the US equity market into reverse? The question is relevant because the US equity markets have been the default investment for many wealthy individuals for years. Would a fall in US equities drag down the Nigerian market? The answer is, most likely, no; the Nigerian market does not correlate with US or international markets
Last week, the exchange rate at the Investors and Exporters Window (I&E Window) fell to a record low of N422.07/US$1 before settling at N415.07/US$1 (-0.19% w/w). The Central Bank of Nigeria’s FX reserves rose by 3.76% to US$39.62bn, the highest level since 5 December 2019. The accretion reflects, in our view, the US$3.50bn International Monetary Fund’s (IMF) Special Drawing Right (SDR) allocation to Nigeria and the FGN’s issues of US$4.00bn in Eurobonds last month. Nevertheless, FX turnover on the official markets remains low in comparison with levels seen in previous years. Our view remains that there may be continued pressure on the official and parallel exchange rates if the CBN does not increase supply.
Bonds & T-bills
Last week, activity in the Federal Government of Nigeria (FGN) bond secondary market was mixed, as market players remained on the sidelines awaiting further clarity on the direction of yields. The average benchmark yield for bonds fell marginally (-1bp) to 11.33%. On benchmark notes, the yield of the 10-year (-3bps to 11.97%), 7-year (-4bps to 11.71%), and 3-year (-2bps to 9.20%) FGN Nairadenominated bonds all tightened, slightly. On Wednesday, the Debt Management Office (DMO) is due to offer N150bn (US$365mn) worth of instruments through re-openings of the January 2026, April 2037 and March 2050 bonds at the primary auction. Nevertheless, we reiterate our expectation that a future rise in bond yields, if any, is unlikely to be sharp over the coming months due to unaggressive borrowing as the DMO manages its debt service costs.
Trading in the Treasury Bill (T-Bill) secondary market was mainly bullish, as market participants sought to fill unmet demand in the recent primary market auction (PMA) and reacted to the fall in the stop rate of the 1-year bill. Consequently, the average benchmark yield for T-bills fell by 7bps to 5.20%. However, the annualised yield on a 328-day T-bill expanded by 38bps to 7.36%. At the PMA, the DMO allotted N187.23bn (US$455.56m) worth of bills across all tenors. The rate on the 364-day bill dropped by 25bps to 7.25% (annualised yield: 7.82%). Demand was strong, as a total subscription of N493.03bn – the highest level since July 2021 – was recorded, implying a bid-to-offer ratio of 4.05x (versus an average of 1.87x at the last four auctions). Elsewhere, the average yield for OMO bills closed flat at 6.47% while the yield on a 305-day OMO bill fell by 1bp to 7.32%.
The price of Brent closed at US$84.86/bbl last week, its highest level since 2 October 2018. Last week’s gain marked the sixth consecutive weekly gain for the commodity. Year-to-date, Brent is up 63.82% and it has traded at an average price of US$68.78/bbl, 59.14% higher than the average of US$43.22/bbl in 2020. The price has continued to rally amidst the persisting energy crunch in Europe and China and constrained supplies from major producers. Skyrocketing prices of gas and coal are precipitating a switch to oil products. Elsewhere, the Organisation of the Petroleum Exporting Countries (OPEC), in its Monthly Oil Market Report (MOMR) for October, revised its estimate for global oil demand growth downwards for 2021 to 5.8mbpd (previously 5.96mbpd). According to the report, the world is expected to consume 96.6mbpd of petroleum products this year and an average of 100.8mbpd in 2022. Consequently, we reiterate our view that the price of Brent oil is likely to remain well above the US$60.00/bbl mark for several months.
The Nigerian equities market recorded its fifth consecutive weekly gain, edging higher by 1.39% to close at 41,438.15 points – its highest level since 9 February 2021. Consequently, the year-to-date return rose to +2.90%. FBN Holdings +29.59%, International Breweries +9.89%, Okomu Oil Palm +8.23% and Cadbury Nigeria +6.25% closed positive last week, while Nigerian Breweries -3.23%, Guinness Nigeria -1.86%, Sterling Bank -0.65% and Oando -0.38% dropped points. Sectoral performances were bullish as the NGX Insurance index led the gainers, rising by 1.60%, followed by the NGX Industrial +0.98%, NGX Oil & Gas +0.64%, NGX Consumer Goods +0.47% and NGX Banking +0.06% indices. See page 4 for the Model Equity Portfolio.
What happens to Nigeria if US equities fall?
Early this year it looked as if US inflation was on the rise. This was reflected in the yield of the US Government 10-year bond which rose from 0.68% pa in October 2020 to 1.74% pa in March 2021. Thereafter the yield fell, confounding those who had sold the 10-year bond earlier. Yet the yield has moved back up, closing last week at 1.57% pa.
At least two venerable market strategists of international repute have weighed in on the subject recently, one being Stephen Roach, former Chief Economist at Morgan Stanley and now a faculty member at Yale University, another being John Plender of the Financial Times. Both warn that policy makers are likely to respond too slowly to the build-up of inflationary pressure, Roach adding that the problem of inflation has been absent for so long (in developed markets) that policy makers no longer remember how to deal with it.
This article is not the place to judge whether inflation in developed markets will continue to rise or not. Our point is that a very long period of low inflation, accommodative monetary policies and low interest rates in the US have coincided – one could say aided – a long bull run in US equity markets, notably the S&P500 and the Nasdaq Composite indices.
Over the past six weeks both indices have faltered, the S&P500 having fallen by 1.27% and the Nasdaq Composite by 2.37%. This, or course, may not mean very much. Both markets have fallen by much more during various setbacks over the past decade, only to continue to rally. And the relationship between US government bond yields and US equity markets is complex (the negative correlation is weak). Nevertheless, investors might want to start to think about what would happen if the long bull run in US equities runs out of steam.
The ideal non-correlating market
After all, the US equity have been a destination – almost a default destination – for wealthy individuals’ funds, as well as institutional funds, for a long time. Where would investors’ spare money go if not into the US equity markets? And would a downturn in US equity markets mean a downturn in the Nigerian equity market?
On that last point, we can reply with a resounding no. The NGX All-Share Index has a negligible correlation with US markets, meaning that the NGX All-Share Index dances to its own tune. This could be good news if US equity markets turn down, as investors could look to non-correlating markets, like ours, in order to find value and returns.