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Saturday, March 6, 2021

Rising Bond Yields See Equity Investors Mull Trigger Point for Exit

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Nigerian stocks which shrugged off the global coronavirus pandemic to become the best performers in 2020 by rising By some 50 percent, are facing a new headwind this year in the form of rising domestic bond yields

As benchmark yields rise amid expectations for stronger growth, the party may be over for stocks as investors gear up for the return to high yielding debt paper amid gradual economic recovery and inflation expectations which could elicit a rate hike.

The Bond Equity Earnings Yield (BEER) Ratio for Nigeria is 2.24, which means that bonds offer more value than equities, according to MoneyCentral Calculations.

The BEER, that helps an investor gauge the direction of the market, is a metric that investors often use to evaluate the relationship between earnings yield of a stock market (the inverse of the price-to-earnings ratio) relative to bonds.

The ratio is determined by dividing the yield of a government bond by the current earnings yield of a stock or stock benchmark. A ratio of greater than 1.0 indicates the stock market is overvalued, while a rating of under 1.0 suggests stocks are undervalued.

The All-Share Index is currently trading above 15.10 times (x) earnings, well above its pre-Covid-19 crisis level of 9x, and par with levels reached during the last domestic investor driven rally in the second half of 2016.

Economists and investors have agreed that there is correlation between equities and bonds as one is high the other should be low.

While the party may be over for the equities market as the NSE all share index (ASI) has a negative year to date return of -0.21 percent as of Friday after it returned (+50 percent) in 2020 and 5.93 percent in the first month, the fixed income yields have been rising on the expectation of higher inflation and possible aggressive monetary policy.

The yield on 10-year Treasury bills stood 10.46 percent as of Friday, that compares to around between 7 and 9 percent last year.

Yields on fixed income instruments which were depressed last year (due to the central bank’s dovish monetary policy amid the pandemic) have been on an upward trajectory in 2021 amidst strong local demand for higher yields and the need to attract foreign interest in Nigerian securities amid a dollar shortage.

“In the near term, we expect equities to continue on the downtrend as yields tick higher,” said analysts at United Capital Research.

“However, the stock market may gain some respite in the form of strong corporate earnings from large caps and tier-one banks, and some support from ample market liquidity and buy interest from bargain and dividend yield-seeking investors,” said the analysts.

But full year earnings have not been stellar so far as companies that have released results capitulated to the difficult operating environment while the stringent policies by the central bank is squeezing banks who have seen interest income come under pressure.

Analysts top pick remain banks, Industrial, and telecommunication stocks that deliver consistent attractive dividend and strong earnings growth even amid a recession.

Analysts at United Capital expect liquidity to taper off in the second quarter (Q2-2021) as they anticipate N300 billion Open Market Maturity (OMO), in sharp contrast to N1.60 trillion in the first quarter of 2021.

Headline inflation for the month of December 2020 stood at 16.47 percent year on year (y/y), the highest in seventeen months.

A lack of clarity on the next line of action by the banking regulator has increased market uncertainty, said Samir Gadio, the London-based head of Africa strategy at Standard Chartered Bank.

The gradual economic recovery means the monetary policy committee could hike interest rates to tame inflation that is far above the target range of 6-9 percent.

Gross domestic product grew 0.11 percent in the three months through December from a year earlier, compared with a decline of 3.6 percent in the third quarter, the Abuja-based National Bureau of Statistics (NBS) said last week.

The government’s forecast for growth of 3 percent this year is double that of the IMF. The lender has warned a slow roll-out of Covid-19 vaccines could threaten the economy’s recovery.

“Although not at an alarming rate, we expect yields in the fixed income space to trend a little upward in the second half of the year if solely left to market forces as liquidity pressure on the financial system emanating from OMO maturities subsides,” analyst at CSL Stockbrokers Limited in a recent note to clients.

“In our view, we believe the factors that would determine the path of the market in 2021, have expanded beyond oil price, monetary policy and the external economy to include financial system liquidity, yields in the fixed income space, corporate performances and corporate actions,” said the analysts.

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