THE FUND
During the month, the Fund went down by 7.1% as compared to the benchmark’s MSCI Pakistan Net (SEK)’s return of -1.5%. In the middle of the month, KSE-100 nudged upwards from recent bottom levels. The out-performing exposures in the current month were Real Estate, Utilities, and Consumer Discretionary while the under-performers were Financials, Materials, and Energy.
On a yearly level, the major alpha contributors in 2017 were Financials and Utilities sectors while the underperforming sectors were Consumer Staples and Discretionary, whose growth story came into doubt because of the rising Trade Deficit and fears of disruptions in the political environment.
THE MARKET
It was a tumultuous year for Pakistan both politically and for stock market investors. Pre-empting foreign inflows at the time of entry into the MSCI Emerging Market Index, KSE-100 peaked May 24th, 2017 at 52,876 points only to close the year at 40,471, a year-on-year decline of 15%. Widely termed as the “tale of two halves,” the first half began full of investor optimism only to be de-rated after the elected Prime Minister was disqualified in the aftermath of the highly public Panama-leaks scandal.
The keenly anticipated depreciation kicked in towards the end of December 2017 engendering a sigh of relief. After bagging a USD 2.5bn bond issuance globally, the government eventually let “market forces” determine the parity of the Pakistan Rupee with no abrupt intervention leading to a +5% depreciation immediately. Belatedly, the government nominated an Advisor on Finance, after the previous Finance Minister left the country during a corruption trial. With potential civil-military tensions on the rise and fears of a postponement to the 2018 election, a blessing in disguise was the Chief of Army Staff’s Senate briefing emphasising his support for the continuation of a democratic regime and electoral process.
In our opinion, 2017 was Pakistan’s year of “normalisation.” With a fantastic run-up in the index since 2008’s bottom, last year saw a consolidation of returns, return of twin deficits (amidst economic expansion), fears of political unrest and a stressed relationship with the United States. Booking their gains in the run-up, foreign investors sold equities worth USD 488mn, which were largely picked up by local Mutual Funds and Insurance Companies.
Pakistan is starting 2018 from a very low base but in all likelihood may end the year well with handsome double-digit returns. Trading at a forward P/E 8x at a nearly 50% discount to MSCI Emerging Markets, coupled with a sound economic growth story: the case looks promising. Macroeconomic indicators show resilience as well: an 18% increase in tax revenues; almost a 10% growth in large-scale manufacturing; a CPI of 4.6% year-on-year in December 2017; an expected GDP growth rate of +5%, and an increase in private sector lending at 17% year-on-year.
However, the challenges are equally substantive, albeit of a different nature. A potential verdict against the former Prime Minister’s trial by theNational Accountability Bureau (NAB) has the potential to mobilise public sentiment and increase agitation. The 2018 election result has never been this closely watched, especially after the emergence of a third political force, led by Imran Khan’s PTI, who has not =been tested at the Federal level. A hung parliament led by PML-N or PTI would lead to ambiguity over policy-making and the changing regulatory platform may contribute to the stock market’s volatility and that of listed sectors. Over the medium run, Pakistan’s ability to navigate an unusually high Current Account Deficit (CAD) of 4.5% – 5% and to manage a Fiscal Deficit below 4.5% would be the substantive economic challenges.
Whether Pakistan is able to maintain “fruitful” ties with the United States, materialise the regional connectivity dream envisioned by the China Pakistan Economic Corridor (CPEC) and emerge diplomatically stronger through ties with India, Russia, Iran, Saudi Arabia and Turkey will be key to cementing the perception of foreign investors. The year 2018 sets up a classic risk versus reward scenario for Pakistan’s stock market. Again, starting from a very low index base, the calendar year 2018 seems to be pricing in the odds of a downside reasonably well to close the year on a good note.
