For all those small investors who have invested their limited savings in stock exchange directly or indirectly (through mutual funds, etc.) have been wondering and asking their stock brokers is it the right time for investment or disinvestment or not? More often or not stock brokers come up with lollipop statements that its just a matter of days that the things will be green again. However, those days have turned into weeks, then months and now more than a year that index has not recovered or stabilized.
The stock market showed a steady growth until it was first jolted by the Panama Papers controversy, which surfaced in April 2016. These papers included the names of Ex-Prime Minister of Pakistan Nawaz Sharif and his family for having offshore companies. However, corruption cases are a norm in our country, so the stock market was still in green zone. However, on 26th August 2016 Imran Khan filed a petition seeking disqualification of Nawaz Sharif. People still thought that the matter will linger on and no concrete decision will be reach and the government will complete its term. However, the disqualification case and the movement got strengthen by each passing day and finally the court on July 28, 2017 disqualified Sharif from holding public office. In between all this political mess the index reached its peak of 52,876 in May 2017 and then started to decline.
The interim period from the disqualification of Nawaz till the election in July 2018 the political uncertainty prevailed, and index remained red. During this period the index lost 4,573 points i.e. 10%.
The market participants were optimistic about the election and the new government which came with the slogan of ‘Tabdeeli’ (meaning change). But the things didn’t change, and the index kept its nose down. The first six months were understandable as the new government was still in the infant stage and finding its feet in the new roles. However, during the infancy stage the index lost around 2,000 points (i.e. 5%).
The next major milestone eyed by the investors was the IMF programme. The USD 6 billion program that cost the job of the ex-finance minister Asad Umer finally reached a staff level agreement on 12th May which is yet to be approved by the Executive Board of IMF. Since this positive news the stock has shown green lights with approx. 1000 points gain on two consecutive days of 22nd and 23rd May.
During all this period of uncertainty the index has lost around 17,000 points (i.e. 32%) since its peak of May 2017.
Factors affecting stock market
Other than the political uncertainty there are various other factors that impact the performance of stock exchange. These factors can be listed down as follows:
- Monetary policy measures primarily Interest rates
- Foreign exchange rates
- Fiscal policy measures – GDP growth, current account deficit, etc.
- Commodity market (especially gold rates and oil prices)
- General security situation in the country
- Earnings of the listed companies
The above factors do help us in understanding the current valuation and predicting the future movement of the index. For the sake of simplicity, a regression analysis can be performed to derive the equation for KSE 100 index by taking the impact of the discount rate and exchange rate as variables.
If you apply the Simple Linear Regression on the last 10 years data of PKR/USD Exchange Rates, Discount Rate and KSE 100 index, we arrive at the following equation to calculate the current valuation of the KSE 100 index (with a correlation coefficient of 94%).
KSE 100 index = 20,069 + 369(Exchange Rate) – 314,215(Discount Rate)
If we apply this equation to the numbers as at 29th May 2019 the KSE 100 index arrives at 34,712 i.e. overvalued by 1,262 points. Yes Surprised!
Don’t be, though the above equation does give us the raw idea of index valuation. A conclusion can be drawn that the index was artificially inflated in May 2017 where if you apply the same equation the index was over valued by 11,000 points.
However, the above equation has its limitations as well. It does not incorporate all the quantitative variables and it also does not consider the qualitative factors such as political stability, security situation, etc.
So, should we invest or not?
Its up to you, don’t ever invest in stocks on someone else’s recommendation. Do you own small analysis and invest accordingly to your risk appetite. However, in a longer run the stock market has rewarded those who have invested in a well-diversified portfolio.
[Return = (10%) p.a.]
[Return = 1% p.a.]
[Return = 29% p.a.][i]
The trend line of index shows different directions for different investors. For short term investors the trend line is downward sloping from left to right, however the slope moves upward if you change your horizon to five- and ten-years’ time period. So, if you are an average investor which does not have the perfect understanding of the market mechanics then you should only invest if you have the ability and capacity to hold the investment for a longer period.
There have been lots of positives for the market in the last couple of weeks such as IMF staff level agreement, expected Rs. 20 billion market support fund, political stability, etc. However, again invest only if you can hold your investment in crunch times.
P.S: The writer is not an expert in the financial market and the above material is for general information only. The writer will not be responsible for any loss that an individual may sustain by making investment based on the above analysis.
[i] The above return is pretax capital gain only and does not include the impact of dividends