IMF’s loan sparks soaring markets
Naysayers are unmistakably caught off guard. A mere revival of the International Monetary Fund (IMF)’s bailout programme has done the trick. What could have been achieved much earlier was needlessly delayed until the brink of default. Perhaps our culture is entrenched in the notion of hard work only when the sky is on the verge of falling. The clouds of macroeconomic uncertainty are finally dissipating. The Pakistan Stock Exchange (PSX)’s 22% surge is merely the beginning. Or is it?
Stock markets are typically evaluated using the Price to Earnings (P/E) ratio—how many Rupees (price) investors are willing to pay for an asset generating (earning) Rs1 profit per year. Of course, the “E” represents a calculated bet involving the company’s future growth rate, industry dynamics, and anticipated economic conditions. The broader Karachi Stock Exchange (KSE)-100 Index was trading near a 3x P/E—a feat not witnessed for decades—only to now hover around 4sh P/E despite recent gains. Whether these jubilations persist hinges on our expectations and government initiatives.
The constant oscillation between optimism (boom) and pessimism (bust) has systematically eroded Pakistan’s economic allure in the eyes of investors. In stark terms, our discount has widened to the extent that investors have steered clear of Pakistan as an investment hub, demanding significantly higher returns to offset risks. Coupled with the global context of a 5% rise in US interest rates, the attractiveness of Emerging/Frontier markets has markedly diminished. A substantial portion of global and local capital is gravitating toward “risk-free” fixed returns.
In the immediate future, savers revel in earning 20-22% annually. Foreign investors comfortably attain double-digit fixed-income yields through better-rated corporate bonds in their home markets. It’s no surprise that hot money isn’t flowing into Pakistan, and the influx into dollarised Naya Pakistan Certificates remains stagnant. These should be revised upward, regardless. In such a cycle, stock market investors are clamouring for “more.”
Many listed companies are already trading at appealing asset values. Those exhibiting rising profitability—such as banks, energy exploration, textile, and power—are trading at cyclically lower P/Es despite robust rupee profitability. While concerns about liquidity, loan losses, and energy prices cast shadows on the optimism for these sectors, at least their bottom line remains promising. Industries with high-risk profitability—like cement, automobile, steel, food, and oil marketing—see their profits at the lower end of the economic cycle, and so are their asset/replacement values. The bet is that the worst is behind us.
Regrettably, retail investors often enter the stock market after hearing success stories from the past 2-4 years, gaining enough confidence to dip their toes. However, by that point, 50-60% of the total upside—from bottom to top—has already been seized by early adopters. Developed markets with solid macroeconomic fundamentals don’t experience such volatile swings in economic fortunes. In the last 6 years, Pakistan’s interest rate has oscillated twice, from 6% to 13% in 2019 and 9% to 22% in 2023. How can one possibly expect investors to remain loyal to a single equity asset class amidst such drastic changes in alternatives?
In a nutshell, investors must meticulously monitor external macroeconomic circumstances. Paramount is political stability, followed by a nearly balanced current account deficit, stable foreign exchange reserves, controlled inflation outlook, reduced interest rates, sustained export growth, maintained primary surplus, improved tax-to-GDP ratio, gradual reduction of circular debt, unwavering adherence to IMF reviews, and robust geo-political ties. Meanwhile, company-level fundamental analysis demands projections on volume, prices, margins, financial costs, new products, asset quality, diversification, utilisation, cash flows, and expansion plans.
Achieving returns higher than risk-free alternatives isn’t simple, but it’s worth avoiding regret down the road. Assuming a long-term P/E of 5.5-6x is restored, we can reasonably expect mean-reversion in valuations within a few years under stringent IMF compliance, boosting investor confidence and anticipated returns.
The next phase of economic returns will hinge on sustainable earnings (“E” based) recovery, requiring rigorous due diligence and prudent selection of investments. Currently, foreign investors have absorbed $20 million in shares, sponsors are conducting share buybacks, and astute investors are accumulating. Although retail investors typically join the party late, they shouldn’t gate crash when the concert is over. Buying shares equates to taking ownership—don’t leap without doing your homework.
THE WRITER IS AN INDEPENDENT ECONOMIC ANALYST
Published in The Express Tribune, August 7th, 2023.
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