In the stock market, as with horse racing, money
makes the mare go. Monetary conditions exert an enormous influence on
stock prices. Indeed the monetary climate — primarily the trend in
interest rates and the central bank's policy — is the dominant factor
in determining the stock market's major direction — Martin Zweig (The
We have quoted Zweig before, and we will continue to
do so. Indeed, what Zweig elucidates above is the fundamental
philosophy, which forms the basis of all our market calls. Like Zweig,
we base our investment opinion on what we perceive as the direction of
SBP policy. To be more precise, we believe that the bet on future market
performance is simply premised on how the SBP prioritizes (and balances)
its dual goals, economic growth and price stability, as the manager of
Pakistan's monetary policy. We recognize that achievement of one goal
may be at the cost of the other.
The KSE continues to be one of the best performing
markets in the world, despite a dangerous global environment, strong
domestic opposition to the political structure that was defined by the
previous government and continuing tensions with India. Under conditions
that were prevalent about 3 years ago, these exogenous factors would
have combined to undermine KSE performance. Though, presently there are
strong secular trends that make and will continue to make these
exogenous risks increasingly irrelevant to market performance. We
believe that the stellar market performance is set to continue over the
medium term, with an intermediate index target of 3362.
Our views are predicated on the following
observations and assumptions:- 1)
the SBP accords higher priority to exchange rate stabilization, even
above inflation considerations,
2) the US dollar continues to struggle
under the weight of its twin deficits and declines gradually (we would
venture a sharp decline), 3)
the GoP continues to secure concessionary funding from IFIs, and 4)
continues to deliver its domestic balance sheet.
The key to understanding where the equity market is
headed is, we believe purely a call on where the SBP's policy priorities
lie. Fundamentally, the SBP is charged with promoting economic growth
and controlling inflation. This contrasts, in some ways, to the change
in central bank priorities globally, which in the nineties saw central
banks being largely charged with controlling inflation — the ECB
inflation targeting. With regard to the SBP's priorities, we must admit
that we have had a radical change in thinking. We feel that the SBP is
not willing to take any policy action that may endanger the nascent
recovery that we are presently observing in the economy.
We feel that the SBP's inclination towards protecting
growth is also a function of the impending implementation of the WTO
protocol, where we feel that one of the most significant factors
determining a country's competitiveness will be the exchange rate.
Curtailing the Rupee appreciation to 2% in the current fiscal year has
been accompanied by reserve money, narrow money and broad money growth
of 16.6%, 19.8% and 13.1% respectively. Simply put, this growth in the
aggregate money supply should at the least be maintained (if not
enlarged) over the next few months. The Rupee strengthening trend does
not show any sign of waning. We believe that it should gain momentum as
the GoP is working on paying back expensive external debt (some of which
will be done before the end of this fiscal year) that can improve
Pakistan's external vulnerability indicators.
Once the SBP reaches its 'competitive exchange rate'
level, then possibly the rate of monetary expansion will have to be that
much faster. If exchange rate stability is a priority with the SBP, then
one of the foremost challenges that the SBP faces over the twelve months
will be how to deal with a decline in the US dollar's value against
global currencies. We do feel that the US dollar has yet to bottom-out.
The SBP's stated policy, in this context, is that they will allow a
gradual appreciation of the Rupee against the US dollar, and it is a
policy that they have been following.
Furthermore, the SBP realizes that the attractiveness
of fiscal contraction for the government will only last as long as it
plays its part in compensating for the successively lower fiscal
deficits as a percent of GDP with an increase in corporate (and
consumer) levering. Hence at least keeping aggregate demand stable (and
hopefully spurring it). This is particularly significant with the advent
of the democratically elected government of Prime Minister Zaffar Jamali,
where any downshift in aggregate demand will have unacceptable political
risks. Growing aggregate demand can only be good news for listed
companies' earnings, which is a trend that we believe will ultimately
underpin the liquidity-driven rally at Karachi Sock Exchange.