Since the last easing of the policy rate by 50bps to 13.5 per cent, the bond market has witnessed a bullish trend and the most interesting aspect noted is that the whole yield curve is now trading below the policy rate. This is very rare in Pakistan’s case of the debt market, said Muzzammil Aslam at JS, adding that another interesting attribute which the current yield curve is depicting is an “inversion”.
Comparison of bond markets
The spread between 1-year T-bill and 10-year bond has turned negative to 24bps compared to 10bps on the positive side on July 29, 2011. Consistent with the theory, the stock market has also negatively correlated during the same period depicting a decline of 9 per cent. A question arises: what is the normal condition for the bond market and what does empirical evidence suggest? We traced a similar situation which occurred in the USA in 2006, where the Federal Fund Rate was at 5.25 per cent compared to the 2-year note at 5.17 per cent, the 5-year note at 5.10 per cent, the 10-year at 5.13 per cent, and the 30-year at 5.17 per cent. Far from being a normal condition in the bond market, this has only happened on four more occasions in the USA over the past 25 years – March 2000, August 1998, January 1989 and January 1982. Each of these was preceded either by an economic downturn or a major financial strain on the economy or both. We view neither economic downturn nor financial strain on the cards for Pakistan, as the economy is already in shambles and financial stress is fully stretched, he added. In our view, as inflation is likely to head south with economic growth to remain under stress and little appetite for private credit in the system, the SBP should ease its stance again in the upcoming policy reviews – making it more lucrative for corporates to invest in bond market. However, we recommend investors to reduce investments in long-term bonds at current level and invest in key blue-chip stocks that offers high dividend yield, currency hedge and growth in future including HUBCO, PTC, FFC, and NBP.
Preference of KSE over treasury bonds
He further said that with the recent meltdown of 9 per cent since July 29th, we believe market is trading at an attractive 2012F PE multiple of 5.8x and a dividend yield of 9.3 per cent. Additionally, the spreads between earning yields (17 per cent) and inflation and earnings yield and 1-year treasury bill have turned positive for the first time since September 2010.
Therefore, we expect yield hunters to target Pakistan’s capital market, he said, adding that since Pakistan’s debt market is still offering one of the highest yields around 13 per cent in the world we expect some foreign flows in to debt market as well. This, we believe, will protect rupee exchange rate from any steep depreciation, he added.