ASI: The markets mixed signals

Have investors gone loony? Nigeria’s All Shares Index (ASI), an index of the strength of the stock market, has swung from the depth of a valley (25,233.39, November 30, 2016) to the peak of a mountain (34,375.60, June 20, 2017) and is just about flipping back to where it came a few weeks earlier (ended the week at 32,122.14).

So is this the right time to bail out of the stock market and dump capital gains for treasuries? Perhaps not. Not everyone thinks that the ASI has gone berserk. Segun Olaniyi, chief executive officer, Andersen Consulting, believes that the previous surge in the Index reflects a fundamental adjustment of investor’s perspective of the economy and is justified by renewed optimism. ‘Foreign portfolio investors are slowly coming back to the local capital market, especially the equities end of the business, and this has introduced fresh funds’, he says. According to Olaniyi, ‘the economy is no doubt still sluggish with a first quarter growth of minus 0.52 per cent but the overall expected annual growth rate could still easily climb above one per cent’ he insists.

Olaniyi’s happy outlook is being challenged by developments in the international oil market.   Oil prices which hovered over $50 per barrel for the better part of the first half of the year have started tumbling as excess crude oil supply in global markets start to pull at the feet of cartel members of the Organization of Petroleum Exporting Countries (OPEC).  Lower oil prices have especially sinister implications for countries like Nigeria who have high break even budget points.  The country’s 2017 budget assumes an average oil price of $44.50. This price has already been breached as the week closed at a price of $42.86 or 4 per cent below the fiscal 2017 benchmark. Oil market analysts speculate that prices could drop to below $35 per barrel with dire consequences for Nigeria’s 2017 budget projections.

The first problem would be the government’s fiscal deficit. If oil prices stay below $40 per barrel for an extended period of time the budget deficit will be by far larger than the N2.4 trillion expected, indeed the deficit could come close to N3.9trillion or 63 per cent above earlier estimates. This could send inflation spiraling and interest rates blazing as the central Bank of Nigeria (CBN) rallies to help the fiscal books by raising treasury bills at higher coupon (interest) rates. Higher interest rates will in turn move money out of the stock market and into government treasuries resulting in a cascade of equity prices (a trend already beginning to emerge).

‘We seem to be heading for another rough season of high rates, low equity prices and rising inflation’ says Peter Folorunsho , chief executive officer, Freewill Investments, ‘if the last period of falling fiscal revenues was bad enough this new round of shrinking federal incomes could prove devastating’, he argues.

He may be right. Tumbling revenues in the second half of the year could spook the federal authorities into clamping down harder on tax evasion and tax avoidance while also raising marginal local tax rates.  Doing this at a time of recession would put downward pressure on nominal disposable income and worsen the ongoing recession.  ‘The way things are with the economy and the current state of the international oil market we are set to face a thunderstorm. Unfortunately I can’t see the umbrellas and rain jackets, conventional fiscal and monetary tools may be pretty useless in the short term’, says Suraj Aknyemi, an economist and managing director of local feed milling company Surak 79. According to Akinyemi, ‘the short term prognosis is quite dreary; the economy lacks the fiscal buffers needed to absorb the impending shocks’.

Perhaps reflecting the changing mood of investors mid week and chasing up on the challenges faced by thirteen local banks that lent $1.2 billion to Nigeria’s distressed fourth largest telecoms company, Etisalat,  without any hope of getting their money back any time soon. In the shadows of the unfolding drama and the subterranean intervention of the CBN and the National Communications Commission (NCC) the ASI tanked by 6 per cent within the week ended Friday 23rd 2017 but still retained a year-to-date yield of 19.53 per cent.

Will the market drop further? Most likely. Global oil market somersaults will see the naira cave over the next few weeks despite spirited intervention by the CBN. The central banks capacity to smooth market hiccups will be muted by lower foreign reserve stock and a slower growth of those reserves; this would punch a hole in several corporate balance sheets, if there ever was a time to go on knees and pray, it is now, even the madness of optimism has its limits.

Sources: Bloomberg, macrotrends.net