Likely conversion into EM: equities may rebound on improved stability, indicators

The country's volatile share market may rebound in 2016 with its likely conversion into the emerging markets (EM) from frontier ones by the MSCI. This, market observers believe, would couple with the country's improving macroeconomic indicators and relatively stable political environment. Pakistan market currently trades at 2016F PE of 8.7x, which is at 8.0 percent discount to MSCI's frontier markets (FM) PE of 9.5x and at 32 percent discount to its Asian peers.
The local bourse's PE can potentially re-rate after MSCI upgrade to 9.0-9.5x in 2016, said analysts at Topline Research in a note Thursday. This coupled with cash liquidity with local investors, 14 percent earnings growth (ex-oil and banks) and record low interest rates can take KSE100 index to 38,000-40,000 points generating 16-22 percent in line with last 20 years annual return of 24 percent.
"We have assumed WTI oil prices at $40/barrel for 2016 and $45/barrel for 2017," said the analysts. Reclassification of Pakistan to EM would be a major shift as foreign flows will increase, they added. Though Pakistan's weight would be 0.13-0.17 percent in EM versus FM's nine percent, funds tracking EM ($1.4-1.7 trillion) are higher than FM ($17-20 billion). With $400bn passive funds tracking EM, Pakistan can attract $600m post upgrade.
"After close to $300mn net selling in 2015, key question is how much more selling can come and how much lower the market can go," the analysts said. In worst case, they estimated, at maximum $400mn foreign selling could hit the market next year. The country witnessed strong improvement in economic fundamentals during the outgoing CY2015 due to low commodity prices, which led to improved external situation and low inflation.
This resulted in interest rate at multi-decade low of six percent. And there are strong prospects of sustained GDP growth due to improved macroeconomic fundamentals, security situation and upside from CPEC. Cements would be the prime beneficiary of improving local construction activities and low input costs, analysts said. The banking sector's low valuations were not fully justified given CPEC led credit growth. Insurance sector would earn due to improvement in underwriting business. OMCs would benefit from improved cash flows whereas consumers companies would benefit from rising consumer spending and low raw material cost.