PREDICTING the direction or magnitude of change in the movement of equity securities is a fool’s errand.

John Maynard Keynes once said that “the markets can remain irrational longer than you can remain solvent”, and the same has been proven correct time and again. We cannot predict the direction or the magnitude, but we certainly can work with whatever information is available.

The equity market in Pakistan continues to be consistently cheap across all metrics — relative to its historic levels, as well as relative to other regional and frontier markets. Market capitalisation, which represents the sum of market value of all companies listed on the stock exchange relative to the GDP, continues to remain lower than its long-term average.

Pakistan’s market capitalisation to GDP ratio has averaged around 23 per cent during the last twenty years but remains around 17pc.

Similarly, inflation over the last five years has compounded by more than 100pc, but equity prices have yet to catch up to inflation, even though earnings continue to increase. The price-to-earnings ratio is another key metric that one can use to assess whether a stock or market is undervalued or overvalued.

Over the long run, the average price-to-earnings ratio for the KSE-100 index has been around nine times, which is still fairly low for an emerging or frontier market. During the last five years, the ratio has fluctuated between four and five times and has reverted to less than five times following the recent downward price correction.

Every single valuation metric indicates an equity market that is undervalued and has stayed that way for the last many years.

Maybe a structurally undervalued market points towards a deeper and structural problem that traditional market valuation metrics can’t capture.

Economic growth has been in the doldrums in the last few years, and any significant growth spurt attained in the last decade can largely be attributed to a consumption-oriented, import-fueled growth model — funded by external debt. Growth remained a function of external debt-driven consumption-oriented growth, while investment and exports as a percentage of GDP saw their share decline consistently.

Consistently irresponsible fiscal policies of successive governments have led to a scenario where large sectors of the economy remained cash-strapped. The government to fund its spending spree continued to crowd out private sector credit, squeezing the availability of credit for private sector growth. Government-backed assets make up more than 70pc of banking assets, effectively making them conduits for sovereign debt. Oil, gas, power, and other allied segments remained cash strapped as liquidity remained stuck in circular debt.

As critical segments of the economy remain beholden to a spendthrift sovereign, the valuations of these entities started reflecting the same. Effectively, the price of any asset is the present value of its cash flows — the value of an asset that has its cash stuck with the sovereign without any recourse will perpetually remain depressed till the time structural issues are resolved.

It is estimated that eight out of the ten biggest companies making up the KSE-100 index are directly or indirectly related to the sovereign, whether through being its lenders, depending heavily on some concession provided by the sovereign, or by having its liquidity stuck with the sovereign.

The market may be depressed, but it is depressed because of a dysfunctional sovereign that refuses to bring about structural changes and continues to fund its deficits through more borrowing, whether local or foreign. This is sovereign risk at play here, which will continue to overshadow the private sector and asset prices until reforms are implemented.

Net government borrowings make up 82pc of broad money, which is its highest ever level — effectively meaning that the government continues to borrow to bridge its deficits without making any structural amends. Such heavy reliance on borrowing will continue to keep interest rates elevated while continuing to drive out private-sector credit, further squeezing the ability of the private sector to innovate or simply operate at this point.

The direction that the equity prices take in 2024 will largely be determined by the ability of the sovereign to undertake serious reforms and instil confidence in the market. Considering 2024 is an election year, it will be even more crucial for the new government to demonstrate that it can actually undertake serious fiscal and structural reforms rather than rinse and repeat its tried and tested playbook that has only yielded failure.

Interest rates will remain elevated until the government reduces its demand for borrowings by instilling fiscal discipline. As long as the government continues on its debtinduced consumptionoriented binge, moving from one emergency foreign currency injection to another, the equity markets will remain directionless and choppy.

The market remains undervalued, but that is largely a function of the sovereign that refuses to mend its ways and push the economy on a sustainable growth trajectory.

The writer is an independent macroeconomist and energy analyst