When the bulls took over the PSX in the last week of June 2023, few expected their run to continue unbroken for six months, taking the benchmark KSE-100 index from the vicinity of 44,000 points to north of 66,000 points by mid-December.
That was when the historic bull-run petered out, giving way to what looked like an historic bear market that eroded the index by almost 7,000 points in about a week’s time. However, the market promptly rebounded on December 27, giving a lie to any doomsayer among the observers.
This looks like a good time to take a close look at the drivers of both of these trends before crystal-gazing market prospects going forward. John Maynard Keynes once said that “the markets can remain irrational longer than you can remain solvent” and the same has been proven correct time and again. We cannot predict the direction or the magnitude, but we certainly can work with whatever information is available.
In comparison to other frontier and regional markets, as well as to its historical values, Pakistan’s equity market is still incredibly cheap by all measures. The market capitalization, a measure of the total market value of all publicly traded companies in relation to GDP, is still below its long-term average.
The staff-level agreement with the IMF in June 2023 provided much-needed financial stability and optimism about Pakistan’s economic future. This led to greater certainty and risk appetite among investors.
Strong corporate earnings performances further fueled investor confidence in the market’s potential. High inflation that rendered effective interest rates negative made the stock market a more attractive investment option, leading to improved investment inflows and higher valuations.
After Pakistan secured IMF backing and pushed through stock market reforms, the PSX was seen as undervalued compared to international markets, providing a potential for greater returns and attracting FDI inflows to the tune of about $15 billion from bargain hunters and foreign investors.
The move to bring government securities to the bourse mobilized additional investment, as did the inclusion of small-town investors through online trading. The trend was helped along by an array of external factors, including a global commodity rally, ease in global inflation, and positive regional sentiment.
Eight of the top ten largest corporations in the KSE-100 index are thought to have some sort of relationship with the sovereign, either directly or indirectly, either as lenders, as recipients of significant concessions from the sovereign, or as a result of their liquidity being locked up with the sovereign.
The recent market uptrend is a function of clarity that Pakistan isn’t defaulting, is in an IMF program, has no choice but to take structural reforms, moderate oil prices, gradual resumption of imports and dividend repayments, strict fiscal prudence, tight monetary policy, falling fixed-income yields, and clarity over election dates.
Smart money is accumulating shares trading at a fraction of the replacement and asset values, with several top companies buying back their own shares using corporate treasury. Blood was already on the streets, but someone took the bet.
Nevertheless, at a 22% interest rate, many conservative and risk-averse investors would shy away from equity markets that need to offer more than the risk-free 21-22% rate to compensate for higher volatility in returns. Investors who have already lost their shirts in the stock market would pray to break even or not venture until their views are substantially altered.
Empirically, it takes a decade to erase the memories of such sharp 40–50% declines in equity markets from people’s investment avenues. It will be difficult to convince investors to enter the market today until they see people around them making money from the stock market, their bank deposits offering inflationary 14–16%, the PKR remaining stable against the USD, and property market performance being much lower than PSX broader returns.
Markets are sentiment-driven and look forward. Foreigners will eventually lead Pakistan’s re-rating story if the country keeps up its current course of improving energy security, raising tax revenues, selling off loss-making SOEs, and persistently cutting debt. This is assuming that the geopolitical climate stays favorable.
The direction that equity prices take in 2024 will largely be determined by the ability of the sovereign to undertake serious reforms and instill confidence in the market. Considering 2024 is an election year, it will be even more crucial for the new government to demonstrate that it can actually undertake serious fiscal and structural reforms rather than rinse and repeat its tried and tested playbook that has only yielded failure.
Interest rates will remain elevated until the government reduces its demand for borrowings by instilling fiscal discipline. The equity markets will remain aimless and erratic as long as the government keeps up its debt-fueled, consumption-focused binge, switching between emergency US dollar injections. The market is still cheap, but this is mostly because of the sovereign, who is unwilling to change its ways and steer the economy into a trajectory of sustainable growth.
Copyright Business Recorder, 2024