Taking Stock Equity market outlook for 2024

This article is based on a webinar titled ‘Equity Strategy 2024’ facilitated by CAL.

The stock market serves as a barometer of a nation’s health, responding to various factors such as economic indicators, political stability, and overall consumer sentiment. Sri Lanka’s equity market has been showing signs of strength and optimism in recent months, with a bullish trend that has caught the attention of investors. 
Despite facing a prolonged period of volatility and uncertainty including a contraction in GDP, soaring inflation rates and a rise in taxes, the Sri Lankan economy has been displaying tentative signs of stabilisation since 2023. 
While not completely out of the woods, the country’s stabilizing political climate and improving economic conditions including reduced inflation, currency appreciation and increased remittances are contributing to the increasingly positive sentiment surrounding its stock market. It is vital to explore the positive indicators and contributing factors that have fueled this resurgence.

Unlocking liquidity

Reduction in interest rates leading to minimal yield on time deposits increases the attractiveness of equity markets:
Both banks and equity markets are major constituents of the financial system. In recent weeks, Sri Lanka has seen a marked liquidity infusion into the equity markets. One of the reasons for this shift, which can also be observed historically, is the negative correlation between interest rates and the All Share Price Index (ASPI). 
When the interest rates are depicting a downward trend, ASPI, which measures the movement of share prices of all listed companies in the Colombo Stock Exchange, performs well. This is because a decrease in interest rates will prompt investors to move money from bank deposits into the equity market. The influx of new capital causes the equity market to rise. 
According to research conducted on maturity profiles of deposits held in banks as of December 2023, it was noted that 20% of bank deposits are set to mature within 3 months, (indicating that these deposits are maturing about now), implying that there are investors in search of better returns and alternative asset classes to invest in. This repricing of deposits at substantially lower interest rates resulting in a sharp deceleration in deposit growth, will lead to a liquidity shift away from fixed income investments as they mature, and a reactivation of the equity market. This momentum is expected to continue since low interest rates are set to prevail for the upcoming quarters. The entire deposit base of the banking sector currently amounts to around Rs 16.6 trillion - even 1 percent of this amount flowing into the equity market is substantial enough to boost liquidity to a significant extent. 
Even conservative investors with minimum to zero knowledge about the equity markets can recreate a fixed income portfolio within the equity market by investing in dividend yielding stocks. The dividend income on average in the last couple of years of the top 10 dividend yielding counters has outperformed tax adjusted fixed income securities like fixed deposits, thus allowing investors to recreate a fixed income generating portfolio through the equity market. 

Capital gains being realized from investments in Government securities 

Another significant factor contributing to the increased liquidity in the equity markets is the exit of investors from Government securities. Over the past few years, Sri Lanka began printing money to fund the country’s fiscal deficit, resulting in currency depreciation and exacerbated currency volatility. The Central Bank responded by lowering reserve ratios and selling securities, leading to a substantial increase in investments in Government securities by local individuals. With yield patterns now declining, investors are set to gain notable capital gains on these securities. At the same time, attractive returns in the equity market offer opportunities for reinvestment of these funds at more attractive rates.  

Corporate dividend payouts and 
share buybacks

Based on dividends declared, around Rs. 20 billion of dividends are anticipated to be paid out to public shareholders in the upcoming months of 2024, providing further liquidity and reinvestment opportunities in the share market (historically a portion of dividend payouts always flows back into the equity market). 
Furthermore, the decision by Expolanka Holdings PLC to de-list the company’s shares from the Colombo Stock Exchange could also result in an increase in equity market liquidity. Expolanka Holdings PLC, a globally acclaimed conglomerate based in Sri Lanka, known for its diversified presence in four pivotal sectors of logistics, leisure, IT and food was also the largest listed company in the Colombo stock market. 
Listing and delisting are a standard process seen in every equity market, but the recent decision of a multinational of such magnitude has captured the attention of the public. The delisting would result in approximately Rs 36 billion being released to public shareholders, and if investors accept the share buyback offer and move out of the company, there would be a sizeable inflow into the stock market, enough to boost liquidity significantly. 

Recovery of corporate earnings

Sri Lanka has been through a series of economic challenges, starting with the Covid-19 pandemic and followed by the turmoil that ensued in 2022, with galloping inflation, crippling fuel shortages, power cuts, unsettled political conditions, declining dollar reserves, supply chain interruptions, import restrictions, as well as (from a business perspective) high interest rates and dampened investor sentiment. However, the nation is finally transitioning from a rough period into one of relative normalcy, and with the improving economic conditions corporate earnings are set to increase as well. 
The surge in the country’s stock market has been underpinned by improving corporate performance across various sectors such as banking and finance, consumer goods and tourism. The stability and growth potential of these sectors have drawn the attention of both local and foreign investors, further boosting market performance. Improving economic conditions in the form of reduced interest rates (and therefore corporate finance costs), limited room for further taxation, price stability and increasing consumer confidence and spending have resulted in an expected year on year growth in corporate earnings of 15 percent in 2024. 
A growth in earnings in the banking and finance sector is expected, despite declining interest rates, due to improvements in loan repayment capabilities and substantially lower impairment charges, thus allowing banks to maintain or increase profitability in the upcoming quarters.
The performance of the consumer goods industry has also been a driving force behind the stock market’s upswing. A reduction in price fluctuations of general consumer goods, improvements in real wages (many private sector companies are reporting fairly consistent increases in employee salaries and benefits for 2024 compared to previous years) and lower borrowing costs are expected to drive consumer spending upwards.  
High inflation over the last few years created substantial burden on consumer wallets, causing consumer sentiments to diminish. During the prevailing inflationary environment of the past few years, we witnessed a decline and strategic redistribution of average basket value and size. 
To address this issue, many companies in the consumer sector even adopted various strategies (for example the introduction of value for money products and sachet packets/smaller sized products) to cater to reduced budgets. However, with inflation since returning to single digits, and anticipated to stabilise further, the economic pressure on consumers has considerably eased. As a result, the retail sector is expected to see steady and stable growth, with consumer staples to benefit initially followed by discretionary items (such as electronics, alcohol, tobacco etc.)
Notably, the tourism sector has witnessed significant interest, with companies in this sector experiencing substantial share price gains and a bullish outlook. The country’s tourist arrivals have hit the highest levels since 2019, when hotel attacks, COVID-19 and an unmatched economic crisis devastated Sri Lanka’s tourism sector. With the return of visitors, we have witnessed not just a direct impact on tourism counters like hotels but also additional income trickling down to smaller enterprises and communities that are benefiting through increased consumer spending.
Several forward economic indicators also signal a recovery in economic activity from the decline experienced in 2022 and 2023. High frequency macro indicators that point towards growth include:
Petrol sales: Sri Lanka recorded acute fuel scarcities in 2022 due to unprecedented foreign exchange shortages. Sales volumes reached average historical levels once again in 2023, despite prices being exceedingly higher than pre-crisis levels.
Energy usage: A clear upward trend in electricity usage is a sign that manufacturing activities in the country are normalizing, following the steep plunge in consumption and power tariff hikes experienced in 2022. 
Cargo operations: Year on year growth in cargo and port operations have been experienced, in part due to the Red Sea impact (where rerouting of containers passing through the Red Sea made the Colombo port an attractive transshipment point) as well as improvements in import and export activities in the global market and the gradual recovery of the country’s economy. 
Paddy cultivation:  – as per information provided by the Ministry of Agriculture, the country achieved a growth in paddy cultivation despite fears of crop shortages. With the Maha season approaching, as well as bumper harvests expected during so-called El Nino years, the country can expect normalized crop cultivation levels in the upcoming quarters.
The recovery of corporate earnings and margin expansion is driven by a reduction in lending rates as well as limited supply-side disruptions and stable input costs and overheads. The past couple of years have involved several supply-side restrictions and disruptions including the imposition of various import bans and tariffs. The recent move to reduce or remove such restrictions has had a positive impact on margins and corporate earnings.

A turn of sentiment

Historically, consumer sentiment improves during the run-up to an election, with spending on campaigning trickling down to consumers, increased consumer confidence due to election promises and Government projects and handouts. The impact on equity markets can be significant, resulting from various policy changes and political actions by parties to secure their position in the upcoming elections. The lead up to the 2024 election could follow a similar trend thus contributing to economic improvements in the country.  However, this impact could gradually reduce post-election.
The revival of the Sri Lankan equity market is a testament to the positive indicators that are shaping the country’s economic landscape. Political stability and favorable economic indicators as detailed above, have generated confidence in the equity market’s potential for growth. Should the country continue to work towards sustained economic stability and growth, the stock market is likely to reflecting this positive trajectory.