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Sri Lankan stocks weakened by rising interest rates, political uncertainty

Economy Next – 04.07.2018

By First Capital Research

ECONOMYNEXT – Expectations of higher interest rates and uncertainty in the run-up to crucial polls have brought down Sri Lanka’s stock market in recent weeks to an almost 15-month low, despite improved earnings and macro-economic stability, brokers and analysts said.

Foreign funds have been selling stocks with a heavy weighting on the benchmark index with higher interest rates expected in the United States after a rate hike by the Federal Reserve, as well as locally.

Investors are nervous about forthcoming elections, especially presidential polls, which could lead to a change of political leadership and hence, government policy, explained Atchuthan Srirangan, assistant manager of research at First Capital Holdings’ stock brokerage.

Furthermore, investors are already disappointed with the slow progress of promised governmental reforms aimed at improving the investment climate and speeding up growth, he noted.

The All Share Price Index of the Colombo stock exchange has slumped to a near 15-month low and is hovering just above the 6,000 point level. The ASPI is down 3.4% this year.

“The Colombo bourse extended its losing streak for the fifth consecutive week, burdened by continued foreign selling pressure while local players stayed on the sidelines,” Bartleet Religare Stockbrokers said in a note to clients last week.

The slump has wiped about Rs5.6 billion in terms of shareholder value, the brokerage noted.

Foreign selling in stocks with a heavy weighting on the index, like John Keells Holdings and Commercial Bank, has helped drag down the benchmark index. JKH has fallen 7% this year.

The CSE’s fall is partly attributed to foreign funds cutting their stakes in emerging and frontier markets.

Sri Lanka is not the only market to fall, with other emerging and frontier markets having also fallen, Srirangan of First Capital Equities noted.

Foreign funds are pulling out of emerging and frontier market following the US Federal Reserve interest rate hike, he told

“It is not only in Sri Lanka that stocks are falling,” said Srirangan. “Most emerging and frontier markets crashed last week. With the Fed rate hike, most funds flow toward the US.”

Analysts expect further weakening in emerging and frontier markets where volatility remains high.

“When foreign funds give a sell call, they cut positions in each market.” Srirangan explained.

“We’ve seen a lot of selling in Commercial Bank and John Keells Holdings in the last month because foreign funds are cutting their portfolios. All emerging market funds are cutting portfolios of blue chip stocks.”

However, Srirangan noted that there is no huge selling by foreign funds and turnover levels have been low.

The year-to-date daily foreign net outflow was less than Rs1.3 billion up to end-June.

Sri Lankan stocks are now comparatively cheap with a price-to-earnings ratio of below 10.5 times. But PE ratios are also low in other south and south east Asian markets.

The market is not reflecting improved company earnings and a more stable macro-economic situation, largely because of the political uncertainty, with presidential and parliamentary key elections in 15-18 months.

There is uncertainty about the presidential candidates of the key parties in the fray.

“We don’t know who is coming as potential presidential candidates,” said Srirangan.

Foreign investors are wary of policy changes if a new president comes, he said.

Stocks that have weakened are being picked up by locals and foreign funds but the main local funds like the Employees’ Provident Fund and Employees’ Trust Fund are not active yet.

Commercial Bank and John Keells Holdings both have a big float on the CSE and a heavy weighting in the main index. So any weakness in these two stocks can bring down the index.

Domestic government bond repayments that are coming up are also adding to the uncertainty with expectations that interest rates might rise.

“This month and in the next two months, there is an increase in maturity of local bonds,” Srirangan said.

“People feel bond market rates will go up, which will affect the stock market.”

The low turnover levels are also a deterrent to trading by fund managers.

“Big local and foreign players need big volumes,” Srirangan said.

Daily average turnover levels were below Rs600 million in the past month.

“With the market coming down, we are also seeing turnover drop,” Srirangan said. “Local investors are aware of the foreign sell-off and are on the sidelines. Normally retailers are active when the market starts to move. If local funds like the EPF and ETF get activated, then retailers will start to buy.”

The steady depreciation of the rupee against the US dollar is also adding to uncertainty along with delays in payments by China for the lease of the southern Hambantota port and a new syndicated $1 billion loan.

Srirangan said investors had also noted the drop in foreign exchange reserves because of selling by foreign

funds and government loan repayments and fear further depreciation of the rupee.
(COLOMBO, July 05, 2018)