Pakistan stock exchange is hitting new highs, is the recent run sustainable?

[dropcap]T[/dropcap]he author is a PhD in Business Administration with a focus on Finance. He carries an experience of eleven years of teaching in different institutions. Presently, he is associated with National University of Sciences & Technology (NUST), Islamabad and working as Assistant Professor. Email: zubair@s3h.nust.edu.pk)

A country’s stock market is considered an important indicator of the financial health and provides investors with estimates of the volatility and returns associated with investment. The stock market provides a summary of companies business and indicates the magnitude of trading activities of listed firms being undertaken by investors. As the market index moves higher, the prospects to obtain higher abnormal returns increase.

An examination of the near term trading history of the Pakistan Stock Exchange (PSX) after the recent upswing shows that investors have obtained abnormal returns. It is interesting to note that PSX crossed the milestone of 50,000 which indicates that it grew by 2720 mark from January 31, 2000 to January 24, 2017. The bullish behavior of the PSX is more prominent over the last year whereby the KSE-100 Index grew by 46% showing an increase of 18,701 points. The substantial improvements posit that the PSX is growing more rapidly when compared to other exchanges of the world.

In comparing the KSE-100 and S&P 500 indexes, the S&P 500 shows less growth when compared against the KSE-100 Index. Conversely, the S&P 500 index is also a stable index that shows a consistent improvement with pace to grow more.

The figure below indicates that the KSE-100 Index is more volatile and has recently generated higher abnormal returns.

As market prices increase, investors tend to participate in its rise and to capitalize on the market’s returns but for an investor a question arises as to how and where?

Presently investors keep their funds in a bank, invest in mutual funds, micro financing, small industrial estates, real estate, gold or commodities, stock market, and foreign currency trade in kerb market. In the case of current circumstances, all investment possibilities are generating smaller returns when compared against the stock market. Most of the investors, thus, are exploring business in stock market to earn higher returns.

At present, the economic indicators reflect slower economic growth, stagnant large-scale manufacturing, declining trends in exports, remittances, foreign direct investment, massive borrowing by the government from the State Bank of Pakistan (SBP) to finance fiscal deficit, and subdued credit off-take by the private sector.

In the presence of these indicators, PSX evinced bullish behavior and consequently represented progression in KSE-100 Index.

By keeping in mind all above factors, a question arises for a general investor as to why stock market is thriving despite the fact that other sectors of the economy are sluggish and not showing any substantial improvement? It’s a general phenomenon that investment in stock market is much riskier and provides higher returns. However, there should be some rationale for growth in the stock market. The abnormal movements of PSX raises concerns for the investors (e.g. in case of bearish behavior how much loss they will bear?) What are the other options for investment? How long will bearish behavior prevail?

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To address such concerns, various factors as are explained below:

I- PSX is still underpriced illustrating that on average price-earnings (P/E) ratio of listed companies is just 10 relative to P/E ratio of 14 and 20 in developing and developed countries respectively. This shows the main reason for booming PSX and, therefore, in near future it will further flourish.

II- The emergence of three stock exchanges into PSX boosted the confidence of investors.

III- Imposition of property tax reduces the investment in the real estate business. Hence, less activities in this sector generated more focus on investments in the stock market.

IV- Investments made by the China-Pakistan Economic Corridor (CPEC) had a significant impact on stock market activities evidently and lead to a sharp rise in scrip prices of cement, steel, automobile, and electric sectors. Due to various projects being undertaken through this opportunity, there would be increase in demand and supply in the times to come helping in increase in scrip prices.

V- Recently, PSX sold 40% strategic shares along with the management control to a Chinese consortium worth of $85 million. This consortium includes 30% shares of Shanghai Stock Exchange and Shenzhen Stock Exchange and 5% shares each by Pak-China Investment Company Limited and Habib Bank Limited. The control of new management will help devise and monitor stock market activities more efficiently and effectively thereby resulting into enhancement in the confidence of investors.

VI- Development of online trading system is one of the important reforms taken by the Securities & Exchange Commission of Pakistan (SECP) of which every investor can monitor their trading activities and reduces any manipulation of funds by brokers.

VII- SECP imposed the capital gain tax on the sale of shares, but if investors hold them for a period of three years, they will be exempted. This tax exemption incentivized investor to retain their holdings for a longer time frame and not focus in on obtaining short-term profits.

VIII- The stability of currency exchange rates also increased the confidence of foreign investors. Earlier, due to volatility of currency exchange rates, it was difficult for investors to estimate their returns.

IX- A very few opportunities prevail in the economy to make investment and obtain higher returns except stock market. This has increased the confidence of investors to explore business opportunities in the stock market as a result of which an improvement in market capitalization is witnessed every now and then.

X- The government influence in the shape of providing incentives to diversified sectors resulted into deriving more confidence by the business community for further investment.

Last but not the least, it is argued that PSX is not motivated by economic fundamentals but the boom recorded therein is as a result of numerous measures taken by the regulator that is SECP as well as the Government which led reposing the confidence of investors to flourish the stock market to its peak. The PSX has a potential to grow more in near future where investors may earn abnormal returns because of a number of investing activities.