May 8, 2006	Monday	Rabi-us-Sani 9, 1427

IT is said investors have incredibly short memories. That’s an old saying. But what’s truly intriguing is that this notion applies equally to good and bad occurrences in stock markets.

Just as investors have so readily abandoned thoughts of the nuclear test of 1998 that pushed the index to 800 points, and far more recently the March 2005 crisis that was largely swept under the rug, they’ve also become remarkably comfortable with these once-unheard of index levels of 11,000 and 12,000. These figures are now bandied about as if the index was always floating around these levels.

And so it goes at the Karachi Stock Exchange. Since the KSE-100 index made records crossing 12,000 points, the index has had its conventional ups and downs. In the second half of April, a chunky correction chopped 800 pints or seven per cent off the index. But this was largely on account of the supply and demand gap of available stocks. Indeed every time there’s a correction, it is used as an entry point by those investors waiting in the wings.

In the past year, the oil and gas and banking sectors have powered gains at the KSE. According to data from AKD Securities, the market capitalization of the banking sector in the overall index has risen from 12 per cent in January 2005 to 20 per cent today.

Similarly, the market capitalization of the oil exploration and production sector in the overall index has risen from 25 per cent in January 2005 to 32 per cent today. Meanwhile the previously favourite telecom sector has lost out as its market capitalization has declined from 13 per cent to nine per cent.

Strong corporate earnings have been a major contributor to a growing market. Growth in corporate earnings has averaged 25 per cent over the last three years and dividend yields have remained uncommonly attractive.

Now, of course, as prices have climbed, the returns of the last four years are unlikely to be seen again but nonetheless, investors will continue to win well at the KSE.

“Valuations are not as attractive as two years ago,” says Arshad Arif, executive director of research and business development at KASB Securities. “And then countries like the Philippines and Korea are seeing strong growth.”

The fact that Pakistan’s market is compared to others in the region is a new phenomenon.

“The potential is there since a lot of funds are comparing Pakistan to Indonesia, Malaysia, Thailand and India,” says Mohammed Sohail, head of research at Jahangir Siddiqui Capital Markets, who forecast an index year-end level of 13,000 to 13,500 points. One, he expects corporate profits to grow 29 per cent this year followed by 15 per cent next year and five per cent the following year.

Fundamentals and liquidity: Some analysts still rank the oil and gas and banking sectors are favourites. But Nadeem Naqvi, CEO of AKD Securities cautions that while banks’ performance year-on-year (based on first quarter’s results) has been remarkable, on a quarter-to-quarter basis, there is a decline in earnings. “The earnings momentum has peaked off,” he says.

“They will do well and stay at 20 per cent of the index (in terms of capitalization) but won’t be key drivers of the index any longer.” The oil and gas sector will continue to be an important driver of the index, despite the high risks and mass speculative activity.

Meanwhile, PTCL will reverse the losing streak it’s been trapped in for the past year and from January 2007 its earnings decline will turn around. Until then, while the new owners of the company make changes, earnings in the first two quarters of 2006-07 could be lacklustre, analysts warn, barring some dividend-related speculative activity.

Overall, however, the combination of strong fundamentals in the major sectors and high liquidity will lead the index to record levels. The cement industry may not lap up the same prices but high demand from both within Pakistan and from Afghanistan will persist.

Similarly, fertilizer is likely to produce at full capacity with high prices persisting. The oil marketing companies could go either way. If oil prices remain high, volumes will be hurt but inventory gains could also lead to positive earnings surprises.

The government is likely to raise local POL prices on account of pressures on the current account deficit. AKD Securities estimates that the government has already taken a hit of Rs2 billion on POL subsidies.

Liquidity will also help propel the index. KASB’s Arshad Arif expects the index to gain 20 per cent in value by December as changes in the CFS make more liquidity available and cash flows of public sector enterprises become freed up from National Savings Schemes.

Another positive is the pile of cash big funds are sitting on. Eventually this will find its way into the market. Additionally, a slew of new mutual funds are also in the pipeline and as they set up shop, more cash will go into the share market.

Foreign portfolio flows may be slower to come. So far some $325 million have come into the market in foreign money and this could rise on account of the GDR issue. Otherwise, the next few months will be slow since allocations by foreign funds are typically made in January and August.

If the second lot of allocations favour Pakistan, total net inflow of foreign portfolio funds could reach $500 million by December. If the market sustains the 12,000 points level after the budget, foreign funds will trickle back in after August.

Factors to watch: All these happy prospects, however, will depend on various factors. First is political stability. While general elections are still far away from a market perspective, the possibility of big changes is already playing on some minds.

The government’s commitment to investing in infrastructure will also be important. Then, of course, is the growing worry of the expanding current account deficit which has begun to become talk in international investor circles.

While the issue of a Eurobond next year along with the planned OGDC GDR and some receipts from privatization may ease pressures, investors would like to see recurring inflows via growing remittances and higher exports.

“If the current consumer driven growth converts into investment-driven growth, we’ll have a self-correcting mechanism for the current account deficit,” says Naqvi of AKD Securities. It is still unclear what the government’s policy response would be if international oil prices hit $100 per barrel.

The upcoming federal budget announcement could also affect market sentiment but this is only likely if major taxation measures change, the probability of which is low. Of particular worry, is the capital gains tax exemption that the stock market relishes. If that goes, the market could see some high velocity jitters.

Additionally, talk of bringing the real estate sector into the tax net could also cause ripples. While logic holds that tighter regulation in property will bring additional funds flowing into shares, in truth since the major investors in both sectors are the same, taxes in one area will lead to worries about replication in the other. This would act to restrict free liquidity.

In the immediate term, one worry is how the OGDC GDR will be priced. Some analysts are concerned about the size of the offering given limited appetite in the international markets.

The next three to four months are expected to bring a slow summer with an index that’s largely range-bound within a 10 per cent band between 11,000 and 12,000 points. That’s based on a forward price-earnings ratio of 9.6 to 10.6. As autumn gets underway, however, most expect the index to begin charging towards the 13,000 points level and beyond. That’s probably something investors could easily get used to.