A game of nerves

There is a reason why stock market punters snort that white stuff, the stuff that inspired Seal’s epic rendition Kiss from a Rose. If it’s not unabated optimism, it is days like these when you really need nerves of steel to take a decision and stick your guts to it.

But let’s take a step back. That stock market has an inverse relationship with the bond market is usually taught in Finance 101. The timing in terms of how and when changes in bond yields act as a leading indicator for stock market isn’t – not least in Pakistan’s business schools. For that you play around with moving averages until you figure out when short-term moving averages of 10-year PIB yield bottom out and start looking north, it usually spells bane for equities.

That signal was given as early as December 2017, when trends in secondary market PIB yields (10-year paper) had signaled a rise in interest rates. It was reconfirmed in June 2018. Its reaction is now self-evident at the Pakistan Stock Exchange (PSX). Considering that interest rates are expected to rise further, expect the yields to yield further wrath on equities to the extent that the benchmark index could even slide to 32,000-33,000 points.

If only life was as simple. There are a host of reasons why this view is currently in the minority at the bourse. Discussions with various stock market players reveal that for many, the market has either bottomed-out or just about to. This is largely attributed to the fact that the government has finally decided to go to the IMF, and thus reducing the uncertainty surrounding the external accounts situation.

Then of course there is that classic valuations argument, which is quite honestly difficult to argue with. Across the four-key metrics of market valuation, Pakistan sits in a sweet spot compared to its peer in the region (See scatter graphs). Brokerage BMA Capital pointed out last week that KSE-100’s price-to-earnings are at their historical lows of near about 7x, from which it always springs up (sans that dreadful 2008 crisis of course).

The bottoming out thesis is also supported by financial statements side of analysis. A high interest rate scenario bodes well for banks, whereas higher oil and rupee depreciation helps energy and power sector. These sectors are index heavy weights. Meanwhile, if this Naya Pakistan housing business really kicks off, the construction related stocks, including select players from the auto sector – truck makers and all – will get a high as well.

There are also talks that Pakistan may soon find itself plucked out of MSCI Emerging Markets index and placed back to MSCI’s Frontier Markets index. As much as it might hurt egos and give fodder to the PML-N to take a jab at the PTI, it may just bring dollars back to the market, especially when valuations are as attractive.
Then again! If only! It’s too early to say whether or not the negotiations with the IMF will go smooth. Any hiccup in the deal, emerging from Uncle Sam’s bossiness, or hiccups over CPEC transparency, can create cracks in KSE-100’s current support of around 37100-37300 points. Even fears of a deal not going through or facing tougher-than-expected conditions can unnerve those ascribing to the bottoming-out thesis. We all know how poor PTI’s public engagement has been lately in so far as economic management is concerned.

The bottoming-out supporters would also do well to keep in mind that unemployment in the US is at its lowest since 1969. Capital market outflows from emerging markets are on the cards. Just last month, the US Fed hiked interest rates and dropped its ‘accommodative’ language.

Little wonder that average trading volumes of top 100 companies last week rose about 58 percent at a time when the KSE-100 went through what some brokers said, ‘bloodbath’. Box standard market wisdom tells us that if volumes rise when prices are falling, the underlying sentiments are bearish.

What should investors do in such a scenario? BR Research cannot offer any investment advice. But whether or not you go for cherry picking stocks (as some brokers advice) or become all out buyers betting on the bottoming-out thesis, remember that once fear starts disemboweling hope, it won’t stop until it’s slayed.