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It could be a case of ‘what goes up will eventually come down’, for Nigeria’s red-hot stock market as risk of higher bond yields combined with stretched valuations and potentially disappointing fourth quarter (Q4), earnings is set to bring equities back down to earth.
Nigerian stocks have emerged as one of the best performers globally in 2024, with the broad market up 31.89 percent year-to-date.
Individual stocks have performed even better with bellwether Dangote Cement up 103% year-to-date, BUA Cement +68.4%, Eterna Oil +100%, Transcorp +89.2% and Wema Bank +74.46%.
However, the rally could soon be severely tested with Nigeria’s central bank expected to raise interest rates by as much as 500 basis points next month. The Central Bank of Nigeria announced a monetary policy committee (MPC) meeting for Feb. 26-27, the first for Governor Olayemi Cardoso since taking the helm in September, 2023.
“Equities have been supported because they offer an inflation hedge to investors and one year yields dropped to around 6%,” Charlie Robertson, Head of Macro Strategy at FIM Partners UK Ltd, told MoneyCentral in an email response to questions.
“Higher interest rates then should make bonds more attractive, and should help push down inflation, so two supports for equities then suffer.”
Since taking office, Cardoso has hinted at a return to orthodox policies, a departure from his predecessor Godwin Emefiele, whose unorthodox approach to policy unnerved investors and led to a rapid slowdown in capital inflows into Nigeria.
The Central Bank of Nigeria (CBN) has adopted an explicit inflation targeting regime, and is committed to achieving monetary and price stability, Cardoso said, in September 2023, at his first policy speech since becoming governor.
“Dislocation of our monetary transmission mechanisms is rendering the MPC policies redundant. We need to ensure these meetings are effective. Regular open market operations (OMO) to mop up liquidity has also ensued,” Cardoso said.
The CBN last week offered short-term 365-day paper in auctions of its so-called OMOs — which refers to open market operations— which it issues to banks and offshore investors, at 17.5%.
While at the top end of the range for short term yields, it’s still lower than consumer prices in Africa’s most populous nation, which climbed an annual 28.9% in December.
It was the fastest pace in almost three decades, fueled by the abolition of fuel subsidies and a rapidly weakening currency that has lost around 50% of its value against the dollar since June.
“Tighter monetary policy should help stabilise the cheap naira, and the market becomes more interesting to me if we see that,” Robertson of FIM Partners UK Ltd, said.
Higher bond yields are often negative for equities for a number of reasons. As bond yields go up the opportunity cost or risk premium of investing in equities goes up and therefore equities become less attractive.
The yield on bonds is also normally used as the risk-free rate when calculating cost of capital. So when bond yields go up then the cost of capital goes up. That means that future cash flows get discounted at a higher rate, which compresses the valuations of stocks.
For foreign investors, when yields go up, they may find Nigerian debt more attractive in relation to developed market debt (the so called carry trade). This may lead to capital outflows from equities and inflows into debt.
The MPC last met in July, when it raised the benchmark rate to a record high of 18.75% to rein in surging inflation — then at 23%, more than double the top end of the central bank’s 6% to 9% target range.
Nigeria’s President Bola Tinubu has been eager to claim credit for the stock rally with special adviser Bayo Onanuga writing on X, that:
“In eight months of Tinubu administration, Nigeria’s stock market leads the world. The upswing in the market began 30 May 2023, the second day Tinubu was sworn into office.”
The recent rally in Nigerian stocks is both speculative and fundamental, according to Abiola Rasaq, economist and former head investor relations at United Bank for Africa (UBA) Plc.
“I think the market would soon cool-off, with or without a raise in interest rate. Some locals are pricing expectation of rising foreign portfolio investments (FPIs) and implicit impact of Naira depreciation on the stock market. However, as some companies begin to prepare for primary market offerings, the market would gradually cool-off, especially as 2024 Q1 results may not support some of the valuations,” Rasaq said.
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