Equity market to outperform other asset classes in the coming months

July 11, 2023 (MLN): The equity market is expected to outperform other asset classes in the next 6-12 months and possibly reach a new high, thanks to a favorable deal with IMF that will bring $3bn inflows in the coming 9 months, the latest report by Insight Securities Limited highlighted.

This investment proposition is primarily based on cheap valuation of the domestic market which is trading at a forward P/E & P/B of 3.4x & 0.7x vs. the 5-year average of 6.3x & 1.1x, respectively, it added.

This is primarily attributable to the country’s scarce foreign exchange reserves which are only sufficient to cover one month of imports.

Therefore, market participants were pricing in the probability of the country’s default on its financial obligations.

“The equity markets have seemingly priced in a default if we compare to countries which have recently experienced the same, such as Sri Lanka and Ghana,” Mustafa Pasha, chief investment officer at Lakson Investments Ltd told Bloomberg.

Furthermore, other avenues where people generally park their investments have now become less attractive, as compared to equities.

Domestic equities have remained laggard for the last 24 months due to a sharp rise in interest rates, a bleak economic outlook, and the flow of investment toward dollars or dollar-linked assets.

However, with clarity emerging on the political front along with a better-than-expected IMF program, equity markets can outperform other asset classes in the short to medium run.

With IMF stand-by agreement in place, the probability of domestic debt restructuring is low, at least in the near term.

Moreover, over the past year or so, there has been a significant influx of funds into the foreign exchange (FX) markets as individuals sought to secure USD and other stable currencies, in order to protect themselves from the ongoing economic crisis.

Furthermore, the imposition of administrative controls on imports and exchange rates has led to a substantial gap between official and unofficial rates, encouraging people to hoard dollars.

However, the introduction of a $3bn IMF program and the implementation of a market-based exchange rate mechanism are expected to facilitate the convergence of official and unofficial rates.

“We believe that energy sector stocks will perform relatively better due to timely rebasing/revision of energy tariffs as demanded by IMF.” Muhammad Shahroz, an analyst at Insight Securities noted.

Sectors that are negatively affected by import restrictions such as pharma, autos, electrical appliances, etc. can also witness a jump amid the removal of import restrictions.

Similarly, banking sector stocks are also expected to bounce back sharply, as they were trading at historically low multiples due to talks of domestic debt restructuring and a slowdown in economic growth which induced risk of NPL formation.

“We continue our liking for companies having decent earnings quality, strong cashflows, and attractive dividend yield,” the report noted.

However, a smooth run-up to the general election in the next couple of months and a swift transition of power along with necessary reforms under IMF watch, are necessary ingredients for a sustainable rally in the local market.

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