Russia vs. Ukraine faceoff: Coronation analysts see effects on oil prices, FGN Eurobonds

The invasion of Ukraine by Russia began on February 23, 2022, after months of military build-up and diplomatic activity which had failed. Nevertheless, with the novel coronavirus pandemic effect still in play, equities analysts think the escalation of the current geopolitical tension between Russia and Ukraine could erode parts of the gains from the global economic recovery in 2021 in the near term.

However, some sources much familiar with the event have said that the sanctions announced by several European Union (EU) economies and the US on Russia, the world’s third-largest producer of crude oil with about 10 percent share, could lead to sustained gains in oil prices.

Despite the above trending issue, which has, to a larger sense, disrupted the thoughts around the covid-19 pandemic, several thoughts and questions have arisen from various quarters to analysts on the attendant systemic and economic risks, the implications of this impasse on Nigeria’s economy and the financial markets, as well as the possible investment approach for investors in a bid to avoid the downside as much as possible.

Analysts have pointed to the importance of understanding that the impact of the war in Ukraine is coming amid bad economic conditions in developed markets and that these conditions were already feeding through into equity and bond prices. Inflation in the US has been rising, forcing US government bond yields up and equity prices down.

Before the outbreak of the war, what started as mere jaw-jaw on the impending crisis by all and sundry saw the S&P 500 Index down 10.3 percent, and the Nasdaq down 13.9 percent from their opening levels in January. The effect of the war will likely be to make nervous investors sell more, while long-term investors will weigh the odds of buying sold-off stocks at discounted values. Safe-haven assets such as gold, US dollars and US government bonds are being bought.

A few days into the offspring of the invasion by Russia, the international markets took a beating as the rise in the tension between Russia and Ukraine thronged broad-based sell-offs across major indices. Similarly, without a doubt, global markets are suffering from a sudden rise in risk-aversion, but this risk-aversion was already evident from the beginning of the year, thanks to rising inflation in developed nations and the near-certainty of interest rate raise by their monetary authorities.

Should investors in developed markets buy on the dips?
In response to this, analysts at Coronation Research have noted that in emerging and developing markets like Nigeria, many sovereign borrowers and companies will avoid negative supply-side disruptions and the knock-on effects of sanctions on Russia. Falls in bond and equity prices are providing buying opportunities and may continue to do so.

Coronation Research analysts, in a flash note on the ongoing Ukrainian situation and its effects on Nigeria’s economy, said the outbreak of war has put investors into a classic ‘risk-off’ posture, and some traders have sold FGN Eurobonds, pushing yields up still higher. But have the fundamentals of Nigeria’s creditworthiness changed? Most likely, they have not, with the price of its most important commodity rising. In their view, this yield rise presents an attractive opportunity to lock in attractive US dollar rates.

“The investment approach of Coronation Research is to buy value as cheaply as possible and to avoid the downside as much as possible. Think about this in the context of a listed company with strong fundamentals and healthy cash flows. Unless the company is directly caught up in the Ukraine situation (e.g., it is directly or indirectly affected by sanctions or supply chain disruptions), its cash flows will remain strong. Its stock may be marked down by traders, in which case it becomes fundamentally cheaper. This presents an opportunity to buy.

“The question is: “How much cheaper is it going to get?” This question never has a precise answer. So, the point is to set a range of valuations and prices at which you are prepared to purchase it. As your entry point, you may even use mean reversion to estimate a valuation level (e.g. one standard deviation below its long-term price/earnings ratio). A catalyst (e.g., a peace deal or rapid end to the war) may make the market recover, but today, this is not an immediate prospect. Waiting for a little is likely to pay off, but do not wait forever.

On the implication of the impasse on the Nigerian markets which span across the oil and gas sector, the equities and the fixed income space, Coronation Research analysts asserted that Nigerian T-bill, fixed income and equity markets do not correlate with global markets. This is a strength in a situation like this.

Implications on oil and equities
Though the oil and gas space has remained a major beneficiary of higher crude prices which currently stands above $115 per barrel as of Thursday, market investors have in recent times, begun taking positions in names that have seen price declines in the recent sessions. But what are analysts saying about the likely implication to the oil sector and the equities market?

In the view of experts at Coronation Research, where the upshot will be seen “First, and most obviously, is oil. As a long-term rule-of-thumb, oil prices above $60 per barrel are good for Nigeria’s public finances (i.e. the reserves of the Central Bank of Nigeria and the budget of the Federal Government). Nigeria has been in its comfort zone since July 2017 (although there was a prolonged trough below $60 per barrel between January 2020 and May 2021). In other words, very high oil prices support Nigeria’s position.

“Over the long term, oil prices do not correlate with the NGX All-Share Index. On the other hand, over the past two years, there has been a positive correlation that, (although not strong), suggests that high oil prices may support the current equity rally for a little while longer. Oil producers are in the index, but they are a small part, e.g. Seplat Energy at two percent of the NGX Exchange All-Share Index.

US government bonds, risk appetite and FGN Eurobonds
Taking a deep-dive into the likely effect on the bonds and fixed income space, they said, “Second, there is a touch-point between US government bond yields with investors’ risk appetite and the yields of Federal Government of Nigeria US dollar Eurobonds. FGN US dollar Eurobond yields have been moving up for over a year now in response to rising US rates. The outbreak of war has put investors into a classic ‘risk-off’ posture, and some traders have sold FGN Eurobonds, pushing yields up still higher this week. But have the fundamentals of Nigeria’s creditworthiness changed? Most likely, they have not, with the price of its most important commodity rising. This rise in yields presents opportunities to lock in attractive US dollar rates, in our view,” they explained.

Conclusively, it is difficult to see many directly negative effects for Nigeria of these developments, though there may be some negative effects to shipping and other supply lines that impact imports of petroleum and other important products. Overall, however, Nigeria’s exposure to the conflict is much less than that of European, Asian and North American nations.

According to the flash note, the aim of NATO (the North Atlantic Treaty Organisation) and its partners worldwide is to exact a price from Russia for the war in Ukraine. NATO itself wants to avoid conflict with Russia, and the extent to which sanctions will isolate the Russian economy over the medium term is now a significant foreign policy lever. The risk of escalation beyond Ukraine, at this stage, appears limited, although it is clear that western policymakers are assessing the risk seriously.