The combination of CAD, fiscal deficit, depreciating PKR, rising inflation, and high interest rates will lead to demand contraction, margin compression due to higher imported raw material and energy costs, and higher leverage costs leading to bottom line contraction. The question is whether this has been factored into prices and market participants will generally respond with a “Yes.”

However, consensus earnings data seems to suggest otherwise. Active research coverage is available for only 46 companies listed on the KSE100 Index, accounting for 53% of the KSE100 market capitalization, with aggregate consensus earnings projected to grow at 19% in FY19 over FY18. Further deep dive reveals earnings growth for cyclical stocks is being projected at 15% and for non-cyclical stocks at 29%. In the current environment, the growth being projected appears unlikely and we are likely to see earnings downgrade as we move into the year.

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The demand contraction argument is supported by Large Scale Manufacturing (LSM) data which points towards a sharp slowdown with overall LSM 12-month YoY rolling growth now at 0.6%. Industrial production growth is currently flat while consumer products growth is at 1.3%.

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KSE100 forward PE is currently estimated at 7.1x and one may argue the market is already trading at its trough level. However, if one agrees with the earnings contraction argument, then the market is likely to dip to its historical trough levels.

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KSE100 forward PE trough over the past 10 years was 5.6x and using that as a proxy for the potential bottom translates into the KSE100 Index dropping to c. 30,000 level.

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As always, cherry picking opportunities based on solid fundamentals are available for those with the appetite to take on risk. Else it is a time to be patient and invest when the market bottoms out.

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