Pakistan Equities Monthly Commentary A solid relief rally; 5 May 2020 breather can be forgiven . Interestingly, the local stock market and crude oil (WTI) both happened to Syed Hussain Haider, CFA, CIPM close the month at key resistance levels. Both have already gone through [email protected] a commendable relief rally; WTI has doubled and the KSE-100 has posted +9221 111-574-111 Ext: 3118 25% returns. Hence, any breather during May should not be concerning. Ali H. Zaidi [email protected] . Looking at the decent stock market performance in the ongoing holy +9221 111-574-111 Ext: 3103 month, it might just be the best one in a decade. However, empirical evidence suggests May has historically been relatively tamer. Perhaps this Ahmed Lakhani time, we could be in for something different? [email protected] +9221 111-574-111 Ext: 3035 . Presently, the market is basking in the glory of sympathetic measures (and potential budgetary relief around the corner) in lieu of Covid-19 – both local and foreign. Also, even with the back-to-back policy-rate cuts already announced by the central bank, a further cumulative 200bps cut (at least 100 bps in coming MPC meeting) should not be too surprising. With the market trading at forward P/E of 6.2x and a forward P/B of 1.03x (10-yr average of 8.2x and 1.6x) as per Bloomberg, there is no denying that valuations are more than attractive from a longer term perspective, even though the near-term earnings outlook remains hazy. The elephant in the room is the pandemic, which is still a developing story. In the absence of scientific evidence of a flattening out infection curve, easing lockdown remains a major risk that could potentially make the situation extremely challenging. JS Research is available on Bloomberg, Thomson Reuters, CapitalIQ and www.jsgcl.com Research Entity Notification Number: REP-084 Please refer to the important disclosures and disclaimer on the last page A solid relief rally; breather can be forgiven First the good news! The dark clouds of Covid-19 finally gave way to a ray of hope in Apr-2020. As global Coronavirus infections crossed 3.5mn, clinical trials of Remdesivir, an experimental drug by Gilead Sciences, may have given the world a whiff of optimism. For once, despite all differences, the world seems to truly be united by a single goal: survival. Each country is facing this challenge with its own unique skill set with varying degrees of success. For instance, while developed nations such as Germany and UK have been looking to conduct human trials for their drugs, Pakistan has been looking to enhance its testing capacity and domestically manufacture ventilators. Any success story regarding a cure would be great news indeed and we, as much as anyone, pray for one. Hoping for the right decision Pakistan seems to be charging headlong towards a cliff, at least if statistics are to be believed. The infection tally has been growing rapidly on a weekly basis and even though testing capacity is said to be on the rise, it remains woefully insufficient. Moreover, considering the sheer size of its population, Pakistan is grossly under-equipped in terms of testing capacity. Such statistics alone make a strong case against easing lockdowns. But, suppose if we do decide to follow in the footsteps of some European nations – as suggested by some corners in our society – shouldn’t we at least follow them wholeheartedly rather than selectively and wait for the rate of new cases to subside? Premature easing of lockdowns could lead to consequences that Pakistan (or any other country in our situation) is just not ready for. Focus on Covid-19! Downward revisions to growth forecasts have recently come to light with the ongoing pandemic. For instance, according to its latest Staff Report, the IMF expects Pakistan’s GDP to contract by 1.5% in FY20 (+2.4% previously) and grow by 2.0% in FY21 (3.0% previously). Needless to say, the Coronavirus is still a developing situation and these forecasts are not etched in stone. While the Staff Report did share other projections, SBP’s Deputy Governor highlighted in the latest analyst briefing that the overall impact on Pakistan was relatively modest vis-à-vis some other EM economies due to the former’s limited trade openness and low levels of existing FDI. A special word of thanks is due to IMF, which has generously released US$1.4bn to Pakistan under the RFI, effectively triggering PKR appreciation. Meanwhile, the EFF | 1 A solid relief rally; breather can be forgiven has been temporarily put off and is expected to be revisited later. We reiterate that the feared frontloaded-ness should not return upon resumption of the program. Furthermore, the G-20 has offered to defer loan repayments due from a list of developing countries that (thankfully) includes Pakistan. On the fiscal side, after announcing the largest stimulus package in the country’s history earlier in Mar-2020, we saw the Prime Minister announcing a specific package for the construction industry. And this when Pakistan’s social safety net is being stretched to record levels. The SBP has also provided much needed support through back-to-back cuts in the policy rate and announced numerous other packages in its efforts to cushion the impact of the pandemic. With regards to the upcoming budget, we believe that the government will aim to provide as much leeway as possible to sustain the economy. However, for a change our economic woes should not be our greatest concern; we will rise again as we always have. What matters more is how successfully and quickly we can overcome the Coronavirus challenge. What else is going on? Apart from Coronavirus, the matter of the 18th Amendment received much attention during Apr-2020, portrayed as a tug-of-war between the provinces and the center with the prize being control and power. However, a less-talked-about area of the amendment is the Council of Common Interests (CCI). The council that is supposed to meet every quarter to ensure inter-provincial harmony has remained somewhat inactive. Side by side, there were countless debates on how the government and IPPs have locked horns. On top of that, there were further reshuffles in the cabinet (Special Assistant to Prime Minister on Information and Minister for Economic Affairs) and top administration (Federal Secretary for Commerce). Obviously that is now water under the bridge. What matters now is how the government plays its cards on debt relief and further potential funding. In this regard, a ‘slimmer’ cabinet could go a long way in sending across a message of fiscal prudence. Oil – is the relief rally sustainable? Apr-2020 was a historic month for the oil industry. A combination of contracting demand, insufficient supply cuts and depleting storages threw US oil contracts into negative territory for the very first time. Domestically, investors opted for a typical ‘buying the dips’ strategy as they took the | 2 A solid relief rally; breather can be forgiven opportunity to accumulate E&P stocks. For instance, OGDC did not revisit its recent low of ~Rs75 and instead recovered from Rs83.80 in intra-day trading. From an economic perspective, lower oil prices are, as a rule of thumb, cause for rejoice for oil importing countries. Considering the substantial cuts in domestic retail prices of oil products, we believe CPI during 4QFY20 will average at ~8%, limiting the full year average to under 11%. The oil future curve is currently in Contango (Jun-2021 Brent and WTI trading at ~US$36 and ~US$32, respectively) indicating the broader expectation that oil prices will eventually normalize as the Corona-effect wears off. It remains to be seen how much steam is left in the current relief rally with resistance (WTI) at US$19-21 followed by US$28-29. Domestic institutions on a shopping spree! Four general observations can be made regarding flows. Firstly, the trend of foreign selling continued during Apr-2020, with considerable offloading in Banks, E&Ps and Cements. Secondly, institutions, particularly Insurance Cos., have domestically led buying activity CYTD which is in contrast to what happened last year, when individuals were at the forefront. In fact, this time slightly over half of the selling by foreigners in the aforementioned 3 sectors was absorbed by insurance cos. Interestingly Banks/DFIs followed Insurance cos. as they rebuilt positions in Banking, Fertilizer and E&P stocks during 1QCY20, while they were firmly on the fence during April. Thirdly, individuals who have been relatively noncommittal for the majority of the year sprang to life in April, with most of their buying activity targeted towards Cements. However, note that during the latest major bearish spell (13’Jan to 25’Mar), E&Ps remained their preferred sector. Finally, mutual funds which were among major net sellers in 1QCY20, emerged as the major net buyers in Apr- 2020, covering back in E&Ps and Fertilizers while also building fresh positions in other sectors. Hazy outlook but a brilliant opportunity! The ongoing result season has not been surprising so far. While some corners were not as bad as others, earnings erosion was not hard to spot. But then what else can be expected at the very beginning of economic recovery? Now, as Coronavirus infects businesses, the earnings outlook becomes hazier, not just for the coming quarter but possibly for the remainder of CY20. During the current season, we witnessed two major events: (1) monetary easing well ahead of broader expectations and (2) Oil prices crashing down to make | 3 A solid relief rally; breather can be forgiven history.