Where should you invest during a period of hyper inflation?
Markets have become uncertain and volatile due to food chain supply and energy crises occasioned by geopolitical Russia’s invasion of Ukraine almost 10 weeks ago and resurgent coronavirus in China. Wheat and oil are both 50 per cent more expensive than they were a year ago. For importing countries, fiscal costs of food and energy subsidies have increased; draining hard-currency growth.
According to a CNN Business report of April 29, 2022, US personal consumption expenditure index increased by 6.6% for the year ended in March, energy costs increased by 33.9 per cent, while food prices by 9.2 per cent over the same period.
In Nigeria, consumer inflation rate fell in January to 15.60% from 15.63% recorded in December 2021, but increased to 15.92 per cent in March from 15.70 per cent in February, while food inflation rose to 17.20 per cent from 17.11 per cent, according to the National Bureau of Statistics (NBS). This situation has led to the review of growth expectations in 2022.
The IMF in its April 2022 World Economic Outlook did a downward revision of its growth projection for 2022. The world body changed its earlier Global forecast growth expectation from 4.40% to 3.6%. But Nigeria’s growth expectation saw an upward revision from 2.7% to 3.4%, citing the improved crude oil price as a factor that would enable such an outcome.
As a result, over the last week, interest rates were the main focus of many markets as several central banks announced hikes to their benchmark interest rates. Every central bank attributed the rise to tackling the significant inflation affecting their economies and normalising their respective monetary policies. The US Federal Reserve on Wednesday, May 4, 2022, expectedly raised rates by 50 bps, pushing the Federal funds rate to a range of 0.75% to 1%, and the current market pricing rate rising to 2.75%-3% by year’s end according to CME Group data. The Fed also announced that it will begin reducing asset holdings on its $9 trillion balance sheet, just to control inflation. This is normal.
Countries adopt suitable measures to curb or control macroeconomic challenges, just like in 2020, when the COVID-19 pandemic affected the global economy, most economies adopted expansionary monetary policy; cutting interest rate. Reportedly, the bank of Korea reduced their key rate to a record low of 0.50%. Kenya’s Apex bank had to cut benchmark lending rate three times; 8.25% in January, 7.5% in March and 7.0% in April 2020: Their cash reserve ratio for commercial banks was lowered to 4.25% from 5.25%. The Fed Reserve slashed its benchmark interest rate to near zero, bought nearly $3trn in assets and launched a bevvy of lending programs. Central banks of the euro area and Japan pushed their short-term interest rates into negative territory.
The primary goal of this was to stimulate economic activities and increase aggregate demand.
What is the relationship between benchmark interest rates and inflation?
Interest rates and inflation tend to move in the same direction because the benchmark interest rate is one of the monetary policies used by apex banks to control money supply, inflation and maintain price stability. Any change in the quantity of money produces exactly proportionate change in the price level.
By reducing interest rates, businesses can borrow and have funds at a cheaper rate, thus reducing their cost of funds, which will in turn reduce finance costs and increase profitability.
In contrast, by increasing benchmark interest rates, the level of risk-free reserves in the financial system is increased, limiting the money supply available for purchases of riskier assets. Borrowing cost is increased, limiting consumer and business consumption and spending.
In regards to investment markets, higher interest rates typically decrease the value of expected future cash flows, as the Naira today is worth more than a Naira tomorrow (because they are worth less when discounted back to today at a higher rate), especially those businesses that only expect to earn cash flows in the distant future and not today.
Furthermore, investors often move their money from higher-risk stocks to safer investments like government bonds and treasury bills because these investments now offer a higher yield which is likely to be closer to what they would have expected to receive from investing in stocks.
What are the effects?
Interest rates are closely watched by economists, analysts, investors, etc. because it is very important as it affects them differently.
High finance cost is associated with interest rates hike; limiting profit, future cash flow and eventually lowering returns to shareholders, which may lower stock prices. And an aggregate drop in stock prices definitely would affect the whole market or key indexes. On the flip side, a hike in benchmark rate encourages capital inflow. As capital flows to the country to take advantage of higher rates, the international demand for the domestic currency would rise causing the domestic currency to appreciate. For the Nigerian economy, the US Fed’s interest hike could lead to increased capital outflow, and increased cost of foreign borrowing, which may lead further to the depreciation of the Naira. On the equity market, it will reduce foreign portfolio inflows, which have been on the decline since 2021.
Where to invest:
Despite the CBN’s retention of the benchmark interest rate at 11.5 per cent, analysts believe the apex bank may be forced to tighten its monetary policy before the end of the year to curtail possible effects of the US Fed rate hike and 2023 election spending on capital outflow and high liquidity respectively.
In an uncertain and volatile environment enthused by the cold war, investors need to craft and readjust their portfolios to either take advantage or hedge against investment downside risk. Therefore, investors can consider taking a position or realigning their investment:
Stocks
Investing in stock is good. The Nigeria equity market has been doing well this year. The market recorded a positive performance in the month of April 2022, growing at 5.69% MoM. This left the Index at a year-to-date gain of 16.21% sponsored by positive earnings surprise coupled with dividend reinvestment. However, analysts are of the opinion that the market rally would slow down in May 2022, with Q1 2022 earnings season out of the way and no further catalyst.
In this turbulent time, if you are considering investing in stock, pick stocks whose underlying business has the staying power. Investors should look beyond earnings and earnings projections. Stocks whose underlying businesses produce higher cash flow or free cash flow and high cash flow yield are safer. With strong cash flow, the company would be able to sustain its ongoing operations.
Also when investing in stock, pick cyclical stocks. In 2021, cyclicality played out first-hand in many areas of the market and is being sustained in 2022. Cyclical stocks such as consumer goods, industrial goods, financial services, manufacturing, real estate, construction and ICT technology are good. In fact, financial service/banking stocks are very cyclical. Banks and financial service firms have seen an improvement in interest income and operating profit margins when rates are high. Even when rates are low, banks remain profitable because of fees, commissions and service charges they collect from their customers. Investors can look for banks with good earnings, good earnings potentials and most importantly with positive free cash flow records.
Still, on stock market options, investors can invest in defensive stocks as they provide consistent dividends and stable earnings regardless of the state of the overall stock market. In periods of high volatility or during a weakening economy, investors seeking to protect their portfolios may increase their exposure to defensive stocks. High dividend yield stocks present drawdown opportunities that can be taken advantage of, especially in difficult times. Investors should look out for stocks with notable dividend and/or high dividend yields that are at least above the top 25% of dividend payers in the NG Market’s average yield of 7.5%. As an example, Zenith Bank’s dividend yield of 12.68% is in the top 25% of dividend payers in the NG market. Other top notable dividend payers are Dangote Cement, GTCO, Nestle, Total Energy, MTNN, Conoil, UBA, Okomu Oil, etc.
Fixed Income
Investors can consider turning to short-term or floating rate bonds. Generally, longer-term securities are more susceptible to interest rate changes because of greater duration and greater probability of experiencing rate fluctuations than short-term bonds. Bond investors can decrease this volatility by moving into bonds with short-term maturity dates or purchasing bonds with floating coupon rates in tandem with the market rate.
Invest in Real Estate
Real estate in Nigeria like in many parts of the world is an ever-increasing in-value investment, which tends to rise and even outpace interest rates and helps keep pace with inflation. As inflation rises, so does property value. Investors can buy real estate or invest in real estate investment trusts (REITs). REITs are trusts that use the pooled capital of many investors to purchase and manage income property and/or mortgage loans. They are traded on NGX just like stocks.
Source- Nairametrics
