Pakistan reclassification in MSCI EM provides new impetus

After Pakistan’s reclassification in the MSCI EM space, the PSX-100 index skyrocketed reaching its all-time high to close the week ending 17^th June at 38,777 level, up 4.97%WoW. The key drivers were Cement, Bank and Fertilizer sectors. Additionally, Oil & Gas sector remained volatile due to weakness in global oil prices.

Participation during the week remained stayed strong, with average daily traded volumes rising to 183.2 million, up 20.7%WoW as compared to 151.9 million shares a week ago despite shorter trading sessions on account of Ramadan.

Key news flows guiding the market included: 1) MSCI announced to reclassify Pakistan in the MSCI EM (Emerging Market) Index in its Annual Classification Review this week, coinciding with the May'17 Semi-annual index review, 2) National Assembly Standing Committee on Finance recommended 7 key amendments in Finance Bill 2016 that includes maintenance of zero-rating sales tax regime on dairy and milk products, 3) ECC of the cabinet in its meeting ordered increasing the price of RLNG by about US$1.2/unit by allowing a series of factors in its price previously rejected by the OGRA, 4) SECP approved draft amendments in Non-Banking Finance Companies (Establishment & Regulation) Rules 2003, and Non-Banking Finance Companies & Notified Entities Regulations 2008 for smooth transition of Micro Finance Institutions (MFIs) into Non Bank Microfinance Companies  and 5) Ministry of Petroleum & Natural Resources sought approval of the ECC for the award of second LNG terminal contract to the successful bidder.

Gainers at the bourse were: HBL, MCB, BAFL, DAWH and MLCF while scrips losing value were: MTL, HASCOL, PSMC, PPL and EPCL. Volume leaders were: KEL, PIBTL, EFERT and TRG. Foreign participation also stayed positive, with foreigners buying US$19.6 million worth equities during the week as compared to net buy of US$70.2 million a week ago.

The market rallied significantly on MSCI driven sentiments, where analysts expect this momentum to continue in coming week also. While benefits to derive are numerous, increased foreign visibility and participation particularly along with potential multiple re‐rating are likely to be the most profound. Post reclassification in MSCI Emerging Market index, investors are likely to shift interest to scrips that are likely to enter the EM index, namely LUCK, ENGRO, HBL, UBL, MCB, OGDC, PSO and FFC.

Lucky Cement (LUCK) price performance remained volatile during the year likely due to 1) fears of possible pricing indiscipline owing to expansions announcements, 2) persistent foreign selling due to market volatility on global growth concerns and 3) tumbling exports amid anti‐dumping duty imposed by South Africa. However, LUCK's recent rally (+47% returns to date from its low in February) on expectation of inclusion into MSCI Emerging Market Index in spite of increased taxation (increase in FED on local cement price and re‐imposition of super tax for another year), more than made for the earlier losses. Budgetary implications have resulted in an increase in cement prices where prices in the northern region have risen by Rs22/bag to Rs530/bag. That said, southern region has not yet passed on higher costs as the price in the region was already at a premium. Additionally, LUCK continues efforts to diversify its energy needs by 10MW WHR at Pezu Plant (expected COD last month of 2016). This will likely contribute in after tax operational savings of Rs1.37/share from FY18 and onwards. LUCK trades at a slightly higher price owing to recent bull‐run on inclusion in MSCI EM Index. Higher multiples are also reflective of associated lower premium and fast paced earnings growth (5‐year forward CAGR of 21%).

Does Brexit mean anything to Pakistan?

As part of my daily chores, I read a lot of content pertaining to commodities, currencies and stock markets. I often wonder if this flood of information makes decision making by Pakistani investors easier or force them to make investment decisions that ultimately become loss yielding for most of them.

At present a lot of being talked about Britain’s exit from the European Union (Brexit). Whatever may be the outcome of the referendum scheduled for 23^rd June, it will be of little consequence for Pakistan. This may sound a sweeping statement but if one keeps various factors in mind affecting trade between the two countries, understanding the likely implications will become much easier.

Britain may be a major buyer of ‘Made in Pakistan’ products but most of the trade is USD denominated. Therefore,the involvement of three currencies i.e. GBP, EUR and USD often nullify the benefit emerging from the movement of one or more than one currencies.

Most of the investors prefer to convert their saving into USD, which they consider more trustworthy, simply because PKR value depreciates regularly. Many of the exporters try to without their payments outside Pakistan in anticipation of erosion in PKR value.

Movement of international gold price is also of little consequence. Pakistan consumes around 250 tons of precious metal per annum. Out of this, 50 percent demand is met through ‘recycling’ and remaining quantity is ‘smuggled’ into the country. Official import is around half a ton for 10 months of the current financial year. On top of this price in the local bullion market is driven by domestic demand rather than international price.

There are two global benchmarks of oil, Brent and WTI, these carry hardly any relevance for Pakistan because the country buys ‘Middle East Crude’ where price is driven by ‘geopolitical’ considerations rather than prevailing international prices of Brent and WTI.

There is also a lot of hype about Pakistan’s inclusion in MSCI Emerging Markets and the overall perception is that up to USD1.5 trillion can make inroads into Pakistan. The statement sounds highly exaggerated keeping in view the inflow/outflow of foreign funds. Overseas investors already hold 30 percent shares of the blue-chip companies. According to some estimates, often monthly outflow comprising of dividend/capital gains exceeds inflow. Therefore, one of the possible fallouts could be outflow surpassing inflow.

Last but not least the hype about the US Fed increasing interest rate sounds like ‘exchange rate maneuvering’. On one or the other pretext the Fed has been deferring interest rate hike for more than a decade and hoping any hike in near future is hoping against hopes.

Pakistani’s should pay more attention to factors affecting its economy and ruling junta should try to remove the impediments affect GDP growth and exports rather than introducing news tax measures. It has been reported in media that the incumbent government has already exceeded its expenditures by more than PKR250 billion against the target, exports have nosedived and there is a visible deceleration in remittances. Many experts warn that debt servicing has become unsustainable and the government is borrowing more and more to pay off the debts.

Pakistan reclassified in MSCI Emerging Market

MSCI has announced to reclassify Pakistan in the MSCI Emerging Market Index in its Annual Classification Review, with a proforma weight of 0.19% (amongst the lowest in the EM group). Pakistan’s leading brokerage house, AKD Securities estimates gross passive inflows of US$500 million upon formal inclusion.

While benefits to derive are numerous, increased foreign visibility and participation particularly amid continuous foreign selling (CYTD net FIPI outflow of US$36.4 million) along with potential multiple re-rating (PSX-100 index traded at an average P/E multiple of 10.2x over 2006-08) are likely to be the most profound.

Despite rallying by 8% since May'16 in anticipation of a favorable decision, brokerage house believes the reclassification announcement is likely to make room for a further continuation of the recent bullish momentum with select stocks (included in the MSCI EM index) leading from the front. PSX-100 Index can statistically gain 15 to 20 percent surpassing 43,000 level over the next 12 months.

It is widely quoted that up to US$1.6 trillion is benchmarked to the MSCI EM Index (including both active and passive). A proforma weight of 0.19% should result in Pakistan attracting at least US$3 billion in both active and passive flows. Assuming passive investment constitutes 15 to 20 percent of overall funds benchmarked to the MSCI EM Index, roughly US$500 million in gross passive inflows into Pakistan can be expected upon formal inclusion.

While Pakistan is now set to compete with EM economies, brokerage house remains optimistic on Pakistan's attractiveness in the index backed by a promising macro environment. Favorable macro trends (decade low inflation and interest rates coupled with external stability) support Pakistan's economic growth trajectory. Major growth themes are 1) spurring industrial activity and consumer demand, 2) investment in infrastructural development and energy generation, likely boost GDP growth above 5 percent over the medium term. With positive implications for corporate profitability, strong consumer demand and development initiatives are now reflecting into a robust topline of Cements, Paints, Glass, Automobiles and Food Producers (excluding sugar).

Wary of continuous selling pressure, brokerage house sees Pakistan's reclassification into the MSCI EM index as a key confidence booster for the market. However, the latent risks exist in the form of: 1) political, both domestic and foreign policy related and 2) Brexit can cause turbulence due to heightened risk aversion of global investors.

Where Iran stands against Saudi Arabia in oil war?

Traditional rivals, Saudi Arabia and Iran, continue to fight to prove their supremacy in OPEC. Neither of them is ready to miss any opportunity to cause damage to the other and crude oil seems to be their most trusted weapon.

With Saudi Arabia ready to sabotage any chances of a production freeze, Iran has followed suit by thwarting attempts by Saudi Arabia to introduce a production ceiling on OPEC production the recent in the recent meeting in Vienna.

Iran, which is close to its pre-sanction levels of production, had earlier agreed to become part of any discussion being part of production freeze. However, in the latest meeting, Iran refused to adhere to any production ceiling, which led to OPEC abandoning the idea.

Iran has been quick in boosting its output soon after lifting of sanction and boosting its market share faster than anticipated. It is being said that Iran has resorted to offering large discounts to its Asian customers, undercutting the Saudi Arabia and Iraq.

According to media reports, Iran shipped 2.3 million b/d in April 2016 the highest level since 2012. These figures are 15 percent higher than the International Energy Agency (IEA) forecast. Iran has been successful in its strategy until now, but increasing its market share further might prove difficult.

Meanwhile, Saudi Arabia is attempting to cement its market share in the wake of this increased production from Iran and Iraq. Saudi Arabia has been attempting to transition away from being an oil-dependent economy, its transformation depends on the successful listing of Saudi Aramco.

The struggle for supremacy between the two nations doesn’t show any signs of abating, and there is no clear winner in this showdown. Though Saudi Arabia has large reserves, it is burning them at a fast rate. On the other hand, experts believe that the Iranian economy is better equipped to withstand lower oil prices because its economy is more diversified and has an educated and hardworking population.

Though Saudi Arabia will never accept, Iran is better equipped to cope with the long-term upheaval because it is less dependent on oil than Saudi Arabia, having raised more through general taxation than through oil duties over the years.

The fight between the two for supremacy in the Middle East region is unlikely to end anytime soon. Currently, supply outages to the tune of 3.5 million b/d are supporting the oil prices by creating a balance between demand and supply.

Once Nigeria, Libya, and Canada resume pumping at their normal levels, the effects of the struggle between Iran and Saudi Arabia will be felt. If both increase production, the world will be once again flooded oil, pulling prices back to around US$35/barrel levels.

Both the countries are involved in proxy wars in Syria, Yemen and Bahrain. Gone are the days when the United States was a friend of Saudi Arabia, in fact it has become a foe now. Iran is supported by Russia and United States seems least interested in the affairs of Middle East. On the contrary, it is feared that Saudi Arabia may have to face the brunt of 9/11. 

Speculators trying to drive oil market

After oil price touched US$50/barrel mark, speculators seem to have entered the market once gain. The situation is ideal because glut is shrinking due to outages. Speculators have started talking about consumption.  I have a gut feeling that outages in Nigeria are part of the usual geopolitical mantra.

The hype about rising demand is paving way for the resumption of output by Shale rigs. Saudi-Iran animosity is also being spread by main stream media, only to divert attention from atrocities of Israel against Palestinians.

According to Oil & Energy Insider, crude prices closed and opened above US$50 per barrel this week, the first time that has happened in 2016. The highest supply outages in years have rapidly shrunk the global surplus. Prices fell back on Friday due to a stronger dollar Speculators were prompt in pocketing profit. The EIA reported inventory drawdown.

It is being portrayed that oil demand is on the rise and the supporting argument is a record gasoline consumption in the US. Demand by refineries is nearing record highs as the world takes advantage of cheap fuel. This sounds dubious because gasoline demand should have jumped when price was hovering below US$40 per barrel.

Top analysts are not convinced that oil prices will move higher, arguing that the rally could be running out of steam. Supply outages in Canada are starting to be resolved. Also higher oil prices could restart some drilling in the shale patch. The dollar could strengthen, putting downward pressure on prices. And oil inventories are still at record highs.

The Trans Niger Pipeline was shut down lately due to a leak, taking another 130,000 barrels per day offline. The pipeline carries Bonn Light and is run by Shell, Eni, Total, and the Nigerian National Petroleum Corporation. Shell declared force majeure on Bonny Light in May when another pipeline that carries the oil stream, the Nembe Creek Trunk Line, was damaged by an attack. The Nembe Creek conduit, however, was just repaired, which could bring back 75,000 barrels per day.

Oman sold US$2.5 billion in bonds on Wednesday, as it seeks to improve its financial position. The Emirate not a member of OPEC went to the debt markets for the first time in more than twenty years, a sign of how badly it has been damaged from low oil prices.

The move comes after some of Oman’s neighbors issued new bonds earlier this year – Qatar sold US$9 billion in debt and Abu Dhabi sold US$5 billion. Saudi Arabia is also expected to turn to the bond markets, perhaps selling as much as US$15 billion worth of bonds. IMF has warned that the Gulf States to need to do a lot more to cut spending to hold onto their currency pegs.

Bloomberg reports that some oil traders are buying contracts that will only pay out if oil surpasses US$100 per barrel at some point in the next few years. The contracts do not suggest that such an outcome is necessarily likely, but only that some traders view it as a potential profitable position.

The traders buying new contracts are aimed at making people believe that today’s severe cutbacks in exploration and development will create the conditions for a supply shortage somewhere down the line.