Monthly comment – July

The market

MSCI Pakistan Net (SEK) declined 10.3% during July compared to MSCI Emerging Markets Net (SEK) which increased 2.1%. The SEK strengthened almost 4% during the month which exaggerated the negative returns. Political uncertainty kept investors away from the market where we saw average daily liquidity declining to USD 91m while foreign selling increasing to USD 38m. In an uncertain political environment and with the looming risk of currency depreciation, foreigners remained wary. The Supreme Court issued a verdict on Panamagate resulting in the disqualification of Prime Minister Nawaz Sharif. In a surprising but pleasant turn of events, PML (N) accepted the decision and the risk of confrontation was put to bed. However, a political tug of war continues with PML (N) debating the potential of rallying public opinion and declaring themselves political martyrs meanwhile the National Accountability Bureau (NAB) continues probing the Sharif family’s asset mismatch. We also saw some volatility in the exchange rate when the PKR depreciated sharply by 3%. This was short lived as the Ministry of Finance clawed it back. On a fundamental level, the PKR seems weak as suggested by rising current account deficit (CAD) which has reached USD 12bn (4% of GDP). Given the higher economic activity, imports like machinery and energy have risen strongly. We also note that remittances from Pakistanis living overseas have slowed down due to weaker remittances from the Middle East. Under normal circumstances the higher CAD would be less worrisome. There is consensus in the market that the PKR is due for a 10- 15% depreciation after three years of stability vs the USD. This is nothing new. The PKR has on average depreciated 4-5% a year during the last 20 years. However, this has not prevented it from being one of the best equity markets in the world. As previously pointed out, more than 50% of the index constituents have more to gain from a depreciation than from a status quo. This applies not only to Energy and Utilities (pricing in USD), Textiles and IT (high export share) but also to Financials (would benefit from higher interest rates). If this currency depreciation is done as part of a wider economic plan we are less concerned. Nonetheless, investor nervousness is understandable given the political uncertainty in recent months.

We foresee political headlines in the pre-election period as all political parties strive to win the vote bank. The government is likely to respond to the opposition by increasing spending on development and social projects as seen in previous election years. The political temperature will go up and down in the next six months, as should be the case approaching election year. At the end we expect a rational outcome. As earning season has kicked in, the market is likely to take its cue from corporate announcements in the short term.

The fund

The fund decreased 5.9% (SEK) during July compared to MSCI Pakistan Net (SEK) which declined 10.3%. Our underweight in Financials and Materials were mainly the reason behind relative outperformance. Additionally, our off benchmark bets in IT added to the alpha during July. On the negative side, an underweight in Energy didn’t bode well for the fund. No major changes were made in the fund during July.

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