Karachi, March 25, 2019 (PPI-OT): Challenges aplenty: PKR devaluation and rate hikes at the forefront yet again
The market finds itself again close to 38,500 level, for the fifth time in slightly over a year, where the charts suggest the market is perilously close to the 233-day EMA (on weekly chart), a level last breached in 2008.
At least sector allocation strategies (banks, E and Ps and fertilizers) have paid off when compared to KSE-100 returns. However, absolute returns for these sectors remained in the negative, barring fertilizer with a small 4% return during LTM (last 12 months).
Lack of clarity on macroeconomic policy pertaining to external and fiscal accounts along with the interest rate and exchange rate outlook has compounded the overall prevailing uncertainty prevailing.
As the backdrop remains the same compared to previous occasions, further monetary tightening and rupee devaluation cannot be ruled out.
Charts paint a dismal picture
Perhaps the best and most convenient way to elucidate the market’s conundrum is by looking at the charts. The equity market has regressed yet again to the ~38,500 level, making it the fifth time in around 15 months that this has happened (Dec- 2017, Jul-2018, Oct-2018, Dec-2018 and now in Mar-2019). As is evident from the chart below, the distance between the first two such instances was ~7 months, since then however, the gap has narrowed significantly as the market reached the 38,500 level every two-odd months and since then all we saw were dead cat bounces. It is therefore clear that a strong support level exists at this level.
As visible in the chart, slightly below this support line is the 233-day exponential moving average (EMA) line on the weekly chart, which the market flirted with in Oct-2018 and Dec-2018, before eventually recovering, and now the market is again perilously close to the 233-day EMA. Just to give an idea of the severity of the situation, the only time that the market breached the 233 day EMA was in 2008 (and we all know what happened afterwards), before recovering back over the line in 2009; however it truly unshackled itself from this level in 2010 and steered clear up until now, i.e. ~9 years later. Naturally in this scenario, volumes and trading activity was bound to suffer and it has. An analysis of trading activity, for instance, indicates that investors are opting to stay on the fence until some meaningful clarity emerges on multiple fronts.
Further PKR deval. and rate hikes on the cards yet again
Thankfully, at least sector allocation strategies based on fundamentals that have been purported unanimously by the analyst community have paid off when compared to KSE-100 returns both on YTD CY19 and last 12 month (LTM) basis. The major recommended sectors i.e. banks (higher interest rates), E and Ps (rising oil prices) and fertilizers (improved demand and supply dynamics) have all outperformed the index. On a lighter note, comparing these sectors’ returns to the index is not saying a lot and absolute returns for all (barring fertilizer with 4% return on LTM basis) have been double-digit negative.
In fact, investors would have been better off placing their trust in fixed income markets (this coming from an equity analyst)! Earlier, with the help of charts, we explained what and how this current market situation emerged. The question ‘why’ is this happening has been answered multiple times in the past – it all boils down to the prevailing uncertainty on the macroeconomic front. This precisely explains why we are reverting back to ‘square one’ (~38,500) for the umpteenth time (fifth actually) in the recent past? If we recall, back in 2017 it seemed that the overwhelming narrative tilted towards political noise being the major (and sole) dampener plaguing the local equity market.
Although post-elections, there was some positive momentum and sentiment had improved, leading some to even predict a 50k market in the not-too- distant future, but even those optimistic voices were quelled in the coming days. The reason is undoubtedly the present economic scenario and our current (and elongated) journey in ‘uncharted territory’ (i.e. no IMF). Lack of clarity on macroeconomic policy pertaining to external and fiscal accounts along with the interest rate and exchange rate outlook has compounded the overall level of uncertainty prevailing at the moment. It will not be surprising to see another 25- 50bps rate hike in the MPS by the end of this week as the backdrop remains pretty much the same compared to previous occasions.
Likewise, delays in expected foreign inflows could make Rs145-150/US$ level by the end of FY19 plausible. We would also reiterate that the financing gap (US$14.6bn net debt repayments up to 1 year and US$7.7bn net short FX forward positions as of January end, 2019) at present suggests that the need of the hour is to secure funding of US$10-15bn, either from IMF or an alternative route. Since so far, although the govt. has been successful in averting a default, yet an FX buffer that would soothe the equity market is still missing.