For those whose fortunes are tied to the gyrations of the stock market, it has been a summer to forget. From its peak on May 25, reached just days after the long-anticipated announcement that Morgan Stanley would be upgrading Pakistan to emerging market status, the benchmark PSX-100 has collapsed in spectacular style, closing out last week nearly 20% below those euphoric highs. The PSX-30, the index of the largest, most actively traded companies, that is tracked by most foreign investors, is down even more, with losses of around 23% from the peak. So Mr and Mrs Aslam down the lane, whose breathless broker got them all excited about the emerging markets upgrade just as they were going abroad to beat the heat, have returned in August to find that a quarter of their money is gone.
Unsurprisingly, they are fuming. What the hell happened, they want to know. Lucky for their broker, he has a simple answer. Panama Leaks. Unluckily for the state of financial literacy and understanding, this lazy answer is being repeated in newspaper articles, on television talk shows, and in phone calls around the country.
To be sure, markets hate political uncertainty. But this is Pakistan. We had one of the best performing stock markets in the world, year in, year out, through bomb blasts, Taliban land-grabs, government removals, political violence—the whole bag of frontier market fun and games. So what gives this time?
Scratch just a little beneath the surface and the components of the full answer start to become clear. The futility of news-chasing, widespread misunderstanding of the impact of index inclusion, an extremely disappointing corporate earnings season, and a sharp deterioration in the macroeconomic situation, all contributed to the summer surprise for the Aslams. And hopefully, understanding all these factors will help Mr and Mrs Aslam become more prudent investors in the future.
Buy the rumour, sell the news, says the market adage, highlighting the futility of investors chasing and reacting to news items. The emerging markets classification has played out like a textbook example of this. For months, the market soared in anticipation of the upgrade. The PSX-30 rose almost 50% in the year leading up to the Morgan Stanley decision, helped along by the tailwinds of CPEC materializing. That alone should have given the Aslams a pause. How much is the market already up in anticipation of this news, they should have asked their broker. And this would have been an easy question for the broker to answer. The harder question to answer, if anyone had asked, would have been: what will be the net foreign portfolio inflows resulting from this upgrade?
The answer to that question took the market by surprise, and left many anticipatory buyers licking their wounds. Central clearing agency data reveals that foreign portfolio investors have actually been net sellers of Pakistani stocks all year, and were especially heavy sellers in the days immediately after the upgrade went into effect. How is this possible? The answer borders on the arcane but merits a mention given its importance.
In a nutshell, when Pakistan was considered a frontier market, it was a big fish in a small pond. Investment funds that focused on this area of the market had to ensure that they held a certain amount of Pakistani stocks so they wouldn’t miss out on any big gains in Pakistan that would move their index. After the upgrade, they needed to remove sizeable Pakistani holdings or exposure from their portfolios. That’s where the selling pressure came from.
And why was there no buying pressure? As an emerging market, compared with the likes of China, South Korea, and Brazil, Pakistan is insignificant. No one managing an emerging market fund, whether passively or actively, really needs to ensure any exposure to Pakistan at all. It makes up less than 1% of the index value. So, while brokers across Pakistan were telling their clients to load up in anticipation of foreign buying, what was actually happening was that foreigners were selling. Why didn’t everyone know this? Because, as always, the most astute analysts, investors, and traders in financial markets have a primary responsibility: to make money for their funds. Not to tell everyone how they are going to do it. Nothing sinister in this, but it is worth being aware that the people selling mutual funds to the Aslams and their friends aren’t typically the most sophisticated market analysts.
This explanation of foreign flows has certainly received some attention in the mainstream media. What seems to have completely escaped those writing about the market’s summer swoon though, is the deterioration in corporate earnings. If Mr and Mrs Aslam don’t know that when they buy a share of stock, they are actually buying a share of that company’s future earnings, then they should know that now. They aren’t buying a share in CPEC, or a share in the fortunes of Nawaz Sharif. They are buying a stream of hard cash earnings from real companies that do real business. And when earnings and expectations of future earnings, go south, so do stocks. And that’s been happening the whole summer.
The six large Pakistani companies that were included in the index were Habib Bank, United Bank, OGDC, Engro, Lucky Cement, and MCB. Ironically, these six companies are the six largest contributors to the KSE-30’s plunge between May and August. In fact, they account for over 50% of the total drop in the index. And here’s what’s even more interesting. This month, when earnings for the final quarter are usually reported, every single one of them, either reported, or is expected to report, a year-over-year drop in earnings for the final quarter of fiscal 2017.
Shrinking margins in the banking sector, a typical effect of a low interest rate environment, drove UBL earnings for the final quarter of fiscal 2017 down 18% versus those of the same quarter last year. HBL earnings were down about 6% over the same period, and are now widely expected to have a similar impact on MCB earnings. Engro earnings for the first half of the year came in down about 30% (granted, year-over-year comparisons for Engro are difficult this year due to one-off items). Lucky Cement earnings for the final quarter of fiscal year 2017 were slightly lower than those of the prior year, and the outlook appears grim, given it has just been forced to reduce prices, signalling fears of cement overcapacity. To round off the gang of 6, expectations for OGDC’s fourth quarter of fiscal year 2017 earnings are converging to around 10% down year-on-year.
Any discussion of the stock market’s performance that does not even mention this earnings whammy, does investors and observers a great disservice.
A full explanation of the market’s performance must also include a survey of macroeconomic conditions. For a variety of reasons, widely discussed in the media, it is becoming a consensus view that Pakistan, with exports falling, imports soaring, and the exchange rate (which should be the balancing mechanism for such a situation) being held artificially constant by government policy, is moving in slow motion towards a balance of payments crisis. This fact alone would likely serve as a bigger red flag on any serious investor’s radar than the non-violent removal of a prime minister.
And it was thus that Mr and Mrs Aslam, out to make a quick buck, found themselves in the middle of the perfect storm.
So what should they learn from all this?
The first thing is, please don’t go out and sell your holdings based on what you have just read! Remember, act on the rumour, take profit on the fact. Or better yet, for most individual investors, take a long view and don’t run around chasing rumours and news in the first place. Ask yourself how much the market has already fallen as a result of all the negative factors you already read about. Study the history of the market to try and understand what prior crashes have looked like, and how far the markets have fallen. Make an effort to understand trends in corporate earnings. Think about price/earnings ratios as a measure of expected return on your investment. Develop a sense of the cyclical and secular macro-economic context for your investments. And most of all, if anyone ever, tries to give a one-word explanation for a 20% market drop, don’t ever listen to them again.
The writer is a Lahore-based columnist and consultant. He has served as a director in the global markets division of a major European investment bank. The views expressed here are his own, and are intended for general informational purposes only. They should not be construed as financial advice. The reader should be aware that the writer has investments in all of the stocks mentioned in this article
Unsurprisingly, they are fuming. What the hell happened, they want to know. Lucky for their broker, he has a simple answer. Panama Leaks. Unluckily for the state of financial literacy and understanding, this lazy answer is being repeated in newspaper articles, on television talk shows, and in phone calls around the country.
To be sure, markets hate political uncertainty. But this is Pakistan. We had one of the best performing stock markets in the world, year in, year out, through bomb blasts, Taliban land-grabs, government removals, political violence—the whole bag of frontier market fun and games. So what gives this time?
Scratch just a little beneath the surface and the components of the full answer start to become clear. The futility of news-chasing, widespread misunderstanding of the impact of index inclusion, an extremely disappointing corporate earnings season, and a sharp deterioration in the macroeconomic situation, all contributed to the summer surprise for the Aslams. And hopefully, understanding all these factors will help Mr and Mrs Aslam become more prudent investors in the future.
While brokers across Pakistan were telling their clients to load up in anticipation of foreign buying, what was actually happening was that foreigners were selling
Buy the rumour, sell the news, says the market adage, highlighting the futility of investors chasing and reacting to news items. The emerging markets classification has played out like a textbook example of this. For months, the market soared in anticipation of the upgrade. The PSX-30 rose almost 50% in the year leading up to the Morgan Stanley decision, helped along by the tailwinds of CPEC materializing. That alone should have given the Aslams a pause. How much is the market already up in anticipation of this news, they should have asked their broker. And this would have been an easy question for the broker to answer. The harder question to answer, if anyone had asked, would have been: what will be the net foreign portfolio inflows resulting from this upgrade?
The answer to that question took the market by surprise, and left many anticipatory buyers licking their wounds. Central clearing agency data reveals that foreign portfolio investors have actually been net sellers of Pakistani stocks all year, and were especially heavy sellers in the days immediately after the upgrade went into effect. How is this possible? The answer borders on the arcane but merits a mention given its importance.
In a nutshell, when Pakistan was considered a frontier market, it was a big fish in a small pond. Investment funds that focused on this area of the market had to ensure that they held a certain amount of Pakistani stocks so they wouldn’t miss out on any big gains in Pakistan that would move their index. After the upgrade, they needed to remove sizeable Pakistani holdings or exposure from their portfolios. That’s where the selling pressure came from.
And why was there no buying pressure? As an emerging market, compared with the likes of China, South Korea, and Brazil, Pakistan is insignificant. No one managing an emerging market fund, whether passively or actively, really needs to ensure any exposure to Pakistan at all. It makes up less than 1% of the index value. So, while brokers across Pakistan were telling their clients to load up in anticipation of foreign buying, what was actually happening was that foreigners were selling. Why didn’t everyone know this? Because, as always, the most astute analysts, investors, and traders in financial markets have a primary responsibility: to make money for their funds. Not to tell everyone how they are going to do it. Nothing sinister in this, but it is worth being aware that the people selling mutual funds to the Aslams and their friends aren’t typically the most sophisticated market analysts.
Central clearing agency data reveals that foreign portfolio investors have actually been net sellers of Pakistani stocks all year, and were especially heavy sellers in the days immediately after the upgrade went into effect
This explanation of foreign flows has certainly received some attention in the mainstream media. What seems to have completely escaped those writing about the market’s summer swoon though, is the deterioration in corporate earnings. If Mr and Mrs Aslam don’t know that when they buy a share of stock, they are actually buying a share of that company’s future earnings, then they should know that now. They aren’t buying a share in CPEC, or a share in the fortunes of Nawaz Sharif. They are buying a stream of hard cash earnings from real companies that do real business. And when earnings and expectations of future earnings, go south, so do stocks. And that’s been happening the whole summer.
The six large Pakistani companies that were included in the index were Habib Bank, United Bank, OGDC, Engro, Lucky Cement, and MCB. Ironically, these six companies are the six largest contributors to the KSE-30’s plunge between May and August. In fact, they account for over 50% of the total drop in the index. And here’s what’s even more interesting. This month, when earnings for the final quarter are usually reported, every single one of them, either reported, or is expected to report, a year-over-year drop in earnings for the final quarter of fiscal 2017.
Shrinking margins in the banking sector, a typical effect of a low interest rate environment, drove UBL earnings for the final quarter of fiscal 2017 down 18% versus those of the same quarter last year. HBL earnings were down about 6% over the same period, and are now widely expected to have a similar impact on MCB earnings. Engro earnings for the first half of the year came in down about 30% (granted, year-over-year comparisons for Engro are difficult this year due to one-off items). Lucky Cement earnings for the final quarter of fiscal year 2017 were slightly lower than those of the prior year, and the outlook appears grim, given it has just been forced to reduce prices, signalling fears of cement overcapacity. To round off the gang of 6, expectations for OGDC’s fourth quarter of fiscal year 2017 earnings are converging to around 10% down year-on-year.
Any discussion of the stock market’s performance that does not even mention this earnings whammy, does investors and observers a great disservice.
A full explanation of the market’s performance must also include a survey of macroeconomic conditions. For a variety of reasons, widely discussed in the media, it is becoming a consensus view that Pakistan, with exports falling, imports soaring, and the exchange rate (which should be the balancing mechanism for such a situation) being held artificially constant by government policy, is moving in slow motion towards a balance of payments crisis. This fact alone would likely serve as a bigger red flag on any serious investor’s radar than the non-violent removal of a prime minister.
And it was thus that Mr and Mrs Aslam, out to make a quick buck, found themselves in the middle of the perfect storm.
So what should they learn from all this?
The first thing is, please don’t go out and sell your holdings based on what you have just read! Remember, act on the rumour, take profit on the fact. Or better yet, for most individual investors, take a long view and don’t run around chasing rumours and news in the first place. Ask yourself how much the market has already fallen as a result of all the negative factors you already read about. Study the history of the market to try and understand what prior crashes have looked like, and how far the markets have fallen. Make an effort to understand trends in corporate earnings. Think about price/earnings ratios as a measure of expected return on your investment. Develop a sense of the cyclical and secular macro-economic context for your investments. And most of all, if anyone ever, tries to give a one-word explanation for a 20% market drop, don’t ever listen to them again.
The writer is a Lahore-based columnist and consultant. He has served as a director in the global markets division of a major European investment bank. The views expressed here are his own, and are intended for general informational purposes only. They should not be construed as financial advice. The reader should be aware that the writer has investments in all of the stocks mentioned in this article