03 September, 2014 / Ziqa'ad 7, 1435

S for Stocks, S for Satta

Published Aug 14, 2013 06:05pm

Investments can be risky, but risk can’t be an investment. This fine distinction is, however, lost at the Karachi Stock Exchange (KSE) that continues to flirt with risk and demonstrates unearned enthusiasm.

In the past 24 months alone, the KSE has risen by 110 per cent. This irrational exuberance in the stock market coincides with a dismal economic performance in Pakistan, where all sectors of the economy have struggled because of power, political, and institutional crises, to name a few. At the same time, other stock indexes, which are based on more stable and much larger economies, have posted relatively moderate results. During the same time period, FTSE was up by 22 per cent and NASDAQ by 43 per cent. A regional bourse SENSEX, widely known as the barometer of Indian capital markets, was up by merely 14 percent.

Stock markets provide an avenue to invest savings with the intent to see them grow. Risk is inherently coupled with investments, but investments are certainly not a gamble. The market fundamentals, to a large extent, inform the stock market outcomes. In capital markets, liquidity is king. The KSE, according to the London-based The Economist, “is illiquid: only 60 of its 569 listed companies’ trade regularly.” With billions invested in the bourse, such cavalier attitude of investors and tampered oversight by the regulators does not bode well for Pakistan’s capital markets.

The Economist in a recent issue warned investors of the unknown risks inherent in investing with the KSE. “You have been warned”, concluded the magazine. Yet, news outlets in Pakistan, with some exceptions – such as Khaliq Kiani in Economic Times in April 2010 – have failed to raise concerns about the Exchange whose performance is out of step with the socio-economic realities in the country. Whereas institutional investors may have the means and the information to time their exit, the small time investors will be left to cope with the collapsing index, which has been the case in the past.

It was only in 2008, and earlier in 2005, that the KSE lost billions in a matter of days depriving unsuspecting investors of their lives’ savings. Each precipitous decline in the exchange was preceded by unprecedented growth that was not supported by the market fundamentals, but instead fuelled by pure ignorance or hubris. In July 2008, the KSE reported losses for 15 consecutive trading days, the Index’s worst performance in 18 years. The New York Times reported that Index had fallen by 36 per cent in mid-July after reporting record highs only in April. The newly elected PPP government, which seemed inept to curb the market crisis, eventually halted trading on August 28, 2008.

The Exchange crashed earlier in March 2005 when the KSE dropped by 27 per cent after it appeared that investors in case of a collapse may not be able to honour the bets made on margin. Just before the collapse, the Exchange had appreciated by a record 65 per cent between January and March 2005.

The current boom in Pakistan’s stock markets is partially the result of the government’s attempt to legitimise black money. An ordinance promulgated in March 2013 allowed investors to buy stocks up until March 2014 without having to declare the source of the invested funds. Billions of untaxed funds thus made their way to the stock markets where the investors were not charged any income tax. Instead, a transaction tax of 0.01 per cent was introduced instead.

The collapse in March 2005 and July 2008 were preceded by exceptional record breaking highs in the Index. It was the margin calls in 2005 and the politico-economic crisis in July 2008 that sent the Exchange tumbling down, wiping out billions in previous gains. The KSE’s performance in August 2013 appears eerily similar to the pre-collapse trading of the last two crashes. The Exchange has risen by 40 per cent since the start of the current year. Last year, it surged by 49 per cent. At the same time, the economy has grown at a dismal rate of 3 per cent per year in a country where demographic growth and inflation make the 3 per cent annual economic growth rate inconsequential.

The stock markets in Pakistan can mature in size to become a viable vehicle for investments. However, this will require honest and effective regulators to mind the markets. The current regulatory frameworks are inadequate to pre-empt disastrous stock market outcomes in the future.


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Murtaza Haider is a Toronto-based academic and the director of Regionomics.com.


The views expressed by this blogger and in the following reader comments do not necessarily reflect the views and policies of the Dawn Media Group.

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Comments (11) (Closed)


Imran
Aug 14, 2013 07:51pm

Its Mar'2012 not March'2013 when government announced "no question asked about the funds"

Nauman
Aug 14, 2013 10:01pm

Poor article....no motivation, no conclusion.....

An Investor
Aug 15, 2013 12:12am

I am color blind to see the performance difference between the blue and purple graphs. However as a foreign investor, while reading your article all was going well until your last paragraph which has thrown a spanner and has made me retract. Sorry.

You may get comments from avid readers saying the Exchange Economy era is on us right now with good tidings and that your view is only that of an academician sitting on top of an ivory tower and all you are seeing are banana peels.

safdar
Aug 15, 2013 01:54am

Very nice article, I know a few friends who have lost considerable amount of money in KSE. The rise is all sata, purely speculative rather than performance of our economy, which ironically is so evident but then how many of those individual investors are fundamental analysts?, their decisions are based on recommendations of few so called technicians, who only win whether you are earning or losing.

Nazim
Aug 15, 2013 09:31am

Pakistan economy in crises, all indicators negative, still Pakistan Stock Exchange index rocketing new heights. It is good opportunity for Mr Ishaque Dar to invent new economics theory on this phenomena and obtain P.hd. Government closes its eyes from such rise in Index, to show its performance. Scruples satta baz take advantage of this weakness to fleece public. Pakistan Security and Exchange Commission should inform public details of dividends declared by different blue chips companies in the past three years. So that public knows return percentage on their investment. In spite of such rosy picture of return on investment why there is stalemate on investment, why no new companies are listed on Stock Exchange with public offering of shares.

B.Ally
Aug 15, 2013 10:00am

Risk management is an acquired skill. If applied effectively, investments even in a manipulated KSE, can fetch good return. One needs to stay alert day in and day out.

Tariq
Aug 15, 2013 12:49pm

Dear Murtaza,

I have enjoyed reading your columns relating to politics and socioeconomic issues, but in this case it appears you have shown little understanding of capital market fundamentals. I justify this with the following points:

1) Rises in stock markets should always be compared with the earnings of their underlying companies and not simply on their own. Pakistan had the highest corporate earning growth in Asia as per Bloomberg in 2012 and continues to have the among the highest in 2013. As a result, even after the recent rally, the Price to Earning (P/E) ratio is still the lowest in Asia at 8.0-8.5x. The P/E ratio on the eve of the financial crisis in Pakistan in 2008 was around 13.0x.

2) In developing countries, the composition of the stock market is very different than the composition of the GDP. The KSE100 Index is mainly composed of Oil&Gas, Banks and Fertilizers whereas the composition of the GDP is Retail & Wholesale Trade, Livestock, Large Scale Manufacturing etc. The large cap companies listed on the KSE still have excellent earning capacity due to their own core competencies despite an overall dismal economic environment macroeconomic environment.

3) Recently, the spread on the Pakistan Euro Bond has gone down by close to 3%, reflecting an improvement of foreigners risk perception about Pakistan following smooth transition in the elections and positive expectations from the new government. This is an additional factor that help improve company valuations and extend the rally.

Tariq Ali, CFA

Tariq
Aug 15, 2013 01:29pm

Dear Murtaza,

I have always enjoyed reading your columns related to socioeconomic issues and politics. But in this case I believe you have shown little understanding of capital market fundamentals. I justify this with the following points.

1) Rises in stock markets should always be compared to the earnings of their underlying companies and not simply on their own. Pakistan had the highest corporate earnings growth in Asia in 2012 as per Bloomberg and continues to have among the highest in 2013. As a result the Price to Earnings Ratio (P/E) is still 8.0-8.5x, which is the lowest in Asia even after the recent rally. The P/E ratio was 13.0x on the eve of the financial crisis in 2008.

2) In developing countries the composition of the stock market can be vastly different than the composition of the economy. The companies listed on the KSE are mainly Oil&Gas, Banks and Fertilizers whereas the GDP is composed of Wholesale and Retail Trade, Livestock, Large Scale Manufacturing etc. Many of the large cap companies listed on the KSE have excellent earning capacity due to their own core competencies and may not be reflective of the overall dismal macroeconomic picture.

3) The spread on the Pakistan Euro Bond has come down by close to 3% recently which reflects the foreigners improved risk perception about the country following a smooth transition in the elections and positive expectations from the new government. The narrowing of the spread would have improved company valuations and help extend the rally.

Tariq Ali, CFA

sja
Aug 15, 2013 09:27pm

you say: "S for Stocks, S for Satta""

Let me add""" S for Shaytan, S satta pay satta, awamunas kha BHATTA""

Karachi Stock Brokers ki "" 'Diwali"" Pakistan kay investors ka "DIWALA""

sja
Aug 15, 2013 09:51pm

@Nauman: that is the exact nature of Satta pay "Satta""???

sja
Aug 16, 2013 08:04pm

@Tariq: Tariq -- I have followed DJ since 1973 and when I graduated in 1975 my professor asked to predict DJ average at the end of 1975. It had been 500-600 range until 1975 then I was the only one to say it would cross over 1000, the professor was surprised and said how come? Then I told him about the formula and the parameters and he said we will see. In December 1975 DowJones was 1150. So like you are a CFA i have been in the profession. It is all very pragmatic and programmed exercise, there are short term and long term strategies and then coupled with derivates and options and other things. Yes there is market analysis and P/E but it all depends who is doing it and what is the intention, have you followed TELECARD activitiy in Pakistan ever, very interesting people loosing and company doing its own turnovers, anyways, I enjoyed also when DOW JONES crossed over the 14000 and it is always like this there are some who are insiders and they make or break the market on the daily basis becaused nobody can program them ---- have you seen on CNN Jim and his throwing things and shouting """"Sell, Sell, Sell""" when you sell price falls in Karachi Stock specially and when you buy the price increase see the daily KS reports for the last 10 years.