Bearish sentiment was the overarching theme in the Kenya equities markets, due to the effects of the Covid-19 pandemic that has made the possibility of a global recession closer to reality. On a year-to-date (YTD) basis, the NSE-20 and NASI have posted negative returns of 24.1% and 15.6%, respectively. Notable out-performers YTD are Barclays ETF Gold (+23.7% YTD), a security whose value is pegged on the value of gold (a safe haven asset), Kenya Airways (+53.7% YTD) on a recent price rally, and Uchumi Supermarkets (+6.9% YTD). All other stocks at the NSE are in the red zone YTD, save for WPP ScanGroup that is at break even.
The bearish market, the ensuing global economic recession coupled with uncertainty around resolution of the Covid-19 pandemic, has shifted investors’ risk appetite to safer assets with the price of the Barclays NewGold ETF rising by about 23.7% this year, following accumulation of the safe haven asset in the global markets, recently trading close to its 5-year high (USD 1,720/ounce). Additionally, and despite the pandemic, geopolitical risks are worsening especially trade tensions between the world’s two largest economies which could protract global economic recovery. With these issues on the table, there is a possibility of persistence of investor flows towards the yellow metal and away from riskier financial assets, mostly equities, especially in emerging and frontier markets.
The banking sector released its Q1 results with performance mostly subdued on increased loan loss provisions under the effects of the pandemic. Banking stocks have priced in this reality with possibility of a tougher Q2 given that the pandemic struck the Kenyan economy in the last two weeks of the first quarter. This dampens prospects of a large upswing in the stock market despite the most investable stocks trading at attractive multiples.
Foreign investors continue their dominance of trading activity at the NSE, exiting the local bourse to the tune of KES9.2Bn YTD. Key counters by foreigners have been Safaricom, EABL, KCB, Equity and BAT Kenya. The pulling of funds from the NSE and other frontier markets points to growing concerns by foreign investors about the impact of the pandemic and the ensuing global recession in frontier and emerging markets, which could be the hardest hit by the effects of the pandemic and the trade wars between the world’s two largest economies.
The cautiousness towards the equities market has also been observed on the local institutional investors who have preferred the fixed income government securities.
Fixed Income assets pricing in increased premium
Notably, yields on the discounted securities edged up in the month of May by 0.11%, 0.11% and 0.09% on the 91-day, 182-day and 364-day tenures, respectively. This mark-up in premium has been on account of investors pricing in fiscal concerns partly attributed to the COVID-19 pandemic. There were key legislative developments on the fiscal front.
First, we had the Supplementary Budget II which was passed by National Assembly at the end of April. This Supplementary slashed budget spending in the current financial year (ending June 30th) by KES48.4Bn. Although the Supplementary budget had been pre-empted prior to the pandemic, the COVID-19 shock exacerbated the legislative amendment on the spending. There were additional expenditures, (although on a muted scale), to address the pandemic such as recruitment of additional health workers (KES1Bn) and cash transfers to the most vulnerable (KES9.94Bn).
Secondly, there was the passage of the Tax Laws (Amendment) Bill 2020 which was to partly address revenue slippage coupled with tax relief measures announced by President Uhuru. If there has been a collision of worlds, this is it! On one hand, National Treasury was on the crux of removing tax exemptions in order to spur revenue collection. To be exact, total revenue collection in the first nine months of the financial year (ideally as at March 2020) was behind the target by KES204.8Bn with ordinary revenue collection trailing by KES132.3Bn. On the other hand, COVID-19 pandemic struck and there was genuine need to pad taxpayers from weightier tax burden which birthed the tax relief.
Thus, the Tax Laws (Amendment) Act has been a mismatch of sorts; a balance of two extremes. The net effect has been a recalibration of revenues from KES1.843Tn to KES1.643Tn in the fiscal year to more realistic levels. Nevertheless, there was a reduction in revenues to the tune of KES200Bn against a slower reduction in spending (KES48.4Bn); this essentially translated into increased borrowing (both domestically and externally). This has been the case and more so, net domestic borrowing has edged up from KES300.7Bn to KES337.8Bn. Furthermore, there is an additional KES152.1Bn ‘domestic financing other than borrowing’.
We are of the view that in light of the above recent fiscal developments, investors have had to bid yields higher. This has been exacerbated by concerns on how to deal with debt sustainability. The first was the proposed moratorium on interest payments on pension funds and insurance companies. That said, this is yet to be effected although Moody’s flagged it as a material risk on private sector bondholders. Second has been the restructuring of the 364-day T-Bill issue that was to mature early June into a 6-year infrastructure bond paper. We view that this strategy is but a testing of the waters if the 2020 Medium-Term Debt Management Strategy (MTDS) is anything to go by.
The 2020 MTDS had proposed reduction in T-Bill issuance. Furthermore, we note that the budget books for the next fiscal year suggesting that net domestic borrowing will be funded fully from T-Bonds (as opposed to the current norm where domestic financing is a 70:30 split between T-Bonds and T-Bills). Bottom line, we expect some volatility in the near-term in the fixed income class. In particular, with a dearth in supply of the fixed rate bonds, we still expect trading in infrastructure bond papers to remain dominant.