Stocks as Hedge against Inflation

finance & economy - January 20, 2021

Goddy Egene writes that given the gains being recorded in the equities market, discerning investors could invest in stocks to hedge against the rising inflation rate the hit 15.8 per cent in December 2020

Last week the National Bureau Statistics (NBS) released the consumer price index report, which showed that the headline inflation rose to 15.8 per cent in December 2020. The inflation rate, which was an increase from the 14.9 per cent recorded in November, 2020, was said to be the highest level of headline inflation since December 2017, and the largest increase (98bps) since January 2012.

This rising inflation is a great concern for all stakeholders- consumers, manufacturers and investors among others. For instance, for investors to enjoy positive returns on their investments, that returns must be above the headline inflation of 15.8 per cent. And considering the prevailing economic conditions, it is difficult to come across such investments that will deliver returns above the inflation.

However, the equities can still be seen as a place where discerning investors could stake their funds and come out with positive returns, though with equally high risks of losses as well. As a market with high rate of volatility, the stock market carries a very risk and high level of returns on investments as well.

The stock market closed 2020 as world’s best-performing stock market by Bloomberg’s ranking with the Nigerian Stock Exchange (NSE) All-Share Index (ASI) returning 50.03 per cent.

Apart from the NSE ASI returning 50.03 per cent, which is well above the inflation, some individual stocks delivered returns above 100 per cent. A total of 48 stocks closed the last year higher with 11 of them growing their share prices by over 70 per cent. The top 10 best-performing stocks for the year were: Neimeth International Pharmaceuticals Plc with share price growing by 259.68 per cent; FTN Cocoa, 230 per cent. Japual Gold & Ventures Plc appreciated by 210 per cent, while share prices of Airtel Africa, Livestock Feeds Plc, BUA Cement Plc and United Capital recorded gains of 184.98 per cent, 178 per cent, 121 per cent and 96.25 per cent in that order.

Other to price gainers included: May & Baker Nigeria Plc (81.9 per cent); FCMB Group Plc (80 per cent) and Vitafoam Nigeria Plc (77.2 per cent). There were other counters that appreciated more than 50 per cent last year.

Also, two weeks into 2021, the stock market has maintained a positive performance with some stocks fetching gains as a high as 91 per cent, a comfortable returns for those wanting to beat inflation.

Year-to-date as at Monday, Japaul Gold & Ventures Plc has garnered 91 per cent. Mutual Benefits Assurance Plc has chalked up 64.2 per cent, while Regency Alliance Insurance Plc has gained 63.6 per cent.

Champion Breweries Plc, Coronation Insurance Plc, Livestock Feeds Plc and AXA Mansard Insurance Plc have appreciated by 58.8 per cent, 53.8 per cent and 46.6 per cent respectively.

Others that have appreciated significantly above the inflation include: Ardova Plc (45.3 per cent); Royal Exchange Plc (42.3 per cent); Niger Insurance Plc (40 per cent);Linkage Assurance Plc (38 per cent); Veritas Kapital Assurance Plc (35 per cent); Seplat Petroleum Development Company Plc (31.7 per cent); BOC Gases Plc (31.1 per cent) and Chams Plc (30.4 per cent).

No doubt the bullish performance being witnessed in the stock market is attractive enough for investors to use it as a hedge against the rising inflation.

A position supported by a stockbroker and Chief Executive Officer of Sofunix Investment and Communications Limited, Mr. Sola Oni, who said that an investor that has a long-term view can use stocks to hedge against inflation.

“Stocks tend to grow in value in the long term while holding a diversified portfolio such as 60/40(stock/bond) has potential to protect an investor from declining purchasing power. Value stocks, inflation-protected bonds, and real estate are silver bullets that attack inflation. A value stock refers to companies whose shares trade below intrinsic value otherwise called undervalued stocks.

“The security is identified by features such as high dividend yield and low price-to- book ratio (P/B ratio). The companies are noted for superior return. They are large and well-established. This is different from growth stocks which are shares of the companies that are expected to outperform the market over time because of their future potential.

“But growth stocks may refrain from paying dividends as it will reinvest retained earnings for expansion. An investor’s choice of growth or value stock depends on his investment objective, time horizon and risk tolerance,” he said.

Oni explained that under the current challenges in the global financial market, inflation-linked bonds and Exchange Traded Funds (ETFs), a basket of securities tradable on the exchange can play vital part in protecting portfolio’s value.

While investors consider using the stock market to hedge against inflation, there are concerns whether or not the market would be able to sustain the bullish performance over time.

According to some market analysts, all the factors that led to the impressive performance in 2020 are still present and would continue to keep the market in the bulls’ territory going forward. For instance, analysts at Investdata Consulting Limited, said the market would likely maintain the positive trend until end of 2020 full year earnings reporting season.

They based their optimism on the fact that for now, there is no other investment windows that has returns and yields that can match the dividend yields of some listed companies still selling below their fair value.

The Chief Research Officer of Investdata Consulting Limited, Mr. Ambrose Omordion, said the market is set to continue to rally owing to high cap stocks rallying on the strength of positive sentiment, which is of interest to many investors, considering the weak economic fundamentals.
According to him, the 2021 outlook is mixed in the sense that it looks positive but dicey, considering the second wave of Covid-19, despite the ongoing discovery of more vaccines and its distribution.

“Government should make policies to encourage more listing to deepen the market in order to play its role of driving the economic development by providing platform for long borrowing, regulators should protect investors and collaborate with research companies to provide proper investment and financial education to attract more participants to the market,” he said.

He explained that if the market is to create jobs for Nigerian youths by engaging in share trading with their little funds with the aid of technology and remote trading, government should reduce cost of trading or transaction to encourage and attract more investors.

Also, analysts at Cordros Securities said the mix of elevated liquidity, low interest rates, attractive dividend yields, and earnings recovery argues in favour of an extension of the equity bull market into 2021.

According to them, the performance in the fixed income market will be a tale of two halves, saying they expect yields to remain in the low single-digit territory through first half (H1) of 2021 with a moderate uptrend to account for reduced market participation as investors seek yields in other asset classes.

“However, in the later part of the year, we believe that a combination of weak market participation, revision of monetary policy to a tightening cycle, widening fiscal deficit, and fragile macroeconomic environment will lead to an increase in yields over 2021.

“Similar to the fixed income market, we also expect it to be a tale of two halves for Nigerian equities in 2021, with the market delivering further upside in the first half of 2021 before retracing slightly in the second half on an expected reversal in fixed income yields.

“The sources of risks remain plenty, the macro story remains uninspiring, and valuations are elevated,” they said.

Looking at some sectors of the market, the analysts said they are overweight on Nigerian banks as they expect a combination of strong dividend yield expectations, and resiliency of sector players into the FY-21 financial period to support price performances.

According to them, in Nigeria’s cement sector, volume growth in 2021e will be modest due to the lingering impact of the pandemic on government finances and household income.

“Although the stiff competitive landscape coupled with soft industry conditions will deter industry players from raising prices substantially, we still see scope for marginal increases in prices,” they said.

Cordros Securities noted that for consumer staples, it’s a mixed bag, while agriculture stocks are likely to benefit from improved volumes from new maturities.

“However, the border reopening is a significant risk to pricing and by extension top-line growth. Brewery stocks are expected to record better volume growth in 2021FY, mostly due to the low base from 2020FY. “However, the ability of brewers to increase prices above inflation remains constrained. Surging inflation and FX illiquidity will also put pressure on input costs and margins,” they said.

The analysts added that on Telecoms, there is a potential negative impact on Q1-21 revenues and earnings if the Nigerian Communications Commission (NCC) does not extend the NIN registration deadline and lines are disconnected.

In the opinion of the President of the Chartered Institute of Stockbrokers (CIS), Mr. Olatunde Amolegbe, the positive trend of 2020 to continue into the 2021, noting, however, investors should ensure that they speak to their certified stockbrokers before taking any decisions.

Omolegbe had said the most gratifying fact about 2020 performance was that it was actually backed by fundamental performances of our quoted companies.

“The performance also underpins the need for improvement in liquidity flow to the market through various sources that we at the CIS have been advocating in the last few years,” he said.

According to him, the reduction in interest rate and fixed income yield has been a net positive for quoted companies that are now able to borrow cheaper to finance their operations as well as for market operators that can see renewed interest in the financial markets.

“The NSE’s performance is also an affirmation of our market’s increasing correlation with other global market markets,” he said.

Commenting, Oni said demand for equities has strongly enhanced market upswing as yields on other asset classes, especially fixed income securities are low.

“The Central Bank of Nigeria’s policies that encourage credit to the real sector in an environment of low interest rate are expected to be sustained. We expect the federal government to utilize the market to finance N5 trillion budget deficit for 2021 through the market. States governments can also take advantage of the capital market to mobilise funds for development projects. This will have multiplier effects on transaction on the exchange,” he said.

He noted that if the introduction of vaccine to combat COVID-19 is pursued vigorously, it will enhance operations of quoted companies, boost return on investment (ROI) and attract more investors into the market.

“However, it is hoped that security issues would be addressed to reduce country risk while another wave of COVID-19 pandemic shall not scuttle all projections,” he said.

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