What’s up at the stock market?

IN case you are thinking of jumping into the stock market given the sustained gains it has seen since July, be sure to ask yourself a few simple questions before you make any decision.

I rarely write about the stock market, and whenever I do, it is not flattering. Especially not when the market is in the middle of registering massive gains. The reason is simple. There is always a catch, and rarely do retail investors come out ahead.

The brokers are adept at selling stories. They have one set of stories for when the market is rising, and another set for when it is falling. When it is rising, their story will tell you how these gains have only just begun, how they still have a long way to go, and how the bad old days are over.

When the market falls, the stories will tell you there was never a better time to buy than this. When the dust settles, you will be left with the story and the broker will have your money. Of course, there are exceptions, important ones, but the majority of stock market brokers should be dealt with cautiously.

So what makes me suspicious of the current rise? Just ask a few simple questions. First of all, where is the rise coming from? You will notice something. From July to the first week of December, the market rose by around 22,500 points. Of this, more than 14,000 points were contributed by two major sectors only: banks and energy (I am including fertiliser in energy).

Automatically, you notice a lopsided growth here. More than 60 per cent of the growth in the market since July has come from companies operating in two limited spaces only. Does this mean the economy is booming? Or might it mean that something is happening in the world of banking and energy that is driving their earnings up?

Banks and energy companies have a high weightage in the KSE 100 index, so whenever their earnings go up, or their share prices move for any reason, they move the index quite sharply. Since July, the overwhelming majority of the reason why the index has performed so well is due to these two sectors.

In the first quarter of the fiscal year, from July to September, total profits after tax were reported at Rs417 billion, of which Rs149bn alone were from the banks, according to a research note put out by Topline Securities.

The other sector that saw a very large jump in its profit after tax comprised the oil marketing companies, who reported PAT of Rs30bn in the first quarter of this fiscal year compared to Rs844 million in the same period last year. That is a jaw-dropping increase. How did they manage this? “This substantial increase is primarily attributed to inventory gains,” the same note says.

Most of the increase at the stock market is coming from adjustments in prices, not innovation or economic dynamism.

The bulk of the increase in the stock market is coming from adjustments in prices, not innovation or economic dynamism. Banks saw one of their most important revenue lines — net interest margins — grow rapidly in preceding months as interest rates were hiked to historic highs, and suddenly the bonanza started to flow on all the government paper they picked up during this sharp rate hike.

Upstream oil and gas companies have their wellhead prices indexed to dollars, and saw their earnings rise as the rupee was devalued. Go through each of the sectors one by one, and you will find that their earnings growth has very little to do with anything they have done, and everything to do with them riding a wave as prices across the system were adjusted to reflect the reality under an IMF programme.

And since most large industry in our country, especially banks and energy companies, rely almost exclusively on government-administered prices for their earnings, they almost always benefit when these prices are adjusted to reflect the market reality.

That is what has happened since July. The price of money, the price of energy, the price of government debt, and so on, have all been adjusted to reflect market realities. One key price — the price of the dollar — has not been adjusted in the same way, but it is very likely that it too will see an adjustment in the months ahead.

With all these adjustments, the earnings of all big industry have been similarly adjusted because in almost all cases, they rely on returns as per a government formula, often indexed to the dollar.

If you entered the stock market earlier this year, and have managed to ride this wave, you are lucky. But if you are looking at the performance, and listening to the stories your broker is likely telling you, stories that are designed to entice you to enter, be very careful.

You will need to know how much more of the price adjustments will be reflected in future earnings, and very importantly, you will need to know the direction of the exchange rate, because very often whatever returns you make in rupees are blown away with one devaluation.

Be careful with the brokers as well. Some of them run a professional shop, but they are not large in number. For most of them, their business model is to deal with the money of a single, or maybe two, high-net-worth individuals.

All their trading is designed to benefit that client, and all retail clients are subordinate in their trading strategy to the interests of their primary client. This is how they develop lyrical stories around certain scrips, urging you to buy this or that stock, because most likely they are trying to generate buyers for their primary client.

The economy is adjusting under an IMF programme, and firms are caught up in this process too. In times like these, it is not a good idea to take on more risk, at least not with your savings or your nest egg.

The writer is a business and economy journalist.
khurram.husain@gmail.com
X: @khurramhusain

Published in Dawn, December 14th, 2023