AKD Quotidian about —: How much of a rate cut is the market expecting?

AKD Quotidian about —: How much of a rate cut is the market expecting?

Karachi: Within the backdrop of weaker global equity markets, the KSE-100 Index has gained -500 points or 4.5% since Sep 19’11 (rebased inflation numbers announced on Sep 20′ll).

According to AKD Securities, they attribute this bullish momentum to expectations of monetary easing with CPI of 11.56%YoY in Aug’11 and then 1O.46%YoY in Sep’11. While almost every quarter is expecting interest rates to come off in tomorrow’s MPS, rate cut projections range from 50bps to as high as 250bps (CPI-based real interest rates are +3% with DR currently at 13.5%). Based on the Justified PER multiple for the market, AKD Securities estimates that the KSE-100 Index has already priced in a rate cut of 75bps-I 00bps. Similarly, going by the DR-l2mTbill yield differential, AKD Securities believes the money market is expecting a rate cut of at least 50bps. In AKD’s view, any rate cut below 75bps may lead to a near-term reversal in the equity market’s recent bull move. However, a rate cut in excess of 100bps would likely extend the rally. In any case, with monetary easing likely to continue over the near- term, AKD Securities flags high dividend-yield plays (PTC, FFC, FFBL, KAPCO, NBP & POL) and leveraged stocks (ENGRO, DGKC & NML) as attractive options.

Justified PER and Index re-rating

 

 Cr. DR  -50bps -75bps -100bps  
Universe Payout   61%  61% 61% 61%
Discount Rate  13.50% 13.00% 12.75% 12.50%
Equity Risk Prem.  5%  5%  5% 5%
Avg. Nom. GDP  9% 9%  9% 9%
Justified PER (x)  6.16  6.49 6.67 6.85
Rerating Effect 5.32 8.2 11.2  
Post-rerating Index*  11,961 12,288 12,633  
*base on Sep 19’11 closing of 11356.64 points

 

Justified PER: Based on the Justified PER multiple (payout/(k-g)), AKD Securities projects that a 50bps cut in the DR would, all else the same, lead to PIE rerating of 5.3%. Considering that the KSE-100 Index has gained 4.5% since Sep 19’11 (release of lower rebased CPI the next day started fuelling rate expectations), it appears the market has just about priced in a 50bps rate cut. However, the recent dip in Pak-US relations has likely also had an impact leading us to believe the KSE-100 Index has priced in a rate cut of 75bps-100bps.

DR-12mTbill differential: Since late 2009, the DR-12mTbill yield differential has averaged 25bps which has widened to 75bps in the Oct 5’11 T-bill auction. Going by this, it appears the money market is expecting a rate cut of at least 50bps. Accordingly, T-bill yields are unlikely to shift much should the SBP choose to cut the DR to 13% tomorrow.

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