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Pakistan Strategy: Foreign selling at PSX; Will this trend continue in 2021?

• The continuous foreign corporate selling has been affecting share prices and stock market sentiments in Pakistan.
• During the past six years, total net foreign selling has been recorded at US$2.1bn, which is 15% of the market’s free float capitalization.
• In 2020 alone, net foreign corporate selling has clocked in at US$529mn till Dec 18, 2020 (total net foreign selling: US$504mn).
• This follows foreign buying that came in on two major accounts in 2014/15 and 2017:
• Secondary Public Offerings (SPO) by the government in 2014/15. Two of these transactions, UBL and HBL attracted strong foreign flows of more than US$1bn, where UBL saw foreign investment of ~US$310mn (81% of the offer) and HBL received foreign investment of ~US$750mn (75% of the offer).
• Lead up to Pakistan’s upgrade to MSCI Emerging Markets (EM) as on the MSCI rebalancing day (May 31, 2017), gross foreign buying of US$452mn was recorded.
• Similar selling has also been witnessed in other Frontier Markets and small Emerging Markets like Malaysia, Vietnam and Sri Lanka.
• The quantum of foreign flows will be a key factor in setting the direction of the market in 2021 as we have seen shares owned by foreigners underperforming due to their rising float in the market.
• According to SBP data, widely followed, FPI stands at US$3.0bn (high of US$8.4bn on May 26, 2017 and low of US$1.0bn on Mar 14, 2009).
• However our detailed analysis suggest the this SBP data also includes few strategic holdings of sponsors (ranges between US$0.5-1.0bn).
• This US$2bn (US$3bn minus US$1bn), which is 4% of market capitalization and 13% of free float capitalization, includes both passive and active foreign funds. So theoretically in a worst case scenario, foreign selling of US$2bn can come into the market.
• However our analysis suggest that 20-25% of the US$2bn are illiquid stocks like Nestle Pakistan (NESTLE), Colgate Palmolive (COLG), Pakistan Tobacco (PAKT), Murree Brewery (MUREB) etc. These illiquid shares may be privately placed and not directly affect local liquidity.
• Therefore, adjusting for this, selling of around US$1.5bn can come into the market. That said, we do not expect this US$1.0-1.5bn selling to materialize in 2021 as there are many long term investors.
• We expect lesser US$200-300mn net foreign selling during year, where overall outlook of Emerging and Frontier Markets are also improving.
• The foreign selling in Pakistan has not just been Pakistan specific but outflows have been witnessed in Emerging Markets (EMs) and Frontier Markets (FMs).
• The EMs have underperformed the S&P 500 since 2010, and hence investing in riskier markets when US market has delivered solid returns makes little sense.
• A narrow majority of market strategists surveyed by CNBC predict that US stocks will continue to rally into 2021, with the S&P 500 rising between 8% and 22% next year from their current levels.
• On the other hand, some international Emerging and Frontier Markets commentators believe that risky assets may come into limelight given expected pick up in economic activity post the introduction of COVID-19 vaccines.
• Another factor that can help Emerging and Frontier Markets is a weaker US Dollar next year. In theory, a weak US Dollar should help drive flows into the Emerging and Frontier Markets as it supports their currencies.
• Recently, there have been some inflows in Emerging Markets (e.g. India, Thailand and Taiwan), however we continue to see foreign selling in Pakistan.

Unfortunately, many Frontier Funds tracking Pakistan have either closed down or their AUMs have come down significantly due to redemptions. Considering this, we expect lesser net selling by foreigners in 2021 and local will continue to drive the market.