Sunday, 26 January 2014

The Drivers of KSE Spectacular Returns in 2013

The year 2013 witnessed a spectacular increase in the Karachi Stock Exchange (KSE) 100-Index. The index increased by 49.4% in the year 2013, which made the KSE as one of the top performers among global stock indices.

KSE has traditionally been regarded as one of the undervalued market based upon price-earning multiples. However, the recent increase in the Index is not solely attributable to the undervaluation of the market. Rather, the economic reforms rolled out by the Nawaz Sharif government have significantly boosted the confidence of the investors, especially the foreign investors. The foreign portfolio investors injected around $404 millions in the KSE in the year 2013, according to National Clearing Company of Pakistan (NCCPL). There are several reasons why foreign investors are interested to invest in KSE.

First, KSE offers good diversification potential for international investors alongside excellent price-earning multiples. Pakistan is not the only market where foreign money managers have been heading to. They have been actively targeting what they term as 'frontier markets' as these markets have high-risk, high-return characteristics. However, from a portfolio perspective, these markets provide better risk-adjusted returns when combined with more developed markets in a portfolio.

Second, money managers have optimistic view points regarding future profit potential of Pakistani firms given that Pakistan population is sixth largest in the world and that this population still has many demands to fulfill. Demands for consumer goods and durables, better health care, education, and luxury goods, are ever increasing in this part of the world. Also, companies in Pakistan have shown good resistance to the ongoing security and unstable economic conditions. These companies can prove to be good investment opportunities.

Third, the present government has shown keen interest in several key areas of the economy to bring improvements in them. First of all, it paid off around $5 billion circular debt of the energy and power sectors which helped in reducing power outages and freeing up funds for fuel import. Second, it has shown interest in privatizing ailing organizations such as PIA, Pak Steel Mills, and the likes to avoid further burden on the national exchequer. Third, the government has been successful in  getting bail-out loan from the IMF and financial assistance from USA for war on terror.

Despite the phenomenal growth in the KSE-100 Index in 2013, there still exist many concerns regarding the future direction of the Index. Since 2008, the index has grown by 330%, which might have an element of bubble and investors' overreaction , given the riskiness of the country. Historical research show that when a market rises substantially above its historical levels, the chances of further increase become less and less. Moreover, as fickle as foreign  capital can be (as one can refer to the Asian Crisis of 1997), capital flight poses a serious threat to the future performance of KSE. Furthermore, it is expected that State Bank of Pakistan will have to increase its discount rate to curb the rising inflation rate. Another factor that can pose risk for the KSE is the foreign exchange rate, which the SBP has to leave untouched in accordance with the IMF conditionalaties. Despite all these, stock analysts are still optimistic that the KSE-100 Index can reach 30,000 points by the end of 2014.