ASIGMA Capital Market Report: Q2 2019

Equities

Among advanced markets, trade tensions resurfaced following a truce, and major central banks grew more accommodative. Following the record returns by US equities in Q1 2019, the S&P 500 proceeded to deliver its worst May return in seven years falling 6.6% as trade tensions resurfaced and investors balanced the Fed’s accommodative tone with the broader negative outlook for economic growth.

Among emerging and frontier markets, growth was constrained by rising trade barriers, slowdowns in major economies and subdued investments.

Emerging market returns in Q1 2019 were largely driven by the stabilization of the USD and signs of progress in US-China trade negotiations. However, US tariff actions early in Q2 2019 fueled the market uncertainty that triggered the ensuing EM stock selloffs.

Frontier markets such as Kenya have been subdued in Q2 2019 following a resurgence in Q1. The downturn is attributed to an investor risk-off regime in response to renewed trade disputes and rising inflationary pressure on account of global oil price turbulence.

Investors sought safe assets to avert the rising risk profile of emerging and frontier equities following the latest influx of trade war tension. This bolstered the demand for US Treasury securities and intensified the volatility in Treasury markets.

In Uganda, 2018 listed companies’ earnings announced in H1 2019 have revealed robust health. Most local companies reported higher earnings and dividends in comparison to 2017. Most notably, UMEME registered a dividend yield of 9.4%, recovering from a regulator-induced impairment to its earnings the previous year.

REGIONAL EQUITY PERFORMANCE

South Africa
The Johannesburg Stock Exchange (JSE) All Share Index rose by 7.1% in Q1 2019, erasing most of the losses incurred in 2018. Mining companies delivered the bulk of the returns due to a rocketing Palladium price. However, mining returns were subdued in Q2 2019 by wide variations in the price of Palladium due to muted demand from Germany, China and the US.

Palladium is a platinum-group metal used by car makers to manufacture catalytic converters which are fitted behind exhausts and convert damaging pollutants into less harmful gasses. As stricter auto emission limits are enforced the world over and diesel cars are phased out, Palladium is becoming more in-demand than ever. The largest reserves of platinum-group metals can be found in the Bushveld Complex in South Africa.
Nigeria
Nigeria has barely recovered from the severe slump in returns that characterized 2018. Nigeria’s Purchasing Manager’s Index (PMI), a measure of the economic health of the manufacturing sector and a trend indicator for the stock market, has improved modestly in Q2 2019 from a downward trajectory in Q1. The sector expansion was supported in part by a rate cut by the Central Bank that preceded Q2 2019, the first cut since November 2015.

UGANDA EQUITY PERFORMANCE

Banking Sector Analysis
Following a slump in 2016, the banking sector has enjoyed a 2-year rally supported by prudent monetary policy, high-yielding treasury securities and a rejuvenated private sector. Private sector credit has grown by 24% between Q1 2016 and Q1 2019 while the Non-performing Loans to Total Gross Loans ratio has traversed downward from 7% to 4% over the same period.
The above growth in assets and asset quality is reflective in the robust fundamentals of sector constituents. The three listed local banks – SBU, DFCU and BOBU – all registered gains in net interest income in 2018 as compared to 2017.

Stanbic Bank (SBU) has maintained a Return on Equity (ROE) in excess of sector norms indicative of its earnings efficiency. DFCU’s stark fall in ROE is largely attributed to the adjustment of the bank’s equity following the acquisition of Crane Bank assets.
Dividend Performance
UMEME registered the highest dividend yield, 9.4%, recovering from a regulator-induced impairment to its earnings the previous year.

A modest rise in the Local Company Dividend Index has been realized in 2019 following positive earnings announcements by large contributors to the Index, UMEME, SBU and BATU.

The Local Company Index (LCI), which in recent years have moved in tandem with the Dividend Index, is estimated to average within the 373-420 range in 2019. In the first 6 months of 2019, the LCI has averaged at 377.

2019 USE Price Gainers and Losers
The EABL stock has been the major driver behind the performance of the Uganda All Share Index (ALSIUG) in 2019. Following positive earnings announcements by EABL, the stock’s price and the ALSIUG rose sharply until the brewer’s ex-dividend date, February 19th.
Supported by strong fundamentals and increased production capacity, EABL rallied in early Q2 despite considerable inflationary pressure and weather concerns. The outlook for EABL has recently been marred by a 15% increase in the excise duty on wines and spirits announced by the Kenya National Treasury in the 2019/20 Budget.

Fixed Income

In Q2 2019, market concerns of a recession in the near future were intensified following the resurgence of trade tensions. These concerns are illustrated by the Q2 spikes in the CBOE Volatility Index (VIX), a measure of risk and investor sentiment in US equity markets. Consequently, yields on all US fixed income securities fell throughout Q2 2019 as demand for these safer assets rose. The yield on the 10-year US Treasury Bond fell lower than that on the 3-month US Treasury Note, resulting in an inversion of the US yield curve and a negative yield spread between the two securities.

REGIONAL FIXED INCOME PERFORMANCE

In Q2 2019, African Eurobonds prices rose farther following a strong showing in Q1 supported by declining yields in advanced markets and strong economic output from the region. Q2 2019 ended with strong demand for these higher yielding fixed income securities despite muted demand early on in Q2 due to rising trade barriers in advanced and emerging markets.

UGANDA FIXED INCOME PERFORMANCE

The Bank of Uganda (BoU) has maintained a stable 10% policy rate in 2019 reflective of subdued inflationary pressure. In line with the easing stance regarding monetary policy, money market rates have remained relatively stable during the year and throughout Q2 2019.

While short-term yields on Treasury securities declined marginally during Q1, Q2 saw yields stabilize at 11.28% driven by Government Treasury issue amounts. Government borrowing in July exceeded UGX 380 Billion thus marginally increasing Treasury yields to early Q2 levels as anticipated by the BoU in March.

Currencies

GLOBAL CURRENCIES

 US Dollar 
The USD has posted positive returns against a basket of global currencies in 2019 albeit subdued by the Fed’s dovish stance, concerns of a recession and trade tensions. USD performance has been supported by Q1 2019 US GDP data. Despite recessionary fears, the U.S. economy grew at a healthy 3.1% rate in Q1 recording the strongest start to a year in over 2 years, therefore supporting much of the appreciation early in Q2 2019.

However, as trade tensions resurfaced following a Q1 truce and US Treasury yields continued to fall, investor angst boosted demand for safe haven currencies such as the Japanese Yen (JPY) and the Swiss Franc (CHF).

REGIONAL CURRENCY PERFORMANCE

Currencies in Africa have remained relatively stable against the USD supported by the Fed lowering its projection for US economic growth and its dovish stance to policy rates in 2019.

The Nigerian Naira (NGN) has converged at 360 to the USD in part due to an oil price resurgence in Q1 2019 supported by production cuts implemented by the Organization of Petroleum Exporting Countries (OPEC). Surplus money market liquidity placed downward pressure on the Kenya Shilling (KES) against the USD in Q2 2019. The knock-on effects of surplus liquidity are evident in the spread between Kenyan inter-bank rates and the Central Bank policy rate.The Zambian Kwacha has recorded significant depreciation against the USD in Q2 2019 as concerns surrounding the country’s debt levels intensified. Zambia’s foreign debt has more than doubled since 2014. The yields on its USD 750 Million Eurobonds maturing in 2022 have risen to 19.7%. No other nation apart from Venezuela, which is in default, has yields as high.

UGX PERFORMANCE AGAINST KENYA SHILLING

The short to medium trend of the KESUGX currency pair is to a significant extent driven by the performance of the individual currencies against the USD. Kenya’s foreign exchange reserves are on average 4 times the size of Uganda’s and therefore are a greater buffer against a USD surge. Therefore on this time horizon, the performance of the UGX against the KES is closely tied to the performance of the UGX against the USD.

For the 5 months between October 2018 and February 2019, the UGX appreciated 4% against the USD, enabling the Bank of Uganda’s forex reserve build-up of over USD 300 Million via the Interbank Foreign Exchange Market.

The UGX proceeded to depreciate in March and for much of Q2 2019 as a risk-off regime flooded the market and USD demand from offshore investors surged on account of international trade volatility. Furthermore, USD demand during Q2 2019 increased with the growth in net foreign assets held by local commercial banks in anticipation of dividend repatriations by offshore investors.