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The stock market is booming. The KSE100 index posted a return of 60 percent this fiscal year to date, and the rally has surprised many.

The PSX is such a low-base asset class where the valuations were so beaten down, and it did not take much investment to bring the market to this crazy rally. The free float (shares which can be publicly traded) of the market on the last close was Rs2.5 trillion, which is less than deposits-base of a big bank. It’s a very small base.

Initially, the rally was spurred by a state-owned insurance company, and then companies joined the party (perhaps buying back the shares, as the valuations were dirt cheap). This further squeezes the effective free float and lowers the investments level to jack up prices.

In the last few weeks, foreigner interest started building up. Now the momentum has picked up, and the animal spirit is in play with everyone is in tezi (becoming bull).

This is overall good for the market that has remained suppressed for very long. With all this spike, the CAGR (cumulative annual growth rate) of last ten years is a mere 10.3 percent, which is less than the average annual return (10.7%) on so-called risk free 10-Year government paper.

The trailing P/E (price to earning ratio) of KSE100 index is at 7.15x. Within it, three sectors (banking, energy, and fertilizer) have over 60 percent weight, and these sectors are trading at a discount to the rest - as their trailing P/E is around 5. These are highly regulated businesses, as their profitability is linked with government policies, and the regulatory risk in Pakistan is very high.

Banks in a high interest rate environment make money by raising current account deposits (at zero cost) and investing these in government papers. Then the banking exposure is very high to the government debt, and any debt restructuring/reprofiling of domestic debt adversely impacts the commercial banks.

Energy sector of Pakistan is plagued with the circular debt, and the top performing companies have guaranteed returns while the others are state-owned where government sets prices and dictate the market.

Then the third biggest sector, fertilizer, is running on the model of government subsidy – receives subsidised gas to produce Urea and sell at a discount to international prices to farmers. The government is ensuring their demand and companies are making chunky profits.

All these regulated businesses have heightened risks.

The overall macro picture of the economy has not improved, though the economy is bottoming out as the global commodity super cycle is over, and prices are expected to slide which bodes well for net importing countries such as Pakistan. However, medium-term external repayments risks are very much present, and the fiscal house is not showing any improvement. There is no Pakistan breaking out or turnaround story.

The stock market had an overdue rally. The KSE 30 index (it’s a price index which is used for valuation purposes) is still 25 percent lower than its all-time high. The P/E ratios are still at discount to their peak.

Hence, the market moving up is not surprising; but there is no big money in it. It is a market of small club, and the free float is not even 10 percent of banking deposits, and 60 percent of market cap is highly exposed to regulatory risk.

The bottom line is that this robust performance may have been long overdue, considering the persistent undervaluation despite strong corporate results. It is noteworthy that the influx of net new money into the market has been relatively small compared to the magnitude of price movements. The market’s limited free float implies that even a minor injection can disproportionately influence market trends.

For every rupee of fresh investment has contributed almost 200-fold addition to the market capitalisation. However, investors should be aware that this volatility can also manifest in the opposite direction.

Last but not least, William Shakespeare had wisely said in the Merchant of Venice, ‘All that glitters is not gold;...Gilded tombs do worms enfold.’ Caution is always warranted for investors, especially newbies, in navigating the often-perilous landscape of the Pakistan stock market.

Copyright Business Recorder, 2023

Author Image

Ali Khizar

Ali Khizar is the Head of Research at Business Recorder. His Twitter handle is @AliKhizar

Comments

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Arif Dec 11, 2023 09:02am
Excellent analysis - In some countries this is called market manipulation, but sadly in our country SECP is in coma . I don’t remember when was the last time SECP took actual action under inside trading. All it does is send a letter and after receiving a denial of any wrongdoing , SECP goes back in coma without doing any real investigation.
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Khan Asad Dec 11, 2023 10:13am
@Arif, just say all is well. Army is in no mood to take criticism
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Tariq Iqbal Dec 11, 2023 12:17pm
Good analysis. If we take US$ equivalence of previous high of 53000 points, then it equals to more than 100K points. The P/E is cheaper. The exchange rate stability has attracted foreign investors to make investment decision in PSX as expected returns are more than expected exchange loss. In my opinion, PSX is more favorable for foreign investors than the local investors.
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Dr fahad Dec 11, 2023 03:45pm
@Arif, Are you stupid . Check the Pakistan market valuation. Dividend return . It's least valued stock market.
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Yousuf Dec 11, 2023 05:18pm
Retail investors should be very careful with their investments in this rally as Pakistani economic fundamentals are very vulnerable. In essence only invest in dividends stock and don’t gamble with your money. Currently I am still managing over $10B in Manhattan.
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Yousuf Dec 11, 2023 05:21pm
@Tariq Iqbal, I am seeing PKR will cross 320 by December 2024.
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Imran phoenix Dec 11, 2023 07:56pm
Beg, borrow or steal and invest in stock market. Trust me we will all be millionaires.
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Nadeem Dec 11, 2023 08:51pm
Thank you for very informative article. Excellent analysis. All said the P/E ratios of many companies make their shares compelling buys , even after the recent rally. I see companies with P/E ratios 3 or 4 in Pakistani market and then juicy dividend . Looks like ‘ loot sale ‘. Risk , well stock market is for those who are willing to take calculated risks . Obviously we all know due diligence is essential before buying. In a lighter vein I would say : Buying stocks without due diligence could be “injurious “ to your wealth.
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Az_Iz Dec 12, 2023 12:10am
Does the 10.3% return includes dividends? And what are the tax rates on income from stocks and dividends, comared to government paper? All that determines, which is a better investment, in addition to appetite for risk.
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AA Dec 12, 2023 02:53am
Never seen a positive news from this writer in last 2 years. Selling negativity and despair in society seems to be the objective
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Az_Iz Dec 12, 2023 05:24am
It is a good and timely article. Individual investors are better off, reading this article, and then decide.
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Zafarullah Dec 12, 2023 07:26am
Excellent analysis and excellent advice to the investors. Thanks a lot for the same.
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Xaplin Dec 17, 2023 11:04pm
"Hence, the market moving up is not surprising; but there is no big money in it. It is a market of small club, and the free float is not even 10 percent of banking deposits, and 60 percent of market cap is highly exposed to regulatory risk." Right on the money...its an open secret..the corrupt elite make money using Sataah!
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