The KSE-100 index bottomed out at 28,765 on August 16, 2019 and soared to 43,219 on January 13, 2020. There were three factors that triggered the market rally - falling 10-year bond yield, currency appreciation and current account deficit reduction, and political stability. The first and foremost factor was bond yields. The 10-year PIB yield in secondary market declined from 13.5 percent on August 21, 2019 to 12 percent on September 20, 2019 and bottomed out at 10.9 percent on December 12, 2019. The stock market rally started in September and continued till mid-January. Stocks valuation is based on future cash flows discounted on 10Y yields. Lower the yield, higher is the valuation. Intuitively, when bond yield comes down, institutions shift capital from bond to stock markets. The short-term rates do not really matter for stock market movement. This is evident from the fact that 3-12-month T-Bills rates have largely remained unchanged in the past six months.
The second factor was the stability in the currency market. PKR closed at 160.8 against USD on July 24, 2019. Ever since then, it has gradually appreciated to reach 154.5 on February 3, 2020. The current account deficit reduction continued in the period with a surplus during October 2019. Currency supply remained higher than demand in the interbank market and SBP continued to buy from the market to offload its forward liabilities. The SBP foreign exchange reserves moved up from $7.7 billion on September 27, 2019 to $11.9 billion on January 24, 2020. Confidence in the external account and currency stability boosted the stock market. The influx of foreign portfolio investment in debt market cemented currency stability in short- to medium terms. That has diverted the flows in PKR assets. The option for institutional investor is to select between bond and stock markets. With bond market yields falling, stock market becomes attractive for investors.
The third factor was the political stability. In October 2019, rumours of Nawaz Sharif getting bail and leaving the country started circulating. In November, he left for London for medical treatment. In the past few months, many political leaders in NAB custody have got relief. NAB's pressure on businessmen started easing as well. Markets hate uncertainty, with political rumour-mongering dying down, investor confidence started building.
Market pundits are expecting year end (2020) index target of 47,000 to 52,000. Many analysts were expecting major gains to attain in the first half. Now the expectations are changing. Political and external account (currency) stability is intact. The fundamental change is higher than expected inflation in January 2020 at 14.6 percent. It is a nine-year high. Signs of higher inflation started appearing in 2nd-3rd week of January, when the so-called wheat crisis surfaced. The market moved down from 43,000 plus level on 20th January. The 10Y bond yield moved up from 11.01 percent on 17th January to 11.17 percent on 3rd February. Food supply chain disruption due to administrative failure, closing borders with India and climate change are resulting in high inflation. The house rent index, too, was higher than expectations in January.
Resultantly, the stock market fell by 2.9 percent on Monday and recovered partially on Tuesday. The expectation of monetary policy easing is delayed. Market does not expect any rate hike. There is little upward pressure on 10Y bond yields. However, SBP has already picked higher than targeted amounts in the past few auctions. In the previous 11 PIB auctions (prior to 4th February), SBP has cumulatively picked Rs 1.9 trillion against target of Rs 1.1 trillion. The strategy now is seemingly to manage yields (at lower side) by picking lower than targeted amounts in upcoming auctions. In latest auction, SBP mopped Rs 58 billion against the target of Rs 100 billion. 10Y cutoff yields are up by 10 bps. Therefore, chances of bond yields moving significantly up are less. Hence, stock market downside may be limited. With oil and other commodity prices nosediving in the aftermath of coronavirus outbreak, inflation could come down earlier. Inflation is the key indicator to watch in months to come, and movement of market is somehow linked to it.
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