LAHORE - The week began on a positive note as speculation in domestic politics eased somewhat after the return of President Zardari. Concurrently, further impetus came on the back of rumours related to proposal of KSE to collect capital gain tax under the presumptive tax regime for individual investors. Nonetheless, contrasting views of the government and the army on the memogate controversy and a current account deficit (CAD) of $2.1b reported in 5M kept the market sentiment fairly cautious. Overall, KSE 100 Index gained 273 points, up 2.5 percent WoW. Volumes also improved marginally by 1.4 percent WoW to 45 million shares. Moreover, local bourse outperformed the regional markets by 1 percent. Though, despite the recovery foreigners remained net sellers, offloading shares worth US$8.9 million.

State Bank of Pakistan (SBP) expects the economy to grow in the range of 3-4 percent in FY12. The reason highlighted by SBP for the expected underperformance is its bleak outlook on the agriculture sector. SBP also believes that the fiscal deficit target of 4 percent will not be met as flood in Sindh, dengue fever in Punjab, upcoming elections and absence of IMF program are likely to take its toll on expenditures. Additionally, inflows from coalition support fund are uncertain on the back of strained US-Pak relationship. Consequently SBP has projected fiscal deficit of 5.5-6.5 percent of GDP for FY12. On the external front, SBP projects current account deficit (CAD) of 1.5-2.5 percent of GDP in FY12 against the initial target of 0.6 percent of GDP.

Mix reaction in fertilizer stocks was witnessed amid the uncertainty on gas related issues. The foreign investors at the KSE have yet again been at the forefront in determining market direction. Experts said that the KSE-100 index is down 10 percent in 2H2011 in the backdrop of net foreign selling worth $157 million during the period. Recall that in 2H2009, KSE-100 had gained 31 percent on the back of net foreign buying of US$291 million. According to estimates, foreigners still hold 29.98 percent (US$2.4bn) of the market’s free float vs. its recent high of 32.5 percent (US$2.8bn) on May 21, 2011. Experts believe the gloomy global economic outlook (in general) and the ongoing Euro debt concerns (in particular) have reduced the investor’s appetite for equities, while enhancing the appeal for bonds in search of safe havens. Interestingly, the appetite for commodities has also faded away lately; take cue from Gold (down 16 percent from its peak on Sept 6, 2011) and CRB Index (down 22 percent from its peak on April 29, 2011). Despite equities being the least preferred instrument for investors, Pak equity bourse has seen a milder foreign outflow compared to emerging economies.

Overall, foreign portfolio investment has witnessed a drawdown from emerging economies during 2011 like India (-US$538 million), South Korea (-US$8.9bn), Taiwan (-US$9.8bn) and Thailand (-US$427 million). Interestingly, the frontier markets like Dubai (US$38.4), Abu Dhabi (-US$85.1) and Qatar (US$756 million) are yet to witness such large quantum of selling. We believe, foreigners have opted to drawdown from those countries which either have high fiscal deficit (India) or higher exports to GDP ratio (South Korea, Thailand, Taiwan, Japan etc).

Experts believe during the past few months, foreigner’s uneasiness on Pakistan has also increased due to 1) strained US-Pak ties, 2) domestic political uncertainty, 3) question mark on macro-economic indicators and 4) energy shortfall.

Interestingly, Indonesia and Philippines have managed to attract foreign flows during the period under review. The two markets have witnessed an increase of 25 percent YoY and 8 percent YoY in foreign buying in 2011 YTD. The higher confidence in the two countries is mainly on the back of 1) high growth prospects, 2) relatively lower fiscal vulnerability and 3) political stability.

Atif Zafar, an analyst, observed that the important question that we are fielding these days is whether there is more downside risk to the market? He believes it is hard to predict the exact bottom of the market but looking back in history, since 1996 we have seen that the KSE has rebounded sharply in the year following a decline (see table below). However, clarity on the domestic political front and issues related to capital gain tax will be the main triggers in the days to follow.

Experts also have a buy on weakness stance in ENGRO as well, recent market participation and increase in urea price combined with exhaustion in foreign selling are likely to shift the sentiment in Engro to help it move north. Increase exposure in NBP on close above 41.50.

Price action in Engro Corporation (ENGRO) stock has led to a decline of 40 percent in the stock price in last 6 months. Not only has the market completely ignored Engro Corporation’s fertilizer business (which also includes the company’s older plant facing no gas supply issues and functioning properly) but also has disregarded expected cash flows from the company’s other stable and growing businesses to the tune of at-least PKR10/share.