April issue 2015

Winners have a lot of owners and losers are disowned by everybody. When the Karachi Stock Exchange was hovering around 35,000 points and headed towards new highs, everyone from the prime minister to a fleet of ministers and analysts were quoting the magic figures in every presentation abroad, showcasing the country’s economic performance. However, with the index now receiving a heavy battering, there is silence all around and not a single entity has ventured to come to the rescue of the market.

The index reverted to the same levels it was at when the year of glory began. When the index was registering heavy gains and positive happenings were quoted like falling interest rates, the country’s economic managers were making strenuous efforts to keep the economy in order. Foreign exchange reserves had reached US$ 16 billion, and there was a positive nod from the International Monetary Fund, indicating that the present government had been on track in the restructuring of the economy. The broadening of the tax net, selling of Eurobonds worth US$ 2 billion, the selling of the remaining stakes in United Bank Limited, Pakistan Petroleum Limited and Allied Bank added flavour to the platter.

These happenings were enough to gear up the stock prices but now it appears all the positives have subsided and some good equities have been in the stranglehold of bears. The positive outlook now seems to be nothing more than a mirage. For decades there has been no substantial change in the market, the participation of small investors has been low as on a number of occasions they suffered losses due to moves by the big players. The dimension, size or name of players may have changed in the last couple of years, but the practices are the same one way or the other.

The current decline can be traced in part to the spate of terrorism in the country, starting from the tragic incident of December 16, 2014 when the Army Public School in Peshawar was attacked by terrorists, along with acts of terrorism in other parts of the country and the uncertain situation in Karachi. These were enough to unnerve the investors’ mood, but the deteriorating law and order situation has now become part and parcel of our day-to-day life.

Foreign selling in March was around US$ 65 million but when compared to March of 2014, the KSE saw foreign investment of US$ 217 million.

Another factor behind the stock market debacle was the series of notices served to the security companies. Some mutual funds were questioned about recent deals as the regulator — the Securities and Exchange Commission of Pakistan (SECP) — caught hold of something fishy. Notices were served by the regulator to several brokerage houses and mutual fund companies on counts of insider trading, front running, wash trades, in-house financing and account disclosure. There is a view that several brokerage houses are now facing the brunt, forcing them to sell their holdings. Moreover, several foreign institutional investors have lodged complaints with the authorities at the Finance Ministry. On several occasions, when foreign investors had placed buying orders with trading companies, suddenly the activity on that particular scrip picked up, leading to charges that these trading houses, after taking the cue from foreign placement, were quick in buying shares.

It has also been observed that big orders were placed by traders following information that some positive happening would soon be heralded in some particular scrips. The information had been leaked through the company’s directors or negotiating company, bolstering the share price, which had not been made public.

Professional fund managers are more inclined towards trading gains, rather than relying on long-term investment strategies, accumulating huge quantities of illiquid stocks in their portfolios. In this scenario, fund managers can inflate the share prices for marginal Net Asset Value appreciation.

The main reason behind foreign selling was the crippling global crude oil price, which plummeted by 40 per cent in the preceding six months, hindering the growth of the local oil and exploration companies. Moreover, selling in the global stock market also forced the foreign investors to sell their holdings in regional markets. Foreign investors are selling on the expectation that the US Federal Reserve might increase interest rates from the present level of 0.25 per cent, enticing investors in the bond market.

From the dotcom bubble to the recent real estate debacle, speculation along with price volatility are all a part of the stock market. Even in the most developed markets, we have seen new and more innovative ways to manoeuvre the market or stocks in favour of odds. After every stock market debacle, regulators learn new ways to reduce the number of major speculative games. In Pakistan, we have learned hard lessons from the ’90s, moving in to the 21st century. The closure of the stock market from August 27, 2008 to December 15, 2008, where the regulator placed the floor, and the 1,000-point drop in the KSE on March 18, can be considered a part of the learning curve. The evolution of regulation is a never-ending journey, with new dimensions and challenges to cope with.

Hopefully, our regulators at the  SECP are qualified and intellectually powerful enough to evolve with the growth of capital markets. The recent challenges from front running, price manipulation of illiquid stocks, wash trades and insider trading need to be handled with an iron hand by the regulator. Even though money makes the mare go in all sorts of businesses, fences must be placed by the authorities to protect small-and medium-size investors from losing their hard-earned money. It seems with all sorts of best practices in place, even today, speculation cannot be completely wiped out from the global capital market. Hence our regulators are required to handle every case with extreme diligence and professionalism to put an end to the battering of our stock market. In the interim period we may see shrinking volumes, but sooner or later the market is bound to return to its real intrinsic worth.

The macro-led valuation rerating has not been sustainable with the market now standing below its end-December 2014 levels. According to Naveed Vakil, chief operating officer of Intermarket Securities, this pullback is a function of several factors:  foreign selling in the last three months, partly due to a partial K-Electric stake divestment by sponsors, as well as concentrated institutional selling; compression in domestic liquidity due to recent pickup in selling of shares by some new companies; increase in political noise particularly in Karachi; and, lastly, concerns over tighter regulatory scrutiny. “This is all within the backdrop of policy rate reversal by the US Federal Reserve going forward, impacting the outlook for global risk assets,” he says.

The market grapevine suggests that nearly all of the foreign selling was attributable to one specific fund, which is liquidating due to exogenous shocks. “With the bulk of this fund selling already absorbed, we expect a slowdown in outflow from this head going forward,” says Taha Khan Javed, head of research at Elixir Securities.

Due to some amicable resolution on the regulatory front with SECP and a likely reduction in foreign outflow, we expect the market to react positively. Inflation will continue its descent over the next six months and another likely cut in interest rates is expected in May, says Javed.

The recent dip at the bourses has opened up the valuation gaps. On the liquidity front, the key issue can come from the upcoming secondary public offerings, which may limit the upside. Thus, foreign flows will remain a key catalyst in determining the market direction, he claims.

The recent cut in the benchmark interest rate was on the cards, and another 50 basis points or half-percentage point is expected in the next two months, which will lower the cost of doing business. But much depends on the measures to be announced in the Federal Budget, in the last week of May or first week of June, which might help resurfacing foreign investors and institutional interests in the local stock market.

This article was originally published in Newsline’s April  2015 issue.