The Economic Barometer Indicates Fair Weather Ahead

Originally published in the Financial Post on Monday 18th February 2002

If one accepts notion that the stock exchange is the barometer of the economy's state, one would conclude that the pundits expect good tidings ahead. The KSE Index was at around 1250 a day before 11th September 2001 and is currently ranging between the 1600 and the 1700 levels - an improvement of around thirty percent.

Sceptics would dismiss this by saying that the Pakistan market is manipulated by a handful of speculators and therefore the barometer cannot be relied upon. It is true that the market is influenced by speculators and that the bulk of the volume traded is on account of speculation. However, we must recognise the fact that speculators simply try and forecast the future price levels and then buy shares if they believe that the future levels will be higher than the current levels; and as more and more speculators get involved, the demand causes the prices to rise.

As is true anywhere in the world, as more people notice the price run up, with the typical herd mentality, the public starts jumping into the fray. This causes a further price momentum and prices at times go beyond sustainable levels. This leads to profit taking by the more astute players and the public may be left holding rather expensive shares. This leads to the accusation that the speculators had manipulated the market in the first place.

Irrespective of which side of the story we accept, the fact remains that the initial price run-up is caused because of a belief by some speculators that there are grounds for prices to rise and they try and act in anticipation of that. What we must analyse is whether the run-up this time around is based on a realistic expectation of improvement in the economy or it is merely driven by market manipulators.

The question to answer is, as to why should an anticipated improvement in the economy lead to higher share prices. Share prices are determined by the market participants by first trying to forecast the profitability of companies and thereafter deciding as to what would be a fair value to buy into such profitability.

We know that if conditions are very uncertain, we prefer not get our money stuck in any long-term investments, so even if a company is profitable, we would not want to pay to much for its shares; on the other hand, if we perceive the conditions to be reasonably stable, we are willing to commit our money to longer term investments and we may be...