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Monday, January 30, 2023

Bonds More Attractive Than Stocks in Era of Tightening

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With a few days to the end of the year, bonds are getting love from investors as the adoption of a hawkish stance by the Central Bank of Nigeria (CBN), has led to a Bond selloff and yields looking attractive relative to stocks.

The bond equity earnings yield ratio otherwise known as BEER in the Wall Street parlance stood at 1.39, which means stocks are generally overvalued, according to MoneyCentral calculations.

Basically BEER ratio compares 10 year Treasury bond yield to the earning yield of the stocks or stock index; earning yield is the reverse of the price to earnings (P/E) ratio.

A BEER ratio of 1 means that both equity and bond markets have equal levels of perceived riskiness (or both equity and bond markets are fairly valued). A BEER ratio greater than 1 means that the equity market is overvalued, while a BEER ratio smaller than 1 means that the equity market is undervalued.

The Nigeria 10 year government bond has a 13.8 % yield, according to data from World Government Bonds.

The stock index has an earnings yield of 0.10%, according to MoneyCentral calculations.

It is pertinent to note that the Nigerian equities market started the year positively as the All-Share index recorded a gain of 21.3 percent in the first six months of the year (H1-22).

But that compares to All-Share index year to date gain of 15.88 percent, and analysts are not optimistic the domestic bourse will sustain 2022 gains next year on concerns of the uncertainties surrounding the 2023 elections and fear over the economic policy of the incoming president.

The weak macroeconomic environment is expected to exert pressure on corporate profit expansion and, by extension, valuations and market performance in 2023, according to analysts at Cordros Securities Limited.

“Our baseline expectation is that the market will deliver a positive return of 3.5% in 2023E,” said the analysts.

Of course, the central bank’s aggressive monetary policy that seeks to tame stubborn inflation led to a higher interest rate environment which drove the downbeat mood in the market in the third quarter of 2022.

The Monetary Policy Committee of the Central Bank of Nigeria voted at its last meeting in November, to increase the benchmark interest rate by 100 basis points to 16.5 per cent, the highest since 2001.

Nigeria’s inflation rose to 21.47% in November from 21.09% recorded in October, representing the 10th consecutive monthly increase since the start of the year.

Just like there are concerns incessant tightening of interest rates risk tipping the global economy into a recession, there are also concerns that Nigeria is not impervious to an economic downturn.

Of course, the Russian invasion of Ukraine compounds the woes of a fragile economy reeling from rising manufacturing costs brought on by a severe foreign exchange scarcity and decrepit economy in a country where over 50 percent of a population of 200 million people live on less than $1.98 a day.

According to a recent data from the National Bureau of Statistics (NBS), the country’s gross domestic product (GDP) grew by 2.25 per cent on a year-on-year basis in the third quarter of (Q3 2022); but the national output declined from 3.54 percent in the second quarter of (Q2) to the 2.25 % in Q3 2022.

Analysts at Cordros Securities are of the view that investors will likely continue to seek relative safety in value stocks as they remain concerned about the market’s volatility, political and economic uncertainties, and higher interest rates

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