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STOCK MARKET: WILL THE BOOM LAST?
By A.B. Shahid, MD & CE,
Pak-Gulf Leasing Co. Ltd.
Jan 27 - Feb 02, 2003
Pakistan's stock markets are experiencing a boom that is completely out of step with the trend at stock markets all over the world. During 2002, stock prices fell sharply in virtually every developed country.
Among developing countries, exceptions to this worldwide trend have been few stock markets in the Asian and African regions. Indonesia, Thailand and South Africa registered sizeable appreciation in stock price over their 2001 levels, the best being Indonesia where the stock market index rose by 26% in (US$ terms) over its 2001 level. The only region where, in majority of the countries, stock prices registered a sizeable rise is East Europe.
Coming in this backdrop, the current boom at Pakistan's stock exchanges seems odd. Observers may look for a parallel with the boom witnessed in 1994-96 but, except for the speed with which KSE-100 Index has risen, there are no significant similarities. The positive trend of economic growth spurred by de-regulation, and pursuit of growth-oriented policies followed by Federal Ministries of Finance and Commerce during 1991-93 genuinely boosted investor confidence. As a logical result thereof, the rise in stock prices was credibly backed-up by scores of new companies being floated. During the three-year period beginning July 1993 and ending June 1996 a whooping 131 new companies were floated on the stock exchanges raising their total to 783, and listed paid-up-capital doubled from Rs. 175.7 billion to Rs. 348.5 billion.
Beginning 1997, this trend was blunted by the severe political crises that began to plague the country. The situation was made worse by the nuclear test of May 1998. During the six-year period ending December 2002 only 20 new companies were floated. By June 2002, the number of listed companies fell to 725 as a result of de-listing and mergers but essentially due to de-listing of many companies, both local and foreign. But the listed paid-up-capital rose to Rs. 699.2 billion as a result of companies capitalizing profits and issuing fresh equity largely to comply with the increased capital adequacy requirements imposed by the regulators. By December 2002 the number of listed companies fell further to 711. This scenario, made worse by the impact of 9/11, was not entirely conducive to causing a rebound at the stock markets. Yet, it has happened defying many expert assessments.
Even during the boom in the early 1990s, it was odd to find opening prices for new company shares being quoted at premiums of as high as 150%. The explanation therefore were the round trips foreign indirect investment (tactlessly being secured against exchange losses by SBP policy of providing 6-month exchange risk cover at zero premium) was making of Pakistan's stock markets. But the fact remains that investment was being absorbed by the economy; the birth of 131 new companies was a proof thereof. None of those developments seem to be backing up the rise of the stock prices this time, particularly the virtual absence of flotation of new companies. What is noticeable though is stiffening of regulation. It may have boosted investor confidence but the primary factor pushing up stock prices is the amazing increase in foreign inward remittances, which over-liquid banks have been investing in stocks.
This was inevitable because, after a 6-year spell of bad economic governance and political fallout from the disastrous nuclear tests of May 1998 that prompted US, EU and Japan to slap crippling economic sanctions on Pakistan, the economy lost the capacity for absorbing large doses of investment, domestic or foreign. Thus, at the moment, the massive flow of funds to stock markets is only helping to push up prices of existing shares and, in the process, adversely affecting price-earning ratios. But given the continuing slide in yields on other investments (bank deposits, NSS, T-Bills and FIBs as well as new corporate bonds), stocks seem a better option because they hold out the promise of unrealistic capital gains. It is, of course, questionable whether the exercise is adding real value to the economy because the absolutely amazing 112% rise in KSE-100 index over the past 12 months has not induced any industrial group to float a major new venture. Not surprisingly, therefore, questions are being asked about the sustainability of the KSE-100 stock index.
A credible argument in support of justifying the meteoric rise of the KSE-100 is the fact that in early 2002, stock prices were under-valued. But the questions needing answers in this regard are what was the extent of under-valuation of the stock prices, and has the rise of the KSE-100 index only pushed share prices to their true intrinsic levels or has the exercise been overdone, and if so, what will be its consequences? Before attempting to answer these questions one must take into consideration several factors including.
- how representative of the stock market is the KSE-100 index,
- how many new companies were listed on Pakistan's stock exchanges in 2002,
- the number of scrips that actually registered a rise since end-2001,
- the share of the few big players in the overall trading volume, and
- how many of the listed companies announced their profits until December 31, 2002 and what influence these could have on stock market sentiment.
To begin with, KSE-100 is not truly representative of the stock market because the weightage assigned to certain sectors is overwhelming due to the huge equities of the few companies in those sectors. Only 4 new companies were listed on the stock exchanges during 2002. Majority of the scrips didn't register a rise. Shares of 12 well-performing companies, which were truly under-valued in January 2002, rose to intrinsic levels but even among them prices of some went up unrealistically; for instance Hubco by 158% and ICP by 143%. To add to these surprises, 18 companies whose shares were trading below par at the start of 2002, went up by hefty margins; for instance Pak Suzuki Motors by 634%, Chakwal Cement by 333% and PIA by 310%. The unrealistic gains made by these shares reflect the limited choices traders have. Not surprisingly therefore 10 big companies account for nearly 80% of the total trading volume, which can hardly represent the real health of the stock market and investor confidence. Finally, of the 711 listed companies, by early December, only 340 had announced their results for 2002 compared to 422 during 2001. Of those that announced their results, only 169 declared dividends, not all of them encouraging.
Surely, this could not influence stock market sentiment too positively. What then are the factors pushing up KSE-100 index? The rise in this index has visibly been the result of trading in the shares of about 30 or so companies from which the market expects exemplary growth in operations, revenues and profits. The expectations could be unrealistically high. That is, perhaps, why the confusion about future dividend policy of Hubco and the impact of temporary disruption of gas supply on the profitability of SNGPL sent KSE-100 index in a free fall on January 21 and 22. It was a proof of the fact that shareholders had realized their error of judgment in holding on to shares at inflated prices. Without any doubt, the market is over-bought to an unaffordable level, and given the fact some of the shares are certainly over-valued and badla rates have jumped to as high as 50% p.a., holding on to such shares in the hope of a more than compensating capital gain will eventually prove pointless.
Given this background, rise in stock prices doesn't seem to be the result of sound investment decisions by those engaged in trading in shares. Their actions have primarily been driven by developments exogenous to the stock market itself. The current trend in interest rate management, and as a consequence thereof, progressively lower profits rates on bank deposits have obviously pushed savings out of banks into the stock markets. Among the savers dejected by lower bank deposit rates, the more enlightened are turning into new share buyers but being largely uninitiated to undertake such investment, they may suffer from bad broker advice. It happened all over the world. US is its classical example thereof where 50% of the households invested in shares at inflated prices that later dropped by much as 40% leaving poor shareholders with negative equities. Evidence of similar disasters is not lacking in Pakistan's history. What makes the prospects of such a disaster more imminent is the stark reality that, with the US-Iraq war imminent, the present recession is unlikely to subside in near future. With domestic demand not picking up and exports unlikely to rise substantially given the damage done to Pakistan's image globally, sustained corporate sector profitability does not seem very likely.
The inflated share prices may fall but not rapidly; new share buyers don't account as much for the rise of the stock indices as another, more powerful group — commercial and investment banks. Reduced activity levels and injection of profits earlier siphoned out and stashed away abroad have drastically reduced borrowing by the business sector. This has coincided with large Pakistani banks overflowing with non-resident deposits (thanks to 9/11). Even though these deposits are being accepted at progressively lower rates of profit, the sheer size of these deposits is straining bank profitability. Banks are therefore opting for share trading as a means to sustaining their profitability. In a big way, this trend is pushing up stock prices. The purchasing power afforded by the continuous flow of deposits from abroad may help banks to keep share prices high. But in the process it will progressively worsen price-earning ratios thereby leaving capital gains (rather than dividend income) as the only viable justification for holding on to shares. The small shareholder doesn't have that clout. Besides, how long can even banks afford to do it, and will such a practice engender greater confidence in Pakistani banks among the expatriate Pakistanis, is a question mark.
Notwithstanding the skyrocketing of KSE-100 index spurred by these involuntary trends in investment, the fact remains that sentiment for investment (demonstrated credibly by flotation of new companies rather than artificially upped stock prices) remains sub-duded. It is worth pondering whether this will encourage a genuine shareholder culture that envisages shareholding for dividends rather than windfalls, which may or may not materialize. If this time round too (as since 1995) small shareholders eventually loose out, it will be a lasting blow for developing a healthy capital market driven by the ordinary shareholders. In the past, we have repeatedly failed to develop a vibrant capital market precisely because of such unfortunate developments. We just might end up doing it again.
12 TOP PERFORMERS OF 2002 WITH PRICES ABOVE PAR IN 2001
16 TOP PERFORMERS OF 2002 WITH PRICES BELOW PAR IN 2001