The Karachi stock market is not a casino, Pakistan – stop gambling!

Published: April 1, 2015
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The broader Index, KSE 100, declined by an eye popping 17.5% from 35,055 points to 28,927 points in less than two months. PHOTO: AFP

“Becho, becho”

(Sell, sell)

“Lay maal” 

(Take the stock)

“Karachi stock market mein shadeed mandee (decline)”

“Shares key karobaar mein hazaar point ki kami”

 (A 1,000 point drop in shares)

Such are the headlines across the media nowadays which happens to be the topic of discussion among many. Meanwhile, the broader Index, KSE 100, declined by an eye-popping 17.5% from 35,055 points to 28,927 points in less than two months. For many, this is another bad experience, but for some, it has turned out to be an exciting opportunity.

Like any doctor who sees a sick patient, we must first assess the rational reasons behind the steep fall. Sometimes, the doctor correctly identifies a temporary viral attack and gives a combination of ‘comfort plus painkillers’ to the patient. In other cases, more serious actions are required. Similarly, with the stock market, we should begin by evaluating the reasons of the fall as judiciously and prudently as possible:

Foreign selling

The foreign shareholders had a net selling of $96 million during the period of decline. Many attribute the amount to have stemmed from the following reasons:

1. Everest Capital’s decision to close their funds after defaulting on a global currency trade.

2. The stock market shooting up relentlessly after hitting lows at the time of the Pakistan Tehreek-e-Insaf (PTI) versus Nawaz Sharif fiasco in late August 2014 and thus, foreigners wanted to capitalise on their gains.

3. The withdrawal of exemption on withholding tax on capital gain for foreigners which may dilute their returns and/or reveal their identity (unwillingly) to the tax payer.

Local funds selling

As the market started inching upwards non-stop, from September 2014 to February 2015, many of the retails felt ‘left-out’ and wanted to participate in the rising market. To their (dis)comfort, a few of the products launched by the Asset Management Companies (AMC) entailed a claimed principal protection. In simple words, they assured money will not be lost, but gains from the stock market’s ‘rise’ will be offered.

The underlying methodology usually adopted is called ‘Constant Proportion Portfolio Insurance (CPPI)’, which essentially buys stocks when they are going up and sells when the stocks are going down. Connecting the trick with foreign selling, these funds might have compounded the selling in a falling market as their principal protection cushion erodes and funds sell in panic, mechanically to safeguard the capital.

Margin calls

Individual investors usually take leveraged exposure in the market. They may invest Rs200 (Rs100 equity + Rs100 debt) and if the portfolio declines by 15%, the equity declines by 30%. Such magnifying losses create panic and invite ‘margin calls’ from the brokers which ask them to deposit more money to maintain the exposure or liquidate with losses.

Hence, in a rapidly falling market, some weak holders are filtered out and the exchange of hands takes place to further augment the structural strength of the market.

But the above factors do not signal that the party is over and it’s time to pack up. Disinvesting is a decision that is far more difficult than investing and before any exit, the investors must assess the following:

Is the decline a permanent or temporary feature?

As we said earlier, it was a temporary decline led by a “collision of sellers”.

Am I finding better investment alternatives?

Banks and National Savings Certificates offer even lower single digit returns net of taxes. Gold is likely to further remain in the bearish trend while real estate requires a handsome chunk of capital outflow with ensuing legal and tenancy issues.

Has the economy improved overall lately?

Inflation level has bottomeddiscount rate is historically low, Foreign Exchange (FX) reserves are reaching an all-time high, the costs of electricity and oil have come down drastically, the political and law and order situation has improved considerably, the currency is stable, gas is being injected into the system, remittances are at an all-time high and after a very long time, our credit rating outlook was assigned a “positive” note by Moody’s.

In the last five to six years, the economy has never been on a stronger platform as it is now. In such circumstances, the risk appetite should increase and one should invest in established and/or new businesses.

Has the index reached the maturity valuations?

Pakistan is well poised to stage a remarkable turnaround if the low oil prices and its trickle down benefits are aptly utilised. The index is still considerably cheap and offers higher returns than many other regional players. Moreover, the country has come further into the limelight as one of the few frontier markets which have enormous growth potential, as mentioned by Morgan Stanley’s chief investment strategist,

“Pakistan’s rise is just a matter of time.”

Unfortunately, the retails who join the party late, at the peak, expect the jubilation to continue at the same pace. And when it does not, as it usually does not, they shout, cry, cut losses, leave the table and re-join the party at higher levels when they see someone else (who invested at lower levels) making money.

Such behavioural inefficiencies should be managed and investors should perceive themselves as investors instead of gamblers. If a bystander witnesses heavy unexpected showers, he raises his elbow and walks briskly to refuge until the dust settles.

If a person can adapt to ‘withstanding’ the turbulent weather, the investors should also ‘withstand the ‘volatility’ and stay put.

Arslaan Asif Soomro

Arslaan Asif Soomro

The author has a degree in Investment Management from Cass Business School, London and has also obtained CFA and FRM qualifications. He is currently working as a Senior Advisor to Swedish based Tundra Fonder AB.

The views expressed by the writer and the reader comments do not necessarily reflect the views and policies of The Express Tribune.

  • Parvez

    You’re right the KSE is not a casino…….its the toilet in the casino.Recommend

  • Grace

    What world do you live in ? All over the world stock markets involve “gambling” as you describe it. Ever heard of the New York stock market crash? Speculation, leveraged buying and derivatives are all part of the game. Maybe Pakistanis need to grow up and see the world as it is. You don’t reinvent the wheel. The economy is better now than it has ever been but the nature of the stock market will never change.Recommend

  • Saad

    So a stronger economy would mean less volatility in the stock market, right? In the current situation would it be better to hold on to existing shares, or do a quick financial analysis and buy/sell undervalued/overvalued shares?Recommend

  • Rashid

    True depiction of Pakistani Market…
    Well written Arsalan…Recommend

  • AAH

    The latter is recommended. Whenever the market undergoes a steep fall, stocks become cheap. You should try to divert from cheap stocks to cheaper market-driven stocks as these are the ones which bounce up faster!Recommend

  • AAH

    Rightly said Grace. But it is the behavior of Humans when compounded by “animal spirits” increases their risk appetite and makes them worry/expect less about the losses. It is this emotional exuberance that one has to counter and manager isn’t it? Excessive leverage is gambling – this is exactly what should be addressed. Real Estate, Commodities, Currencies and Fixed Incomes – all classes involve speculation and risk-taking but the approach should be as of an investors instead of daily moitor-er.Recommend

  • Ali Raza

    Overall, a very nicely piece put together piece. Thanks!Recommend

  • Saad

    The author is wrong about the economy. Lower prices and lower inflation are entirely due to falling commodity prices. These prices are falling because the dollar is strengthening and that is happening because interest rates are expected to rise in the US soon. The low interest rates and QE were what led to stock market and commodity bubbles around the world including Pakistan. Now that is coming to a close.

    Pakistan’s forex reserves are NOT at an all time high. The numbers quoted in the local media include commercial bank dollar holdings. If you remove those you find only $11bn at the SBP. Back in Musharraf’s day we had $16bn in forex at the SBP and more at commercial banks.

    Moody’s still rates Pakistani bonds as junk. Rating increase from junk to slightly-better-junk is only because the government has succeeded in borrowing dollars. The cost of that borrowing is becoming apparent now. We will have to fight a war in Yemen on behalf of the Saudis because they gave us $1.5bn last year. Do you think fighting a war against Iran’s proxies in Yemen will be good for our economy going forward? Do you think the Iranians will take this lying down? How much money will be wasted on this exercise and what will happen to our domestic war against terrorists?Recommend

  • Saad

    Do you know of any source that would give me Beta values of kse listed companies?Recommend

  • Khush Dil

    The writer did not include the main reason of this recent fall which is fight btw secp and brokers over sudden notices to even honest brokers. Also he did not mention that finance minister ordered cgt on foreigners Retroactively from july “2014”. Otherwise a good anaylysis.Recommend

  • Khush Dil

    @Grace, Are u saying NY stock market never crashed? LOLRecommend

  • Khush Dil

    Very true…..Recommend

  • Investor

    You can do it yourself. Compare the average change in prices of Index and Stocks using excel worksheet. For example today’s price divided by the price 20 days ago of the kse to find out the 20 day rate of change and do the same for individual stock and then see the difference between the two. If the stock price is risen or fallen more than the Index that means the stock is high beta otherwise low betaRecommend

  • sterry

    Whatever the reason, we all know the economy is more robust. You are wrong about the Forex levels – they are higher than ever and the rating Pakistan is getting is better than before. Don’t waste your effort telling us about how great things were when a dictator damaged the nation for over a decade. That seems to be your main pre occupation. The Iranians can do all they want in Syria or Yemen but that won’t improve the stagnant Iranian economy and their inflation which is way worse than in Pakistan. Millions of Pakistanis work in Saudi Arabia and the Gulf. Many states from Gulf, Egypt but importantly US are supporting the Saudis to defeat Houthi rebels. Pakistan stands to gain a lot by joining the effort to defeat the lawless rebels. Do not be mistaken that the US will let Yemen fall to anarchy so Pakistan better do what’s best for the country and join the band wagon to get rewarded.Recommend

  • Sara ali

    Well written arslaan asif…Recommend

  • Muzzammil

    Above article is well written, but it has managed the interest of government, regulator and obviously the authors existing principals.

    I like to quote what he missed…

    1. Falling earning growth- both oil and banks sets 50 percent of stock market and their earning growth is all set for setback due to declining oil prices and discount rate.

    2. Exports falling and commodity prices are dipping hence textile likely to suffer. Plus dollar surged is also likely to dent exports.

    3. He talked about Macros but he surely missed the declining exports trend, missing tax revenue target, anemic GDP growth LSM in particular, IMF debt payment. And most likely the dip in remittances if gulf engulfed with war.

    4. Since corruption and black economy is the basic ingredient of our asset market. The article has failed to discuss if FBR pro-actively follow the decievers.

    5. Lastly, the article failed to highlight the role of the regulator and SECP In particular, government role of artificially protecting the market, insider trading by fund managers and front running by brokers on behalf of the orders they received from foriegn instituitions.

    What does one expect from market who is so shallow and bear 100mn foriegn selling. Should we deserve to brand as best market in the world!!!

    3. Recommend

  • Sameea

    One thing is for sure pessimists can never make money from KSE like those with an optimistic approach. If everything is so negative how come people are still investing and also making money out of it since last 6-7 years??Recommend

  • AAH

    Dear Saad,

    – An economy is always behaving in response to the “external factors”. If oil prices were to spike up to $150, I would say economy is in bad shape in response to “external factor”. You, perhaps, would counter “no, economy is alright but oil prices have gone up”. Wait till 1 year for you to find out the fruits of falling Oil Prices (energy costs) and Discount Rate (Debt Burden) on the economy – Pakistan in itself is a highly leverage economy which channels a major chunk of tax revenues to pay for the debt.

    – Your cited reason for fall in the oil prices is not correct. Oil has fallen owing to Fracturing and Horizontal Drilling of the Shale rocks. Moreover, Agricultural products are falling owing to excess supply (Cotton, Wheat, Sugar) and Metals are falling owing to slowdown in China’s growth and its shift to services sector (Iron, Copper, Steel, Aluminium etc)

    – Rest assured, our participation in Yemen’s war is going to be economically viable but socially catastrophic. Saudia Arab will channel more funds to us as gift or give discounts on oil. (No, I am not up for a political debate).

    – Our credit rating is set to “improve”. That means, from a very low base, foreigners have “accepted” our ability and willingness to repay our debts. Hence, our cost of borrowing is to decline globally and so would bring us in the radar of foreign investors. Yes, we are junk rated. But if you want to always accept yourself as a junk citizen and not see or work to improve then God bless us all.

    And let me end on a note – stock market is not a pure reflection of economy only. You need to keep an eye to see companies benefiting from change in external factors. For instance, falling oil is good for Cement, Shipping, Autos sector but bad for Oil and Gas exploration companies. Similarly, increasing cotton prices are good for spinners but not good for garment manufacturer. Strong USD vs PKR is good for Exploration Companies, Textiles and Power companies as their revenues are linked to depreciation PKR but bad for importers such as Autos, Pharma and Chemical producers.

    One can not change a negative mind but the a horizon shall always encompass both sides of the coin. Thanks.Recommend

  • AAH

    If notices were served by regulator to honest brokers, they shouldn’t fret but come out in their defense. If they sent it unethical brokers, they did a great job for general public. Such improvement and governance and vigilance is a net-positive contributor to the market development. And you’re correct, withholding tax on foreigners were levied but trust me Khush Dil, with returns as ours, foreigners would still pour money in. Wait till we get a credit rating upgrade and improve our energy supply.Recommend

  • AAH

    I would agree to almost all of the facts you have provided Muzammil but the aim of the blog was not to pitch stock market, nor to do a sector analysis. But to just throw a light (with a limited word count) in a reader friendly way, as to how should the investor recent to the steep fall. I am sure, you are aware of insider trading cases globally, even in the mighty US – champion of governance. But you got to see the trend, and I am sure you see it improving in this cycle compared to pre 2008’s.

    Falling and rising earnings growth in response to business factors is part of the deal. Despite US’s rise, McDonald’s revenues are falling too right. Similarly, you would understand this is not a stock specific recommendation platform but companies behave contrastingly differently to a specific factor. And let me end on a note – stock market is not a pure reflection of economy only. You need to keep an eye to see companies benefiting from change in external factors. For instance, falling oil is good for Cement, Shipping, Autos sector but bad for Oil and Gas exploration companies. Similarly, increasing cotton prices are good for spinners but not good for garment manufacturer. Strong USD vs PKR is good for Exploration Companies, Textiles and Power companies as their revenues are linked to depreciation PKR but bad for importers such as Autos, Pharma and Chemical producers.

    And you being an economist, need to see a simple number of reduction in the government’s debt services — primarily because of falling oil prices and its ability to drag cpi down to 2.5% — to agree that despite all the negatives you (correctly) highlighted in the economy, the benefit is a strong net-super-positive stimulus at this junction.Recommend

  • AAH

    I would agree to almost all of the facts you have provided Muzammil but the aim of the blog was not to pitch stock market, nor to do a sector analysis. But to just throw a light (with a limited word count) in a reader friendly way, as to how should the investor recent to the steep fall. I am sure, you are aware of insider trading cases globally, even in the mighty US – champion of governance. But you got to see the trend, and I am sure you see it improving in this cycle compared to pre 2008’s.

    Falling and rising earnings growth in response to business factors is part of the deal. Despite US’s rise, McDonald’s revenues are falling too right. Similarly, you would understand this is not a stock specific recommendation platform but companies behave contrastingly differently to a specific factor. And let me end on a note – stock market is not a pure reflection of economy only. You need to keep an eye to see companies benefiting from change in external factors. For instance, falling oil is good for Cement, Shipping, Autos sector but bad for Oil and Gas exploration companies. Similarly, increasing cotton prices are good for spinners but not good for garment manufacturer. Strong USD vs PKR is good for Exploration Companies, Textiles and Power companies as their revenues are linked to depreciation PKR but bad for importers such as Autos, Pharma and Chemical producers.

    And you being an economist, need to see a simple number of reduction in the government’s debt services — primarily because of falling oil prices and its ability to drag cpi down to 2.5% — to agree that despite all the negatives you (correctly) highlighted in the economy, the benefit is a strong net-super-positive stimulus at this junction.Recommend

  • Usman Azam

    You are correct on most points. Owing to steep fall in oil prices and other commodities, inflation fell to the lowest level of 2.49% in Mar’15. Moreover, PKR/USD exchange rate remained relatively stable causing import inflation to remain under favorable levels. Meanwhile, foreign exchange reserves currently stand at USD 16mn with an increase to USD 18mn expected over next few months. While a 50bps cut in Mar’15 led policy rate to fall to 8%, we should expect another 50bps discount rate cut by SBP in the near term. Subdued interest rates will therefore contribute to further reduction in MLCF’s financing cost.

    However, there is still a long way to go. We have to end apartheid for one. And slow down the nuclear arms race, stop terrorism and world hunger. We have to provide food and shelter for the homeless, and oppose racial discrimination and promote civil rights, while also promoting equal rights for women. We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern and less materialism in young people.Recommend

  • Grace

    Read my comment again. Got to work on your English mate. Not only did the New York Stock Market crash before the Great Depression but there have been regular melt downs not only on Wall Street but every other stock market in the world. It’s just childish when Pakistanis think that the stock markets in the West function differently than in Pakistan or when they assume democracy functions differently. Basically things are the same all over the world despite some outward cosmetic differences.Recommend

  • Grace

    I suppose you would know from experience from the toilets at your own home!Recommend

  • Ann Thomas

    Fake market of the fake people by the fake people for the fake people Pakistan and its stock markets.Recommend

  • Pakiatani

    Haters will be HatersRecommend

  • Pakistani

    Had he gone to his toilet probably he would have been cleaner and richer HahaRecommend

  • Pakiatani

    Human behaviour is always the same. Sometimes irrational sometimes conniving. Exuberance drives assets up and and panic pulls it down. It is the mid point we should search forRecommend

  • Saad

    Well articulated write up ! I am fundamentalist, I reckon there is battle of fundamentalist and technical mindset, I have seen many fund managers take technical perspective and created panic – Why should we blame Retail investors ? I would also like enlighten the role of Sales representative of Brokerage houses they trap uninformed investors, sometimes their tricks work out and sometimes it goes other way. I would like to sum up your article with one word is the “Herd Mentality” of our retail investors who tries to book gains on rising stocks persistently. As a professional, I would like to ask you one question, “Do you believe these inflation numbers are real, don’t they have structural weaknesses in the statics ? the reporting structure of PBS ? Please do enlighten AAH.Recommend

  • AAH

    The retail investors are not usually “blamed” but are rather part of the exuberance. And by retail investors, my reference was pointing towards the High Net Worth punters who have muscles and power to drive the market – though it is declining owing to institutionalisation of the market investors. The smaller investors are naive and connived by their brokers who offer them higher leverage solely to multiply their commissions. These small retailers are “driven” by brokers and do not seek services of professional asset managements.

    Though I do not have entire faith in the numbers being published by PBS as there is no clarity on the sample being used, nor is there a structural link between the retailers to electronically assemble the variation in the prices and neither is it a 100% reflection of a common man’s basket expenses. Plus the rents they used to calculate expenses are part of some -god-forbidden-secrets that we never know which “basti” they are using for their reference point. Moreover, you would agree that the weightages of expenses drastically vary from a family to family. For instance, for someone earning 20,000 a month, 20% goes to rent, 20% goes to transport, 15% goes to “kunda, 35% goes to food etc. HOWEVER, broadly, these CPI numbers do make sense and are also in concurrence; oil is down drastically, electricity prices have come down, gas prices are going up (not for lifeline users used in cpi basket), and globally agricultural products are in downturn because of excess supply while metals are in bearish trend owing to slack in demand. Hence, the general trend in CPI should be a material negative trend YoY only. So yeah, I would bet met money on the numbers!Recommend