Reading KSE-100

Following yesterday’s sharp gain of 797 points at Pakistan Stock Exchange, investors have begun to wonder whether the move suggests the market has bottomed out, or that it should only be read as a relief rally after eight straight days of bleeding.

Finding the perfect bottom is the Holy Grail of stock markets around the world. Yet that has never discouraged investors and analysts to search for it. Onto the same pursuit, BR Research cautioned in this space late last month that the market is just a shock away from nose diving to about 28,000 points, which could define its bottom. (See BR Research’s Bears last run? July 29, 2019)

However, the August 6th note said “if the market hits close to 28000 points, it would be around 43 percent discount to its 500-day moving average. That should be more than sufficient to bring about recovery - not necessarily a springboard recovery as previously alluded but a sustained recovery, nevertheless.” (Read BR Research’s Bears’ last mile or two! Aug 6, 2019)

Yesterday’s near-800-point recovery, therefore, does not come as a surprise given that the KSE-100 had hit 28,784 by August 16th, after eight consecutive negative sessions. It is, however, interesting to note that average trading volume of top 100 companies between August 2 and 16 – when the market tanked by about 3200 points – was only 53 million. Compared to that, the trade volume of 76 million shares in a rising market yesterday shows promise.

The main sellers during the market’s axing behaviour since the start of this month have been the mutual funds that sold about $22 million worth of equities during this period. Strangely, however, the main buyers have been local individuals; even yesterday’s gain is attributed to individual buying ($3mn). Now, times like these are not for the weak hearted. This was very much clear even as early as October 2018. (See BR Research’s A game of nerves! Oct 15, 2018).

The question, therefore, is who are these individuals buying at the time of panic when mutual funds – who manage assets for individuals and corporates alike – are selling profusely. These individuals must surely represent the smart money – those who seem to be unfazed by the troubles on the external front, domestic political environment and the economy.

As far as the economy is concerned, the worst is over - for now at least – since following the IMF programme, the immediate threat of macroeconomic crises has waned. Domestic politics environment is hostile, but with Khan coming to power it was expected to be hostile, so it was kind of priced in. The external front is new – the Kashmir saga, ensuing exchange of fire at the Line of Control (LoC) and fears of proper war.

There are those who worry that the market has not yet factored in the war risk premium, which is why the bottom is still far away. If the theory of war risk premium is correct, then the market can be expected to fall to 26,000 points, or even 24,000. But that would be pushing the price-to-earnings multiple down to 2x or 3x, considering that by August 16 close, the market was at a forward price-to-earnings multiple of 4.4x, according to Bloomberg data.

Whether or not this theory is correct could have been assessed by looking at KSE-100’s price-to-earnings back in the times of Kargil war or India and Pakistan’s nuclear tests in late 90s. But those data sets are not maintained by any leading brokerage houses that BR Research reached out to; neither do market pundits remember that number off the cuff.

However, Dr Ali, managing director of Next Capital limited who has about 20 years of experience in the market, recalls that the benchmark has never fallen below the forward multiple of 4x even around the time of Kargil. If Dr Ali’s memory is correct, and assuming that Kashmir-related concerns won’t significantly scale up, the market should find its bottom around 28000, or 27000 points at the most, if it has not already.

Another way of looking at it is to compare trailing P/E between now and the earlier episodes of Pak-India tensions. Between May and July 1999 – the trailing P/E was between 7 and 8x, whereas soon after the nuclear test tanked to 6.6x. Compared to these trailing P/E at the moment is about 6.5x – substantially low by all accounts.

To sum up, whether the market has bottomed out, or yesterday’s move should only be read as a relief rally depends largely on how one ought to view the war. By standard theory of nuclear deterrence, a war should not be on the cards because if things scale up to a nuclear war, then all bets are off anyway. Which is why saner minds across the world with deep economic and political influence maintain that Kashmir issue and the ensuing action on the LoC at least do not scale up to a degree where the parties in question start thinking about the N-word. To reiterate the conclusion from last note, this is exactly the kind of situation that separates men from boys.