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Nigeria slipped into its worst economic recession in over three decades this year, but the stock market is on course for its best year since 2017.
Nigerian stocks are up 30 percent this year, according to data from the Nigerian Stock Exchange (NSE), making them one of the best set of performers globally and on course for their best return since 2017 when the market gained 42 percent.
Before now, the stock market had declined for two straight years in 2018 (-17.8 percent) and 2019 (-14 percent).
The remarkable turnaround is due to the low interest rate environment in Nigeria which has made yield-seeking investors to pile into the stock market.
The 30 percent return on Nigerian stocks is 10 times the return of South African stocks which are up 3 percent this year. The Ghanaian, Egyptian and Kenyan stock markets are all down, having declined by 19.4 percent, 21.2 percent and 11.8 percent, respectively, according to data compiled by BusinessDay.
Nigerian stocks seem to have not only defied the economic slump in Nigeria but also perhaps the global turmoil caused by the pandemic.
Read also: Foreign stock investors return to Nigeria with caution as inflows hit year-high
Why stocks are rallying and who’s buying them
The low yield interest rate environment is spurring appetite in stocks, particularly those offering high dividends.
With interest rates on alternative investments such as fixed income collapsing to record lows this year, investors seeking a higher yield have piled into the stock market.
Institutional investors are the biggest drivers of the buying activity.
Local pension funds managers are one of the biggest drivers of the buying activity. The PFAs have increased their investments in the equities market by 17 percent to N544.782 billion (USD1.43bn) in the first eight months of 2020. Most of that surge in appetite has come in the past one month on the back of the low interest rates on the hitherto favoured government securities.
Stocks that are driving the rally
On a year-to-date basis, the listed industrial companies are the best performers this year with a year-to-date return of 50 percent. They are followed by the insurance companies which have returned 26.6 percent year-to-date. The NSE 30 companies, a group of the largest listed companies, are next with a return of 23 percent. The banking index is up 8 percent while oil and gas stocks are down by 15.7 percent.
The Nigerian anomaly
The stock market is supposed to reflect the economic conditions of an economy.
If an economy is growing, then output will increase and most firms should experience increased profitability. This higher profit makes the company shares more attractive – because they can give bigger dividends to shareholders.
A long period of economic growth will tend to benefit shares.
By contrast, if the stock market predicts a recession, then share prices will generally fall – in anticipation of lower profits.
What is happening in Nigeria is the opposite.
Stocks are rising at a time when the macroeconomic picture is one of dark and gloom. Factors such as a second recession in five years, rising inflation and an acute dollar shortage should theoretically cause stocks to fall as the profitability of companies take a hit.
Indeed, company profits have taken a hit in Nigeria. About 50 percent of the biggest companies in Nigeria either made a loss or saw profitability decline considerably in the first half of 2020 amid the pandemic-induced economic slowdown.
Investors are brushing aside the many problems facing the Nigerian economy in the meantime due to the limited options available to park cash amid a low interest-rate environment.
This may be an indication of two things. One is that the rally may not be sustainable since the fundamentals don’t support a rally of this magnitude. Second is that Nigerian stocks may have been grossly under-priced in the past and now only going through some correction.
Nigerian stocks have a price-to-earnings ratio of 13.25x which means investors are only willing to pay N13 for each N1 earning made by the companies whose stocks are listed.
Nigeria’s PE ratio is lower than South Africa’s 27.3x ratio which means Nigerian stocks are priced cheaper. However, compared to Kenya (10.94x) and Egypt (11.48x), Nigerian stocks are now more expensive.
