JS Securities Limited – Morning Briefing

Karachi, June 19, 2018 (PPI-OT): Equities continue to embrace rising economic headwinds

KSE-100 is up 7.9% YTD 2018 though down 6.3% off its peak during 2018. Overall, equities appear to be absorbing the soft economic data quite well given a predominantly range bound market behaviour.

Recent 14% PKR devaluation against the greenback has finally helped strengthen rupee’s competitiveness in real terms against other currencies. However, it remains to be seen how this would fare with imports’ growth and inflation in ensuing months.

We eye (1) widening twin deficits/ falling import cover, (2) sharp uptick in inflation and interest rates and (3) global economic pressure points (US China trade war, unwinding of the QE in US and Europe and a hawkish Fed) as key downside risks.

Oil and Gas Exploration and Banking sectors are our relatively safer bets since these benefit from weaker currency and higher interest rates, however when valuation multiples are justified on the lower side.

KSE-100 continues to withstand economic woes

Despite an acute external account situation, rising inflationary pressure, concerns on the fiscal side and hawkish outlook on interest rates, equity market remains pretty much range bound. Investors seem to have braced themselves with the weakening capital market expectations on the economy, thanks to a plenty of rhetoric on macroeconomic foreshadowing by the press and the sell-side alike. However, a key point worth realizing is that this time is no less critical than 2008-09 when oil price shock played much havoc with the economic landscape. We had a ~25% PKR devaluation against the greenback back then with interest rates nearly doubled. The present economic backdrop seems to be giving a strong sense of déjà vu about it. Given historical evidence and our underlying structural problems, an urgent policy action of monetary tightening and fiscal consolidation is the need of the hour to help fix the prevalent macroeconomic imbalances. Besides, the country desperately requires emergency funding for balance of payments support amid daunting external financing requirement in comparison to the FX reserves. Although, this would, on one hand, be a very positive development in terms of economic direction setting; yet it would continue to restrain equity prices in the immediate term. The earlier these remedial initiatives are taken, the better it would be as otherwise it could only aggravate the situation.

Beware of global economic pressure points

Recent global economic developments seem to be rubbing salt to the wounds by way of (1) US-China trade war, (2) unwinding of the QE in US and Europe and particularly (3) a hawkish Fed. These three factors combined pose downside risks to global economic growth as well as equity valuations. Moreover, with recent high global markets correlation, this potentially would not bode well for local equities either. Granted, the recent rupee devaluation has helped make the rupee competitive vis-à-vis other currencies, a strong US$ remains in fact a key risk for the broader emerging markets. This would not only increase the debt servicing costs but could also prove inflationary. We advise caution and recommend being wary of the upcoming numbers of current account deficit, fiscal deficit and inflation. Impact of PKR weakening on imports growth, trend in international oil prices and its pass on effect on retail prices, fiscal slippages in recent weeks just ahead of the federal budgeting exercise and potential cut in fiscal spending are few checkpoints to keep in mind.

E and P and Banks remain safer bets

We view Oil and Gas exploration and Banking sectors as are our relatively safer bets since these benefit from weaker currency and higher interest rates; however when valuation multiples are justified on the lower side.

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