Rising stock market index is an indicator often used by Pakistani finance ministers as a measure of their success in management of the Pak economy. In the past we saw Shaukat Aziz boast about how the stock market and respectively the investor’s confidence in stocks per se had prospered due to his prudent policies, thereby signaling market’s confidence in his economic management, and now Ishaq Dar seems to be following in his footsteps by often citing this indicator as a measure of his success in handling of our economy. The thing is that while surely strong stock markets tend to be feel-good factor in any economy, most economic management lessons don’t usually have much to say on Bulls having a distinct correlation with a strong economy. Stocks, in fact are most susceptible amongst market-measures to popular delusions and crowd-madness, and stock prices in general have a lot less to do with the state of the economy or its future prospects than many economic managers would like us to believe. Now this does not imply that we should totally ignore stock prices, only that we need to be careful with our analysis. The fact that the major averages have lately been hitting new highs – PSX (Pakistan Stock Exchange) index closed last week at an all time high of 39,151 points – is newsworthy and noteworthy. Still, we need to do a deep dive to truly assess that what exactly is the high PSX index really telling us?
The government has been quick to add that the rising PSX is not merely based on local interest, since recent flow of even the foreign funds has changed directions for the better and the on-going month of July ’16 has already registered and inflow of $29 million, nevertheless the answer to this abrupt bullishness I am afraid cannot be termed as entirely positive. In many ways the stock market’s gains reflect economic weaknesses, not strengths. And understanding how that works may help us make sense of the troubling state our economy is in. Famous economist, Paul Samuelson, has written extensively on the myth or rather debunking the myth that stock prices are a prudent measure of the economy as a whole (a myth mostly popular mainly with either the far right politicians or ultra conservative economists). He argues that the truth in essence is that there are three big points of slippage between stock prices and the success of an economy in general. First, stock prices reflect profits, not overall incomes. Second, they also reflect the availability of other investment opportunities – or the lack thereof. Finally, third, the relationship between stock prices and real investment that expands the economy’s capacity has gotten very tenuous. On the first point: We measure the economy’s success by the extent to which it generates rising incomes for the population. But stocks don’t reflect incomes in general; they only reflect the part of income that shows up as profits. This wouldn’t matter if the share of profits in overall income were stable; but it isn’t. The share of profits in national income fluctuates. Incidentally, it has been a lot higher in the recent year than it has ever been, even when compared to the stock surge during the Shaukat Aziz days. Meaning, that in Pakistan whereas we have had a profit boom in select sectors – which by the way is another debate about rent-seeking – we on the other hand have not had a comparatively similar large size general economic boom, making the relationship between profits and our prosperity weak at best. In fact, we are not anywhere near to the economic upsurge back in the 60s or the 80s.
On the second point: When investors buy stocks, they are buying a share of future profits. What that is worth to them depends on what other options they have for converting money today into income of tomorrow. And these days such legit cum documented options in Pakistan are pretty poor, with interest rates running at historically low or even negative by some accounts whence benchmarked for inflation. Meaning, the investors are willing to pay a lot more for future income than its current net-present value – this investor behavior reflecting in today’s high stock prices for any given level of current profit. And by the way low short-term interest rates aside, the future outlook on the depressed long-term interest rates tells us yet another story of the weakness in investment spending in Pakistan’s economy, which implies that investors in our stocks are aware and conscious of the fact that the long-term interest are likely to remain low at least for some time to come, as the government tries to spur the present low investment level.
However, this presents a yet another paradox, which being that if the private sector does not see itself as having a lot of good investment opportunities, then how can profits be so high? And the answer to this may sadly lie in the economic distortion that current profits in Pakistani firms have little relationship to investment in new capacity creation. Instead profits come from some sort of rent-seeking, monopolistic positions, cartelisation or corruption. Dilemma in such a case being that for the overall betterment of the economy such companies can have high stock prices but do precious little to promote re-investment or job creation or fair distribution. In other words, while record stock prices may present an argument that this government has indeed been raking up some valid business friendly policies, but they cannot be taken as evidence of a fair or a healthy economy. If anything, this is a sign of an economy with too few opportunities for productive investment, especially in manufacturing, and a rather unhealthy corporate structure that lacks competitiveness and self-sustainability in a free and fair market economy. So when one reads headlines about stock prices, one ought to remember: What is good for the PSX may not necessarily be good for Pakistan, or vice versa.