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1- PROGAS EMERGING STRONG IN LPG BUSINESS
2-
EQUITY PERFORMANCE AND RISK PERCEPTION
3-
ENERGY VISION FOR NEXT 25 YEARS
4- BOOM IN REAL ESTATE
5-
STRONG FINANCIAL SYSTEM ALLEVIATES POVERTY


EQUITY PERFORMANCE & RISK PERCEPTION

 

The Siamese Twins

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By BAKHTIAR AHMAD, CFA
ABRAR MALIK, ACA
Jan 03 - 09, 2005
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Of all the factors that are currently driving the asset prices in Pakistan, improving risk perception is probably the most important. The shift in investors' risk appetite has provided the necessary foundation for liquidity to work its magic. In itself, liquidity is impotent. In itself risk is not important either. It is the perception that matters.

We have examined the relationship between risk and equity prices and our findings show a significant correlation that has some interesting implications.

EIU RISK SCORE

Economist Intelligence Unit (EIU) publishes country risk scores that are based on a fairly standard methodology currently being used in sovereign credit risk modeling. An outline of the process is shown in Figure 1. The approach is comprehensive and objective.

A sample of country scores is shown in Figure 2. As of December 2004, Pakistan is ranked 73rd out of a universe of 100 countries.

Figures 3 & 4 chart EIU Risk Scores versus the KSE 100 Index. Equity performance and risk are the Siamese Twins. Sentiment trumps fundamentals.

As we write, the index is close to 6000 level. Based on the fitted fair value curve in Figure 4, this implies a Risk Score of 52. The market is optimistic about the future of Pakistan Inc. For the moment, it is also willing to put its money to back it up.

BOND PRICES

Bond Prices have information about issuer specific risk that can be a very useful indicator. We prefer to look at Stripped Spreads (Bond Yield Benchmark US Treasury Yield) on the dollar denominated debt to assess a clean measure of sovereign credit risk.

PK Republic 6 3/4% 09 is a dollar denominated Pakistan bond (issued February 2004). The bond is benchmarked to 5Y US Treasury. The daily Stripped Spread on this bond is plotted versus the KSE 100 Index in figures 5 & 6.

 

 

TWO ASPECTS JUMP OUT OF THESE PICTURES:

1. A significant part of the move in the equity prices can be explained by the improving risk profile (falling yield spread).

2. Bond prices are a useful leading indicator for KSE 100 performance.

AGENCY RATINGS

The third measure of risk we have studied is the Agency Ratings. S&P have upgraded Pakistan from B to B+ as of 22 November 2004. Moody's is widely expected to follow in the New Year. This will make borrowing cheaper for the government and the corporate sector in the international capital market. We are back to our 1994 ratings via downgrades in late 90's and a default. It has been a fair effort by any definition.

EPILOGUE

In theory, every indicator suggests that current asset valuations can be sustained. Except, that is, for one: Pakistan Cricket Team.

These lads represent the national psyche and character only too well. At one level we know this is true. The emotion that goes with an ordinary game tells us that this is no game. This is the serious and painful business of self discovery. Pure genius interrupted with self destruction. It is awesome and mindless.

No risk measure can begin to capture our ability to self distract. It borders on genius; and it is awesome; and it is mindless. The coming year will show if we can live with our good fortune.

 

 

(For Figures kindly refer to our Magazine hard copy)