LAHORE - The equity market on the first day of last week cheered State Bank of Pakistan’s 50 bps cut in discount rate to 9.5pc, leading to KSE-100 index crossing the psychological barrier of 32,000 on Tuesday. However with the SBP placing six-month moratorium on KASB Bank, SECP suspended trading activities of its brokerage subsidiary resulting in panic selling by some investors during mid-week. But attractive valuations brought back investors’ interest into the market on Friday (+256 points) despite the incumbent government gearing up to face a strong protest from a major political party on Nov 30. All in all, the benchmark index closed up 0.5pc WoW at 31,495 points, with average trading volumes edging down by 8.6pc WoW. Gas utilities outperformed the market during the week as ECC approved policy guidelines for OGRA to allow an average 30pc hike in gas tariff. Other key highlights of the week were: (1) 1QFY15 fiscal deficit clocking in at 1.2pc of GDP, (2) Current Account deficit in Oct-2014 widening to $347mn, (3) FDI rising by 47pc YoY in 4MFY15 and (4) Cotton arrivals rising by 10pc YoY to 10.44m bales in FY15.

During the week, State Bank of Pakistan cut policy rate by 50bps to 9.5pc after keeping it unchanged for just over 12 months. This was on the back of favorable inflation outlook amidst declining oil prices, rising forex reserves and improvement in budgetary imbalances. Earlier, it was discussed that record high spreads between govt. paper and inflation justify policy rate cut. Considering lower-than-anticipated inflation, falling oil prices and expected US-Dollar inflows from Sukuk & IMF, it is expected policy rate to go down by 50-100bps in 2015.

Other factors to remain constant, this development will have a positive impact on textile, fertilizer, telecom and cement sectors. Within Topline Universe, it is expected that earnings of these sectors to increase by 1-2pc. Other than the above, one of the oil marketing companies, Pakistan State Oil (PSO), has been marred by abnormally high short-term borrowings as a result of the circular debt.

Although Pakistan’s banking sector has placed most of its investments in fixed-return Pakistan Investment Bonds (PIBs), policy rate cut will be slightly negative for banks. Margins will squeeze on new deposits; mark-to-market gains on govt. bonds will reflect in the equity. However, as govt. gets to borrow less from the private sector, this will allow more liquidity with the banks for credit expansion. We believe this will spur growth in private sector credit for banks to benefit from.

On the contrary, cash-rich sectors like E&Ps and automobiles may see lower returns on their bank deposits going forward.

With policy rate cut coupled with falling yields on PIBs, valuations of listed companies will theoretically be revised upwards by ~5-10pc. With falling return on govt. papers, we expect more cash flows from institutions and high net worth individuals to come to equities. Pakistan stock market trades at 2015F PE of 7.9x and we maintain our positive stance on the market. Banks and Cements remain our top sectors that can beat the market.

According to experts, in last 4 weeks, Pakistan local currency bonds (PIBs) have posted abnormal gains amid expectations that interest rate will fall further and government demand for long-duration bonds at high rates will decline. Yield (YTM) of actively traded 2-year PIB after touching a high of 12.5pc on Aug 19, 2014 is now 10.6pc (touched a low of 10.1pc). Similarly, 3-year bond yield is down 185bps to 10.65pc. Furthermore, 5-year PIB has rallied to yield 10.8pc, from 12.9pc almost 9 weeks back and 10-year is at 11.80pc, from 13.40pc 9 weeks ago.