Walking On Thin Ice: Concerns Over a Possible Disruption in Economic Recovery

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The United States economy continued to record an improvement after a steep economic decline in Q2 2020. According to data from IHS Markit, the United States Purchasing Manager’s Index (PMI) stood at 53.2 points in September 2020, slightly below 53.5 points in August 2020.

The 53.2 index points recorded in September 2020 implied that the economy expanded during the period, resulting from strengthening demand conditions. The data also revealed a marked improvement in the demand for plant and machinery, suggesting that firms are increasing their investment spending. Notably, the good-producing sector recorded the steepest rise since January 2019. Consequent to the increase in new orders and demand levels, firms expanded their workforce numbers again.

In the financial markets, the United States stock market (measured by the S&P 500) declined in September 2020 after a five-consecutive month of increase since April 2020 during the peak of the coronavirus pandemic. Concerns over another wave of infections possibly heightened fears in the investing environment. Notably, in the United Kingdom, the government considered another national lockdown to stop an increase in infections. There were also concerns in the United States political environment, as the United States Presidential election approaches.

The uncertainty created by COVID-19 further weakened in the sentiment global crude oil markets, resulting from a rise in the number of cases in some countries such as India, Japan, Korea, France, and the UK. Some countries have introduced restrictions on gatherings and other measures, which might extend for a considerable period to fight the pandemic. The implication of these measures is reflected in the weak recovery in energy demand, thus resulting in lower crude oil prices. The outlook of the global crude oil market remains weak, owing to the uncertainties related to the coronavirus pandemic.

Domestic Economy

According to the Purchasing Manager’s Index data for September 2020 released by the Central Bank of Nigeria (CBN), the Manufacturing and non-Manufacturing PMIs stood at 46.9 and 41.9 index points, respectively. The PMI data revealed that, although still in contraction, the gradual improvement recorded in economic activities in the previous two months halted. In our view, the weakened economic activities, measured by the Manufacturing and non-Manufacturing PMIs, suggests a weakened consumer spending as new orders weakened in September. We posit that the impact of the exchange rate devaluation weighed on consumption.

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Walking On Thin Ice, Concerns Over a Possible Disruption in Economic Recovery
Source: CBN, WSTC Research

Equities Market

Walking On Thin Ice, Concerns Over a Possible Disruption in Economic Recovery
Source: CBN, WSTC Research

The equities market sustained its rally in September 2020, as the NSE All-Share Index posted a 6% return, from 25,327.13 index points as at month open to 26,831.76 index points as at month close. The sustained rally in the equities market is attributed to renewed interests of investors in risk-assets, following the liquidity squeeze and low yields in the fixed income markets.

Walking On Thin Ice, Concerns Over a Possible Disruption in Economic Recovery
Source: NSE, WSTC Research

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Walking On Thin Ice, Concerns Over a Possible Disruption in Economic Recovery
Source: NSE, WSTC Research

Fixed Income Market

Walking On Thin Ice, Concerns Over a Possible Disruption in Economic Recovery
Source: FMDQ

The downward trajectory of yields in the fixed income market sustained in September 2020, as the Central Bank of Nigeria (CBN) maintained its pro-growth focus. During the last monetary policy committee (MPC) held on September 21 – 22, 2020; the MPC lowered the monetary policy rate by 100 basis points to 11.50%. According to the MPC, the decision to lower the MPR was driven by the need to keep the economy afloat against a potential economic recession in Q3 2020.

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Although the inflation rate rose to 13.22% in August 2020, the MPC argued that a lower rate would spur output growth, thus subsequently resulting in increased supply, thereby leading to lower prices.

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In the past few years, the MPR has had a weak a transmission mechanism in the economy; however, the body language of the CBN emphasises on the policy focus and drive of the monetary policy authorities. Consequently, the low yields in the fixed income are expected to remain in the near to medium term. Notably, the yields across all tenors currently sit below the inflation rate.

Foreign Exchange Market

The exchange rate was relatively stable in the foreign exchange market. The exchange rate in the I&E window stood at N386 in September 2020 (August 2020: N386). According to data from FMDQ, the total dollar inflow in September 2020 increased to $936mn from $429mn in August 2020. Although the total dollar inflows in the I&E market of $936mn in September 2020 was significantly below $2.58bn inflows in September 2019, we note the significant month-on-month rise.

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I&E FX Inflows

Walking On Thin Ice, Concerns Over a Possible Disruption in Economic Recovery
Source: FMDQ

Outlook

We expect to see a modest improvement in economic activities. Although the PMI report for September 2020 revealed an economic weakness, we believe that it was a result of a full impact of the exchange rate devaluation on consumers’ spending. In the near to medium term, we expect to see further pressure on consumption activities. In our view, the growth prospects of the economy, despite efforts by the fiscal and monetary policy authorities, are weak. Nonetheless, we expect to see an improvement in Q4 2020.

Our outlook on inflation is bleak, as we expect to see a material increase in general price levels in the economy. Some of the basis of our postulation include rising food prices, the pass-through effect of fuel prices after the deregulation of the downstream sector, potential impact of electricity tariffs (although the decision has been suspended for now), and seasonality-induced spending by households as we enter Q4 2020.

In the financial markets, we expect to see a sustained equities market rally, given the reallocation of funds by investors from the fixed income markets to the equities market. While we note that the fundamentals of the economy are relatively weak, we believe that investment opportunities available in high-dividend yield stocks, and other blue-chip stocks that are materially underpriced would drive the equities market in the near to medium term.

In our view, we posit that the domestic institutional investors might be faced with no choice but to allocate some funds in stocks. According to data from PenCom, the weight of equities as an asset class invested in by the pension fund administrators (PFAs) currently
stands at 4% – 5%, below the historical average of 7%. Given the low yields in the fixed income markets and exposure to reinvestment risk, we expect to see a renewed interest in the equities market in subsequent months.

BRAND SPUR

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