Investing in Pakistan, Fundamental Economic and Markets Outlook for 2012
Stock-Markets / Pakistan Jan 31, 2012 - 03:24 AM GMTBy: Bilal_Khan
Executive Summary
If 2011 was the year of living dangerously, then 2012 is likely to be the year of living adventurously for those investors who choose to invest in Pakistan. Our view on Pakistan’s investment outlook remains positive and is driven by the following key convictions:
- Fundamentals: Macro indicators will remain negative during 1HCY12. Any improvement in the second half of the year will be crucially dependent on a decline in oil prices and resumption in international aid flows. Despite this, GDP is expected to record growth in excess of +3.0% during FY12;
- Rising bond yields vs. the 3U’s: Despite the potential upside risk of rising bond yields, equity investors will outperform bond investors in 2012. This will be driven by strong corporate earnings growth supported by robust domestic demand and the likelihood of a rebound in stocks which have remained Undervalued, Under-owned and Under-loved (the 3U’s);
- Policy Initiative and Confidence: Fresh political trends emerging from the possibility of elections is likely to spur fresh policy initiatives, help boost business confidence and investment flows resulting in a sharp upward re-rating of asset values;
- Technical Charts point to a multi year bull cycle: Pakistan’s KSE-100 is amongst a handful of markets which remain in clearly defined secular bull markets which are expected to trend higher for the better part of this decade. From a long term perspective Pakistan remains a compelling buy with the expectation of the index hitting 18,000 – 20,000 before the completion of the secular bull.
By narrowing our focus on the above key issues including Fundamentals, Earnings Growth, Policy, Investor Confidence and the long term technical cycle, investors who maintain Pakistan exposure will not be disappointed with the potential for upside during 2012.
Conviction 1: Bad news on macro indicators to persist
Inflation: With the high base effect from last year’s floods coming to an end, oil prices trending above $100/barrel and increasing electricity and gas tariffs, the single digit inflation number seen in Dec11 is likely to be a transitory phenomenon. CPI is projected to average close to 11.0% during CY12 as further PKR depreciation will lead to imported inflation and exacerbate the supply side pressure on domestic prices.
Interest Rates: With rebounding inflation, a projected fiscal deficit of 6.0%+ of GDP, decline in FX reserves and currency weakness, it is unlikely the central bank can maintain positive real lending rates in CY12 if it continues to ease monetary policy. Further rate cuts would be dependent on the materialization of foreign inflows from the 3G auction, Competitive Support Fund, IMF Letter of Comfort, ADB and World Bank which would partially mitigate the effects of a trade deficit approaching $20.0 bn and debt repayments of $3.0 bn. However if the current equilibrium persists then in all likelihood the interest rate cycle may have bottomed out and the SBP will look to maintain the discount rate at 12.0% for 1HCY12. Upside risk to the discount rate emerges if oil prices continue to rise and the absence of external funding for the fiscal deficit increases risk perception and the demand for higher rates by domestic market players.
Currency: The SBP has reportedly agreed that the PKR is overvalued and that it will not intervene to prevent market movements. Taking the annual inflation differential of 8.4% between Pakistan and its major trading partners in conjunction with the expected drawdown in FX reserves due to a $3.5 bn balance of payments deficit; 4%-5% depreciation is projected for 2HFY12 with a target of 93.4 - 94.5 for the PKR.
GDP Growth: Despite strong headwinds, the economy is projected to grow at nearly 3.5% for FY12 as the large and undocumented services sector (50%+ of GDP) continues to expand.
Conviction 2: Rising bond yields vs the 3U’s
Despite the expectation that bond yields face upside risk in the current macroeconomic scenario, Pakistan equities are likely to outpace and beat the cost of capital over the coming twelve months. This is driven by the BMA Funds’ active universe of companies having a 16% earnings growth, 9% expected dividend yield and a prospective price earnings ratio of 5.4 times. Exposure to Pakistani equities can present a total return proposition of 25% which is attractive when compared with competing asset classes domestically and globally.
Our filter for stocks includes the 3U’s which are undervaluation, under-owned and under-loved from a global investment portfolio perspective. In addition, high liquidity and strong management teams are additional filters for selection of equities. Contributing to the degree to which some large cap companies are more under-owned than in previous years has been the Foreign Investor Portfolio Investments of $121 mn net outflow in CY11 which triggered large draw downs in several banking and chemical stocks.
We like sectors supported by Pakistan’s broad structural theme of domestic demand by a young and growing population. These include the Oil & Gas, OMC, large cap Banks, Cement, IPP’s and Fertilizer sector. Our top picks for 2012 are Attock Petroleum Limited, Pakistan Oil Fields Limited, Pakistan Petroleum Limited, MCB Bank Limited, Fauji Fertilizer Company Limited, Engro Corporation Limited, Lucky Cement Limited and HUB Power.
From a global perspective, Fund Managers outlook in 2012 is to favor equities over bonds. In a recent survey conducted by the Association of Investment Companies – a sample representing a fifth of the UK industry - found that despite concerns of continued stock volatility, 50% of investment managers predicted that equities would be the best performing asset class in CY12. When asked which areas of the world would do well, 27% of fund managers chose the EM space, 19% the USA whilst Europe and Asia Pacific ex Japan both took 11% of the vote.
Conviction3: Investor Confidence tied to Fresh Policy Initiatives
2011 was characterized by a succession of crises which prevented a sustained recovery and increase in investor confidence. Sluggish economic growth, energy shortages, IMF program suspension, declining FX reserves, tension with key allies, the US recession and liquidity issues due to CGT kept investors cautious which resulted in a 17% decline in the MSCI Pakistan index and decade low daily trading volumes at the KSE-100. After a long lull, volumes and trading activity are now expected to pick up considerably in light of the recent relaxation in the CGT regime.
Despite strong macro economic headwinds, key institutions have remained resilient and helped maintain a semblance of cohesion through parliamentary democracy, a free press, independent judiciary, a robust army and a stable financial system. The resilience of the institutional set up provides the system with much needed strength to act as “shock absorbers”. This inherent strength is one of the key characteristics of Pakistan’s institutional framework and has the ability to surprise on the upside even in the face of adverse circumstances.
With elections posing a strong event possibility for 2012, both the incumbent and opposition parties are likely to be aggressive on policy measures aimed at voters. In particular, fresh initiatives aimed at improving law and order, reducing geo political security concerns relating to Afghanistan and India, improving areas of Governance aimed at fiscal responsibility and reducing corruption and measures aimed at boosting industrial and agricultural output despite a global slowdown are more likely in 2012 than they have been in the last three years.
Conviction 4: Long-term technical indicators in a multi year bull cycle
Chart 1: KSE 100 Index Bull and Bear Cycles since 1990 to Date
Source: Bloomberg / BMA Funds
Pakistan’s KSE-100 is amongst a handful of global markets which remain in secular bull markets that should continue to trend higher for the better part of this decade. From a long term perspective Pakistan remains a compelling buy with the expectation of the index hitting 18,000 – 20,000 before the secular bull is over.
Within this secular bull market commencing in early 1990’s after a prolonged bear run, the market witnessed two complete cyclical bull and bear cycles as shown in Chart 1. The the crash of 2008 was the second cyclical bear and a third cyclical bull commenced at the start of 2009 from the 4,800 low. During its first phase it carried the KSE 100 Index higher for 2-yrs, putting in a high in January CY11 at 12,768. For the rest of CY11 the index corrected the 2-yr advance, forcing oscillation in the range of 10,800 – 12,700, testing each boundary twice in a sideways chop throughout the year. CY11 ended with the index +5.5% above support at 10,800 and -12% below resistance at 12,700.
For CY12 a clear break of either level will determine market direction. Violating support would indicate that the market is continuing to consolidate the gains of the first phase of the third cyclical bull market and could see trade as low as 9,500 before the market is ready to embark on phase two of the third cyclical bull cycle. Convincingly taking out 12,700 would indicate that CY11’s sideways chop was the consolidation separating the first phase of the cyclical bull from the second and would see us targeting the 14,000 level as a viable CY12 target.
Risks: What to watch out for in 2012 ?
Despite our optimistic outlook on the stock market and equities for 2012, the market and economy will continue to show volatility and uncertainly. Some of the key event risks that could emerge and negate positive gains for investors include:
- Lack of clarity on roadmap for next elections and the possibility of a hung parliament as one of the possible outcomes;
- Continuation of uneasy Pak-US relationship which could choke foreign assistance and curtail GOP ability to borrow from multilateral donor agencies;
- Escalation in tension between US and Iran which could push international oil prices to higher levels negatively impacting the economies;
- Prolong EU debt crises and recession in US which could create panic and induce equity investors to unload their positions;
- Energy crises and continuation of circular debt problem in Pakistan could impact not only the profitability of the corporate sector but can also create law and order situation;
- Weak economic fundamentals could compel the central bank to revisit monetary easy stance.
About the RIC Report: The Research Investment Committee within BMA Funds is responsible for arriving at decisions relating to asset allocation and investment decisions for client assets managed by the Firm. This report aims to present broad investment themes and views held by the Investment Team at BMA Funds in a thorough, easy-to-read format that provides insightful analysis and specific investment ideas across major sectors. Whether you are an institutional investor or a private client, the best way to put the RIC Report to work for you is to talk with a BMA Funds Advisor about specific opportunities that interest you. You can take advantage of our investment platform focused to help you keep your long-term investment plan on track. For further information, please email us on info@bmafunds.com
Contributors | Muddassar Malik | Farrukh Hussain | Bilal Khan | Mustafa Pasha | Iffat Mankani
Bilal Khan
Vice President, Investments
BMA Funds
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Tel: +92 21 111 262 111 - Fax: +92 21 3242 6829 - www.bmafunds.com
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