Future direction of market dependent on a number of factors

May 10 - 16, 2004

On the back of strong economic fundamentals and profitability growth in listed companies, the Karachi Stock Exchange (KSE) has been an out-performer globally over the last three years. The KSE-100 index continued the fabulous performance. The index was up by 104% in year 2002 and also went up 68% in year 2003. During the first 4 months of 2004, the KSE-100 index is up by 19.5% as of April 29, 2004. The index is up 83% on a YoY basis led by out-performance by the FMCG, automobile assembly and banking sectors.

According to Aqib Mehboob Elahi, Head of Research, AKD Securities, "The performance of the KSE-100 index in 2004 differs somewhat from the exceptional performance seen in 2002 and 2003. Performance in those two years was driven by the attainment of macro stability and the global reflation phenomena. Macro stability has been attained via Pakistan's fairly smooth execution of the macro rehabilitation programme mandated by the IMF and other supra-national agencies. Thus, the improved macro environment and concomitant economic prudence has resulted in steady risk premium compression. However, from the fourth quarter of 2003, the market has begun to price in expectations of substantial upturn in investment and economic growth".

The relative underperformance of export sectors clearly underlines the fact that investors now perceive that the growth is likely to be generated domestically (or in some cases, the rehabilitation of Afghanistan). The outlook for the remaining part of the year continues to look positive (though a short-term correction may be forthcoming). However, there are a couple of things that investors need to be cognizant of prior to investing in the equity market.


First and foremost, it is very important to realize that monetary conditions play a critical role in asset price performance. Relatively loose monetary conditions in the domestic economy have played a large role in the performance of the equity market. In several Treasury bill auctions over the last couple of months, the State Bank of Pakistan (SBP) has clearly indicated that it is gradually tightening monetary policy in order to head off inflationary pressures in the economy. There is no doubt that we are unlikely to see interest rates return to pre-2001 levels, hence asset prices are unlikely to crash. However, tightening conditions will take the liquidity premium out of asset prices. In these conditions, commodities, ordinary shares of companies with high leverage and highly speculative investments are unlikely to perform well. On the other hand, assets with direct correlations with economic fundamentals and well-entrenched growth stories will continue to out-perform.


Secondly, until liquidity conditions stabilize to relative neutrality the likelihood of extreme asset price volatility is quite high. This is particularly pertinent with respect to investors who leverage positions. It was evident from exceptionally high Badla investment in the recent past. Lately, the deliberate effort to curtail Badla volume has resulted in erosion of prices of most of the volume leaders as well as second and third tier scrips.


One of the factors responsible for upward movement of the index has been the divestment policy being followed by the GoP. This include offer of shares of National Bank of Pakistan, Oil & Gas Development of Company and Sui Southern Gas Company. All these offers got overwhelming response from public. It was expected that under the policy shares of Pakistan International Airlines, Pakistan Petroleum and Kot Addu Power Company would be offered before June 30, 2004. However, it has become that shares of these companies would be offered in next financial year.


Another factors expected to keep the equities market vibrant is the flotation of a large number of mutual funds. It is expected that mutual funds, both open-end and close-end, with an aggregate value of more than Rs 10 billion will be floated within next three to six months. According to an analyst, "The upcoming mutual funds are mostly sponsored or seed money is being contributed by commercial banks. The situation has arisen due to Prudential Regulation pertaining to banks' investment in equities. Most of the investment of banks will be parked in these funds and it will be a win win situation for the banks".


AKD Trade was the first to create online trading facility in late 2002 and since then at least three more companies have been established. This platform has enabled a large number of investors, particularly the smaller ones, to indulge more in day trading. The greater participation is evident from the massive increase in daily trading volume.