The dilemma of the country’s equity markets

When it comes to discussing people who ply their trade in the stock markets, especially local exchanges, the general perception is that they are gamblers and nothing short of vampires. Another fable we regularly hear is that the ‘small investor’ always loses out and it is the big fish who make all the money.

Before proceeding, it is essential to highlight certain facts about the Karachi Stock Exchange (KSE).

On January 1, 2000, the KSE-100 index closed at 1,457.07 points. On August 31 this year, the same index had a value of 9,813.05 – a change of 573 per cent. In layman’s terms, if you had invested Rs100,000 ten years back, the value of your investment at the end of August would have been Rs573,000. This figure does not include the dividends you may have received on the shares you purchased. During this period, the market touched an all-time high of 15,676 in April 2008, while the worst closing was 1,075 points in October 2001.

It is not all rosy if you had invested at highly inflated levels. After the market peaked in April 2008, a number of factors must have given investors some nightmares. These included the turmoil caused by a rift between political parties regarding the restoration of the judiciary, falling value of the rupee against the greenback and the liquidity crisis that was triggered by rumours of a lower bound on share prices.

The KSE-100 index was frozen at 9,180 for nearly two and a half months. Volumes dried up and average turnover was less than half a million shares between October and December 2008. When the floor was removed, the market moved downwards, losing 48 per cent between December 12, 2008 and January 26, 2009.

Between January 26, 2009 and August 31 this year, the index went up by 104 per cent. Hence, those who had cash or those who did not sell in desperation, have enjoyed the fruits of the recovery.

The opportunity that Pakistan offers to the world is no less compelling than any other emerging economy of the world. What an emerging market sells is its growing population and the need for infrastructure investments.

Unfortunately, due to terrorism and political storms, albeit in tea cups, the crisis of confidence that Pakistan is continuously exuding for the last three years has taken precedence over its investment opportunities.

When overseas Pakistanis have to sell their country  as a compelling case for investment, the stock market is taken as a barometer and a reflection of the economy.

Investors look at the stock market because it is the most liquid way of investing in a country. In Pakistan’s case, it becomes all the more important because of the very liberal profit repatriation rules that exist.

The amount of Special Convertible Rupee Accounts (SCRAs) and the levels of repatriation of dividends, as monitored by the State Bank of Pakistan, are a reflection of this fact. During this year alone, SCRA outflows have been Rs42.70 billion (around $500 million) and profits and dividends repatriated by foreign companies in fiscal 2010 stood at $775 million.

Regarding the stock market, there are two major pending issues: the implementation of a leverage product, the margin trading system, and the settlement of capital gains taxation. These two issues need to be resolved as investors focus on operational matters instead of opportunities.

Due to the lack of a leverage product, volumes have fallen significantly. In 2005, the average daily volume at the KSE was a very healthy 360 million shares which fell to 131 million shares in 2008. Not many people realise this, but as many as seven members of the KSE have been expelled and five members have become inactive.

A visit to the KSE website will demonstrate the high number of branch offices that active members have closed down. If brokers cannot attract trading business, they cannot cover their operational costs and hence cannot continue their operations. It is as simple as that.

The capital gains tax is a matter which will weigh heavily on the market in days to come. Although many are in favour of taxation on capital gains, the lack of clarity makes investors jittery.

We are now witnessing that investors are showing an interest in the inexpensive valuations offered by the companies on the KSE once again.

According to The Financial Times, KSE-100 companies are trading at price to equity (PE) ratios of nine times and offer a healthy dividend yield of 5.7 per cent. For the sake of comparison, our mighty neighbour’s market is trading at a PE of 22.5 times and offers just a 0.9 per cent dividend yield.

Our stock market has seen difficult times in the last two years or so. When the market is unable to move, investors do not show interest in participating. Political, terror-related and image issues are not under control of key stakeholders but operational issues such as a consensus on a leveraged product and the treatment of capital gains tax should be sorted out at the earliest by KSE members, the exchange’s board of directors, the Securities and Exchange Commission of Pakistan (SECP) and the Federal Board of Revenue.

Our inability to sort out basic operational matters, unfortunately, has become our biggest weakness.

Published in The Express Tribune, September 27^th, 2010.