View from McLeod Road: Pre-earnings season jitters sparking a market correction

Value investors cautiously optimistic about a buying opportunity in the coming days.

KARACHI:

As trade-screens up and down Karachi’s McLeod Road turned almost uniformly red on Wednesday, there was only one question on most minds: is this the end of a spectacular bull run, or is it just the market taking a breather after having seen a remarkable 49% rise over the past one year?

The consensus seems to ride on the latter. Virtually no analyst believes that the market is anywhere near bubble territory, and say it still has a healthy rise left in it. Most analysts spoke of the benchmark KSE-100 index crossing the 18,000-point barrier in 2013, and some even suggested that the 18,500 level may not be out of reach.

On the earnings front, the Karachi Stock Exchange remains highly undervalued compared to its regional peers, with the market price-to-earnings (PE) ratio far lower than even its own historical levels. JS Global Capital estimates that the market’s PE ratio is currently around 7.3, much lower than the historical average of over nine times earnings. And earnings are only set to grow over the coming year, as both the government and consumers expand their spending, causing revenues to rise and profits to soar as the slack capacity from the pre-crisis era gets put to use again.



So why has the market gone down by over 415 points, or about 2.5%, over the last two days?

“There is an absence of positive triggers,” says Raza Jafri, a research analyst at AKD Securities, an investment bank. “We are getting closer to election season, and politics is beginning to make its presence felt. The earnings season is still a month away, so the absence of good news precludes a lift in the market.”

According to research conducted by AKD Securities, over the past six years, the average correction has lasted about 38 calendar days and caused the market to go down by an average of about 9%. The timing element seems almost perfect: if this correction lasts close to the average duration, it will see us off right to the beginning of earnings season. The earnings announcement period is an important time, since nearly all financial sector companies – as well as some consumer goods giants – announce their annual results in that period.

Then, given the fact that the market seems to be going down out of sheer nervousness and little else, and considering that the corporate earnings outlook remains intact, this should be a great time to buy stocks... right?

Portfolio managers and buy-side analysts are reluctant to give an unqualified yes. One answer that portfolio managers seem particularly prone to give is: “I am selectively optimistic about some stocks at these price levels.” That is good to know, because if every market dip caused them to indiscriminately start buying stocks, one would have reason to seriously question their professional credentials to be running an investment portfolio.

One buy-side analyst, however, does offer some interesting insights into the thinking of institutional investors: “If I am a value investor, I still want to make sure that I buy the stock as close to its bottom as possible. I do not want to buy Nishat Mills at Rs62 per share, knowing that if I wait just a few more days, I could get it at Rs59 per share.”

That is a reasonable point, but it does beg the question: why would people be willing to sell stocks like Nishat Mills at Rs59 per share when they know it is going to go back up?

Jafri has an interesting hypothesis about that: “The market has just had a very good year. A lot of people are in the mood to book profits now. They know that the likelihood of the market having another blowout year is low.”

Yet, despite that, Jafri remains optimistic. “We think the market will likely reach 18,000 to 18,500 [points], but its path there will likely not be linear.”

Published in The Express Tribune, January 3^rd, 2013.                

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