Trisha Peries, Head of Research at CAL, Dimantha Mathew, Head of Research at First Capital, and Asanka Herath, Head of Equities at Lynear Wealth Management, discuss the outlook for the economy, interest rates and portfolio strategy ahead of the parliamentary elections in November 2024.
Weighing possible election outcomes and their implications for the IMF programme, SOE reforms, and economic growth, the panel presents investment perspectives based on risk tolerance and market conditions. They discuss approaches such as dividing a portfolio equally between equities and fixed income, given low interest rates and tailoring investments based on individual risk preferences to capture potential higher equity returns. They emphasize the importance of timely investment to avoid missing gains. Overall, the panel converges on the benefits of equities, dependent on political stability and economic recovery.
How do you see the economy reacting in two potential scenarios post-parliamentary elections: an NPP majority forming a government versus an SJB-led government? Could you compare and contrast the likely market outcomes in these cases?
Dimantha: If we assume that the NPP wins, which seems to be the current trend, we can expect a crucial development: policy consistency, something we have lacked for a while. With consistent policies, uncertainties gradually diminish. Recently, we have seen progress on the EDR and discussions with the IMF moving forward. As long as any party engages with the IMF programme, it will benefit the economy. There are two other scenarios to consider. First, if the SJB, the former opposition, comes to power, we could see a left-leaning president and a right-leaning government. This unlikely alignment might lead to significant delays in implementing reforms, similar to what we experienced in 2015. The second scenario involves a hung parliament, where the NPP secures a minority and aligns with another party. In this case, we could face challenges in the speed of policy implementation.
Is there an opportunity for whoever is in power to leave the IMF programme or to enact policies that result in the IMF suspending the programme?
Trisha: There is always a chance to do so, but do I believe the likelihood is high? Not really. While presidential election manifestos made many promises, the post-election rhetoric has shifted towards pursuing the IMF programme, suggesting that all three presidential candidates have a similar approach. If they choose to deviate by implementing looser fiscal policies, printing money, or undermining central bank independence, it would signal a departure from the IMF programme, and such a government would not last long. They have already demonstrated a desire to expedite the external debt restructuring, recognizing that the costs of delays far outweigh the benefits of acting swiftly to achieve rating upgrades. Regarding taxation, they seem to be reassessing how far to go with measures outlined in their manifesto, weighing potential revenue losses against the gains.
Asanka: I do not have much to add, but let me use a metaphor: Sri Lanka is like a train engine on a railway track with a steep drop on either side, and it has about three to four years to reach its destination. Before the election, while there was much speculation, every driver eager to take the helm was fully aware of the risks involved. For me, that railway track symbolizes the path to policy consistency. This consistency will lead to stable lending rates, a reduced fiscal deficit, a more stable exchange rate, increased foreign reserves, improved business and consumer confidence, heightened economic activity, and better corporate earnings. I believe the trajectory for this country over the next three to four years is clear, and it looks like a recovery story.
The NPP proposed significant cuts to income tax and a reduction in VAT. Does that approach align with maintaining the IMF programme over the next two years or more?
Asanka: I believe there is a distinction between what the media reported and what the NPP manifesto stated. My understanding has always been that they plan to adjust the income tax structure to benefit those with lower incomes. Additionally, there will be concessions on essential items. In my view, implementing these changes should lead to a revenue loss of under Rs100 billion, which is less than 1% of GDP, and this is something they can recover through other measures.
The previous government announced a tweaking of the income tax structure, estimated to cost 0.8% of GDP. It looks like the NPP proposed tax cut, if it does materialize, could be higher than that. Any thoughts?
Dimantha: The IMF programme focuses on specific targets, and it is up to the government how those targets will be achieved. I do not believe the new government will introduce significant changes in its first budget. As we approach the second and third budgets, especially with the next election on the horizon, it will become more challenging, particularly as we start repaying the principal on some loans. If budget deficits are not adjusted to allow for borrowing and private investments, things could get tough.
So, for the next year, the outlook seems clearer. I do not expect major changes because if they alter the tax structure too drastically without broadening the base or introducing new taxes, they could face serious consequences. This is more about a long-term strategy. While we don’t have prior experience with this new regime, their current approach reminds me of the 2005 election, when a new party took power and faced negativity in the initial months. However, with consistent policies, things quickly stabilized and continued on a positive trajectory for over two years.
Asanka: When managing investments, it is important to look beyond what is explicitly stated and consider what’s realistically achievable. I believe we adopt a pragmatic approach when making investment decisions. To assess the outlook, we must look beyond the manifestos, which have been true not just in Sri Lankan history but in many other countries.
If you look at what we’ve committed to on the extended fund facility and what we have yet to achieve over the next two years, what are those undertakings that we should keep a sharp eye on to determine whether the IMF package stays on track?
Trisha: I believe the top priority is fiscal management, particularly with achieving the primary surplus targets set by the IMF. This year, the primary surplus target is 0.8% of GDP, rising to 2.3% next year. That’s a significant increase, and they recognize the challenge. To meet this goal, they would need to collect approximately Rs500 billion, assuming a nominal GDP growth of around 9%.
This is the primary surplus on the budget, which is the deficit excluding interest payments. Managing this will be crucial, and I think they recognize there are ways to achieve it without significant difficulty. A large portion of our tax revenue comes from indirect taxes. If we maintain the VAT at 18% and the economy continues to grow, that will generate additional revenue. There’s also some flexibility in adjusting income tax brackets as long as any changes balance revenue from other sources. For instance, if the vehicle import ban is relaxed and taxes on imports are raised to around 300%, that could offset potential revenue losses. It’s all about finding the right balance to meet targets.
Currently, we are on track to achieve these goals, provided we avoid any drastic policy shifts. While capital expenditure has been limited over the past two years, this year we are still running a surplus of about 1.7% of GDP. There’s room for some capital investment as we aim for a target of 2.3% by the end of 2025. It is essential to manage this carefully, as overspending could lead to a need for domestic financing, resulting in increased treasury bills and bonds, which would put upward pressure on interest rates and potentially lead us back to money printing.
Asanka: If you can manage that effectively, you’ll also be able to handle your gross financing needs and the associated maturity structure, which will help meet the debt and gross financing targets set out, particularly those that come after the programme. Printing money would violate the Central Bank Act, and attempting to amend the Act could lead us out of the IMF programme. One of the critical conditions for the debt restructuring agreement with external creditors is our commitment to the IMF programme. There is no alternative.
Given that our primary surplus has to go from 0.8% to 2.5%, the extra revenue is likely coming because the economy is generating more VAT income and maybe a little bit of other taxes. What must growth be in 2025 for Sri Lanka to achieve these numbers?
Dimantha: Sri Lanka’s growth has exceeded our expectations. We initially projected a growth rate of 2-3%, but it now seems likely to approach or slightly surpass 4%. Looking ahead to next year, we initially anticipated a rise from 2-3% to 3-4%. However, given the current situation, growth may remain similar, with a potential range of 3.5% to 4% if the economy registers around 4% this year. We’re also observing a credit improvement; for instance, we saw Rs135 billion in new credit last August. The consumer sector seems to be gradually recovering, with buying power returning to the market.
A crucial factor will be the government’s actions. Will they implement any changes? What will the budget entail? Domestic interest rates play a significant role in influencing the budget deficit and the future of government finances. They cannot afford higher interest rates, and we believe they should aim to keep them below 10% to promote higher GDP growth.
There are two factors to consider here. Economic growth will result in higher tax collections, especially on the sales tax and interest rates, but the interest rates don’t necessarily impact the IMF’s target on the primary balance.
Dimantha: It won’t have a direct effect, but it will impact the overall budget deficit. We need to reach a debt-to-GDP ratio of 95% by 2032. To achieve that, we need lower interest rates to start achieving this target. Specifically, we’ll need to keep rates below 10%.
On top of the higher tax collections, Sri Lanka depends on budget support loans from multilateral institutions. These loans are not going to come based entirely on achieving the IMF’s EFF targets. There will have to be a broader reform programme. Can Sri Lanka manage without these loans? And if we depend on them to balance the budget, what are the likely reforms we must commit to?
Asanka: Can Sri Lanka survive without those lower interest rates? It might be possible, but it would require significantly more domestic fiscal deficit financing. Budget support is essential to alleviate stress on the domestic market. Achieving that support will necessitate broader reforms, particularly concerning state-owned enterprises and key sectors of the economy.
Green energy and similar sectors could attract more budgetary support from multilateral institutions. Given the economic crisis, strengthening social welfare might also draw additional multilateral budgetary support compared to the pre-crisis situation. Multilateral approaches may have evolved in response to our experiences and the need to support those at the bottom of the economic pyramid. So, yes, Sri Lanka can survive, but it will be challenging. We will continue to receive budget support, though any structural changes demanded by multilateral agencies would likely focus on reforming state-owned enterprises.
Dimantha: A key aspect of the IMF programme, aside from the financial targets, is the reform of state-owned enterprises (SOEs). For the next year, we might have a smoother path forward due to the new government, which is likely to avoid major experimentation. However, after that, tough decisions will need to be made regarding SOE restructuring.
These reforms are on hold until after the elections, but I expect they will need to resume within about six months and is something the IMF will closely monitor. As long as we remain in the IMF programme, financial gaps will be addressed by support from the ADB and the World Bank as part of the overall plan. While we’ve implemented many reforms so far, the sustainability of these efforts will largely depend on our ability to reform the state-owned enterprises.
We may have a leftist president for the first time. However, he has not enacted anything to suggest that he is of that political leaning, but the crunch will come in 2025 when SOEs are dealt with. Is that a fair assessment?
Asanka: My immediate perspective is that you don’t necessarily need to address SOE reforms to meet the IMF targets, as many SOEs are currently cash flow positive and not a burden on the fiscal deficit. However, SOE reforms are crucial for elevating Sri Lanka’s growth trajectory. These reforms could attract foreign direct investment (FDI), stimulate economic activity, and open up significant sectors of the economy for more efficient private sector participation.
Trisha: Initiating SOE privatization around 2026 or 2027 could be beneficial for achieving the debt-to-GDP target, especially as we need stronger GDP growth to lower that debt ratio. However, it doesn’t have to be an immediate reform. If we can implement this over the next four to five years under one government, we could minimize the risk of a new administration intervening and potentially reverting to previous issues. This continuity is essential for making real progress.
Dimantha: Reforms are essential for sustainability. While it may not be urgent right now, the next two years will determine our path. Private investments will play a critical role in ensuring growth, and increasing the revenue-to-GDP ratio is vital for supporting the economy. With many countries vying for private investment, failing to implement SOE reforms could lead to a short-term scenario where we would struggle again in a couple of years. It is critical to initiate SOE reforms by the second half of 2025. This timing would help us provide clear predictions to investors about future costs and overall direction, making it a key factor for our economic strategy.
Asanka: We may face growth challenges in a few years if we delay SOE reforms. While these reforms may not be immediately necessary to meet IMF targets, looking at Sri Lankan history, it’s clear that the lack of liberalization in some economic sectors has hindered our growth potential. Addressing this issue is crucial for fostering a higher growth rate in the future.
We had a GDP forecast for 2025 of 3 to 4%.
Trisha: I’d go with 3 to 4%.
It comes across also that this is not a sharp rebound. Why are you cautious? Because we are not going to grow at a higher rate?
Dimantha: We face challenges in attracting foreign investments due to uncertainty about Sri Lanka’s future trajectory. This uncertainty raises questions about whether people are willing to invest locally. To build investor confidence, reforms are essential to demonstrate that we are on a sustainable recovery path. Investors typically look at the long term—around five to ten years—which is crucial for driving future growth. Attracting these investments is challenging, especially with India, Vietnam, and Bangladesh as strong competitors, particularly in costs. It’s vital to provide some level of certainty for investors to encourage them to come to Sri Lanka.
Now that we’re discussing GDP figures, could you share your 2025 market earnings growth forecast?
Dimantha: We anticipate that overall market earnings will be around the 20% range and slightly slower than this year’s growth. This year, we’re benefiting from a lower base, and we believe the markets are poised to move into new territory.
Asanka: Last year at the roundtable, I mentioned that a 4% GDP growth rate is not bad. If we look at Sri Lanka’s history over the past 30 to 40 years, any growth above 4% was typically fueled by money printing and consumption. While I may not remember the details, history shows that significant growth above 4% occurred only after the JVP insurrection of 1988-89 and leading up to President Premadasa’s assassination, largely due to structural developments like the launch of the apparel industry.
After President Kumaratunga took office, we also saw higher growth rates in the first 18 months due to the liberalization of certain sectors. Other than those periods, we haven’t sustained growth above 4%. We must balance multiple factors. Sharper growth would increase demand for private sector credit, leading to rising interest rates and higher import bills, which could deplete our reserves. Until we can attract foreign direct investment, I’d be content with a stable growth rate of 4%. Regarding corporate earnings, I project growth in the 20-25% range which may be slightly lower than last year. There might be certain sectors where the growth rate may be higher than 20 to 25% next year.
Trisha: I would expect about 3–4% GDP growth. Monetary easing can provide some impetus, but lending rates have adjusted significantly already. Regarding earnings, I would adopt a more conservative outlook of 15-20%, although certain sectors may experience much higher growth rates. It’s important to note that this year’s earnings benefited from significantly lower finance costs. In 2022, growth was primarily driven by price inflation. As we move into next year, we can expect a normalization of those conditions, so we must focus on achieving top-line volume growth.
What is your forecast for interest rates in 2025?
Asanka: We expect the one-year treasury bill rate to close at about 10.9% by the end of this year. The AWLR may decrease slightly towards December, as it tends to lag behind the auction yields from July and August. So, we anticipate a slight decline in the next three to four months. However, in the second half of next year, we expect a gradual rise primarily driven by increased economic activity and private credit. We don’t foresee government borrowings significantly pushing up interest rates next year.
Dimantha: We believe the government securities yield curve has room to decline as uncertainties diminish. We’re currently looking at a range of 9.5% to 10.5%, but we expect the overall yield curve to fall below 11.5%, with long-term rates potentially being 50 to 100 basis points lower than the current levels. In the shorter term, we might see increased positivity if a credit upgrade occurs, leading to significant foreign inflows, likely more into the equity market than the debt market. In a bullish scenario, rates could approach around 10% by the end of the year. Thus, we see two scenarios: one where rates stabilize around 11.5% and another more optimistic scenario where they could fall closer to 10% with strong foreign inflows into the bond market.
Trisha: In short-term interest rates, we’re looking at the one-year T-bill rate falling to around 9.5% to 10%, about 50 basis points lower than the current level. As we approach 2025, the fundamentals suggest more downside potential for rates. With uncertainties resolved post-general elections, we could see the risk premium decrease. Additionally, there’s potential for the central bank to implement further rate reductions, possibly in the range of 50 to 100 basis points.
The IMF has indicated a neutral rate of inflation plus 2.5%, allowing for a reduction of another 125 to 150 basis points if they choose to pursue it, especially since inflation is already declining and private sector credit is gradually growing. While it remains to be seen if they will utilize the full extent of this space, it’s clear that there is potential for lower interest rates heading into next year. In the second half, as credit demand picks up, rates would stabilize or increase slowly, but this won’t necessarily be driven by the same risks that have influenced interest rates over the past two years.
Talking about investment strategy, let us look at the asset classes. If you look at the three, equity versus fixed income versus cash in accounts, how would you approach asset allocation?
Dimantha: We can be bullish on the equity market because of low interest rates. While it’s wise to be cautious about the risks and not invest heavily, I suggest allocating 50% of a portfolio to fixed income and 50% to equity. For us, that’s a substantial allocation, and it’s not something many investors would typically pursue to that extent.
Asanka: Asset allocation is crucial for our clients, and it’s important to tailor it to each individual’s risk preference. Equities could potentially generate returns above 30%, while fixed-income yields might be around 12%, creating a significant return premium for equities. My advice to individuals is to align asset allocation with your risk-return profile. However, I want to emphasize a point related to your question. If you’ve been saving over the past two and a half years and haven’t achieved real positive returns, it likely indicates that your asset allocation strategy needs adjustment. That’s my perspective.
Trisha: Currently, I would consider a 40% allocation to bonds and about 20% to fixed deposits. I am not convinced that these will yield strong returns. While inflation is at 2% now, the long-term average is around 4% to 5%, which means real returns might be less than 1%. As we look ahead to 2025, my key message is to lock in returns at the higher rates available now. Gradually, you can shift your portfolio more towards equities. For next year, I’m more optimistic about equities and would recommend increasing the allocation to around 60% while reducing the percentage in fixed income.
Asanka: Historically, when market sentiment shifts, prices can adjust rapidly, often capturing 12 to 18 months of upside in just a few weeks or months. This means waiting to invest in equities could lead to entering the market at higher price points. The risk of missing out on potential gains by postponing your equity allocation is significant. It’s essential to act decisively to take advantage of current opportunities.
We are in the middle of October 2024. Could there be a strong re-rating sometime after the general election?
Asanka: I believe we are amidst a re-rating, which I expect to continue and drive economic recovery and growth. This positive shift in sentiment can set the stage for stronger economic growth moving forward.
Dimantha: We anticipate a re-rating in the market, and our target for the All Share Price Index is 13,500 for 2024, with a projection of reaching 15,000 next year. We believe the targets can be quickly met as uncertainties dissipate and rates decline. In Sri Lanka, there aren’t many alternatives; while property and gold are options, equity offers greater liquidity. Given the current situation, investing in equities at lower prices is very attractive now.
Asanka: You can easily get a bubble on equities because you do not have a lot of options.
Where would the market price-to-earnings ratio be at currently?
Asanka: In my investable coverage, it is between seven and eight times.
What does that say about equity, linking the corporate earnings forecast and the market?
Asanka: The market has the potential to rise between 7.5 to 10, representing about a 25% upside. With a possible 20 to 25% growth in earnings from a select group of stocks, this could lead to overall returns of around 40 to 50% within the next 12 months. However, I want to emphasize that such gains can materialize much more quickly; I’ve seen instances where a 40 to 50% increase occurred in just the past few weeks.
Dimantha: I believe we’ll see positive momentum in the next six months following the elections, with debt restructuring nearing completion and potential credit upgrades on the horizon. However, we must remain cautious about global disruptions, particularly the threat of war. Just as we underestimated COVID-19 initially, an escalation in global conflicts could have detrimental effects on our progress. Historically, we’ve observed a long-term average valuation of around 12 times earnings, which we believe the market could revert to. However, it’s important to note that this has been influenced by volatility in interest rates.
If we assume 12 times, will there have to be significant global financial inflows or investments into the market to realize that kind of PE?
Dimantha: We haven’t seen a significant amount of funds moving into equities yet, but October has shown a rise in account openings, which suggests increasing interest. As interest rates begin to decline, this will encourage more local investment in equities. Additionally, foreign investment will hinge on achieving a credit upgrade, as significant market re-rating requires foreign participation.
Asanka: Building on Dimantha’s point, I believe the market doesn’t necessarily need foreign fund flows to re-rate, as there’s ample liquidity outside the market—likely parked in bonds, bills, and fixed deposits—waiting for greater confidence. However, foreign inflows are essential for taking the market to the next level. I’m optimistic we’ll see this happen for two reasons: the trading upgrade expected in January/February, which has been a barrier for many large fund managers, and the positive perception that comes with systemic changes. Foreign funds prioritize long-term stability, the rule of law, and effective governance. If the government continues its reforms, reduces corruption, and adopts prudent economic policies, we will attract significant foreign investment.
To start unpacking where the opportunity is in equity, what sectors and companies do you think are most attractively priced, given their forward forecasts?
Trisha: Banks are currently a favourite, especially given the significant gains we’ve seen in recent weeks. Some banks are trading at higher price-to-book values, which reflects their strong potential. One key catalyst is the potential for impairment reversals following the finalization of the external debt restructuring, which could significantly boost profitability. Additionally, as we enter a new credit cycle next year, banks are well-positioned for profit growth. Looking ahead, banks like Commercial Bank and HNB are trading at attractive forward earnings multiples—around 0.5 and 0.3-0.4 times, respectively.
Even with recent price increases, there’s still potential for growth. It’s important to remember that markets are forward-looking. Instead of fixating on past performance, we should focus on the potential for future gains. Beyond banks, non-bank financial institutions (NBFIs) are also showing promise. Their net interest margins typically benefit from falling interest rates, as they can lock in loans at higher rates while their funding costs decrease. We’ve already seen positive trends, and if the vehicle import ban is lifted, their leasing portfolios will expand, further increasing interest income.
Our top pick is LB, trading at about 0.9—down from around 1.1 to 1.2 last year. This makes it very attractively priced, and it has a solid trading volume. Commercial Credit also appears to be a strong value opportunity at this time. Central Finance is another strong contender among NBFIs, especially with the potential release of vehicle imports and elevated gold prices. As the Fed continues cutting rates, gold prices will likely rise, benefiting those who have adjusted their portfolios to balance leasing losses with gold investments. LB is well-positioned to capitalize on both markets, while CB focuses primarily on leasing and lacks exposure to gold.
In the past, banks have been trading in Sri Lanka at about 0.8 to 1.0 times book. Is that fair?
Asanka: Banks have seen significant growth, surpassing 1.1, with Commercial Bank hitting that mark in November 2019. Both Commercial and HNB started dipping below 1.0 around the same time. Last year, Kanishka and I highlighted banks as a key focus for equity portfolios. Once the credit rating improves and foreign investment flows in, we can expect the initial influx to be directed towards banks and John Keells Holdings.
Dimantha: Historically, banks have traded above 1.0 times book over the past 20 years, and the drop in return on equity since 2019 has influenced their pricing. However, with the current growth trajectory, we anticipate that banks could re-rate to 1.0 times or even slightly above. Beyond banks, we’re optimistic about sectors like tourism, consumer goods, and exports, particularly with the global recovery. Companies like Ceylon Cold Stores and Hemas could benefit significantly from this economic rebound, along with Hayleys.
Asanka: I don’t want to speak about specific stocks, but here’s a general tip: to minimize downside risk, consider investing in shares that are currently under the radar. Instead of focusing on the banking sector, look at manufacturing companies that cater to the domestic market like those in the consumer goods or construction materials sectors. Target firms with balance sheets that increased capacity but may have struggled due to under-utilization. These companies often present compelling opportunities as the economy recovers.
When you look at long-term returns on listed equities, they don’t come out looking very good versus fixed income. They may be marginally higher than fixed income based on what period you’re looking at and how you analyze it, but there have been these very short periods where returns were fantastic, are we at the cusp of such a boom?
Dimantha: Absolutely, the volatility we are seeing is largely driven by the high interest rates. Typically, there’s around a 10% difference between the highs and lows in each cycle, but this time, it could be even wider due to the ongoing crisis.
Can you explain that 10% disparity in the high and low cycle?
Dimantha: In Sri Lanka, the interest rates have fluctuated dramatically, ranging from 8% to 18%. During high rates, corporate earnings tend to decline, leading to decreased local consumer demand and higher finance costs, which impact the equity market negatively. In contrast, developed countries often enjoy low and stable interest rates, fostering consistent growth in corporate earnings and making equities a more attractive investment than fixed income. Therefore, it’s crucial to seize opportunities during declining interest rates to maximize returns.
So, what period are we thinking about? What’s your estimation before rates start significantly going up?
Dimantha: From the second half of next year, we might see a slight upward trend in interest rates, but the increase is expected to be modest—around 100 to 150 basis points. This will be manageable, especially given that we have a floated currency, which will absorb some of the impact.
Every time we’ve had a panel here in the Echelon studio, in the last year and a half, we’ve been talking about how markets are about to boom. With the benefit of hindsight, are you disappointed about how things have turned out?
Asanka: From my perspective, I am pleased to have invested in equities and profited from it. As we’ve discussed before, this isn’t a buy-and-hold market; it is crucial to engage in active asset allocation based on your investment mandate. We may be on the brink of a significant equity market run. Missing this opportunity could lead to considerably lower returns. While it’s premature to predict a sudden crash that could favour fixed-income yields, we might see sharp equity returns initially, followed by a slowdown. However, overall, equity returns could still outperform fixed income. Ultimately, this will hinge on the duration of our stay in the IMF programme.
Trisha: I think we’re at a pivotal moment for foreign investors. There’s a sense of cautious optimism, especially with the upcoming elections potentially stabilizing policy direction. If we can navigate these elections without major disruptions, it could create a solid entry point for foreign capital. Retail market activity is also showing promising growth.
Post-crisis, there’s been a noticeable increase in financial literacy. People now have a better grasp of the economic landscape, which makes them more discerning about where to invest their money. This shift has led to heightened engagement with equities, especially as individuals recognize the disparity between past high returns and current fixed-income yields. Historically, Sri Lanka’s interest rate peaks have been declining, and if we can maintain that trend, it suggests that fixed income will become less appealing compared to equities. This could further incentivize investors to pivot towards stocks, reinforcing the positive momentum in the equity market.
Things have been slower than anticipated because external debt restructuring took longer than we thought it would one and a half years ago. There was also uncertainty around the presidential election and policy outlook. There’s more certainty now than there was two or three months ago. Were these setbacks for the equity market?
Dimantha: Absolutely, the trend in interest rates plays a crucial role in shaping market dynamics. As we approach that 13% threshold for government securities, it signals a potential shift towards increased equity activity. Lower interest rates typically boost investor confidence, fostering a favourable environment for stock picking. If the yield curve settles below 11.5%, that could further incentivize investment in equities as an alternative to fixed income.
It’s a pivotal moment, especially since your targets of 13,500 and 15,000 represent new all-time highs, suggesting a bullish outlook for the market. With the historical context in mind, if the market can sustain this momentum and navigate the uncertainties effectively, we might witness a robust run in the coming months. Focusing on selected stocks will be key, as not all sectors would benefit equally from these shifts.
What would you forecast a forward PE to be a year from now?
Dimantha: We think the market can come close to 12 times and hit around 15,000 points on the All Share Price Index.
Asanka: I don’t look at the index. A forward PE of 12 times essentially means that there isn’t much upside left and the market can stabilize and consolidate close to that level.
Trisha: In our view, it is tying everything together, corporate earnings growth being a tad lower than expected and GDP growth being lower. I think we’re looking at probably 10 to 12 times and maybe 14.5 at the higher end of our index target.
We’ve talked about the banks. Several of them are trading forwards of 3.5/5.5, not much higher, right? These stocks can double in price if the external debt restructuring concludes and rates remain in their current zone. Is that a fair thing to suggest?
Dimantha: That is also another key reason why the market itself can re-rate because banks are a huge portion of the market. Also, big ones like Commercial, HNB and Sampath are foreign investor favourites. Return on equity of these stocks is going to be very good over the next year, attracting local and foreign investors, and boosting overall market sentiment.
Asanka: Around 2007 and 2018, the foreign holdings in Commercial and HNB were north of 30% or so. A resurgence in foreign investment could create significant upward pressure on prices, benefiting both the banks and the broader market. The influx of foreign capital would drive up valuations for those stocks and release liquidity as local shareholders sell, potentially fueling investment across other sectors.
If we look beyond banks, foreigners have tended to love John Keells Holdings which has launched the first phase of their integrated resort. What does this bode for the company?
Dimantha: John Keells certainly has a strong foundation for growth, especially with its diverse portfolio in sectors like hospitality and leisure. As those long-term investments begin to yield returns, particularly with the anticipated recovery in tourism, it could attract renewed interest from both local and foreign investors.
The dilution may temper short-term gains, but it could present a compelling long-term investment case if the company can leverage its assets effectively and capitalize on the recovery of sectors like hospitality and casinos. Overall, if John Keells can demonstrate strong performance in the 2026 financial year, it could set the stage for a significant re-rating and attract more investment in the 2027 financial year.
Trisha: The coming years will be crucial for John Keells as they work to realize the potential of their various projects. The 2026 financial year will serve as a critical transition year, with initial insights from the casino operations and developments in the vehicle import sector. The launch of BYD and the anticipated completion of the WCT project could boost revenue, but execution and market conditions will be key. The stock’s price point at around Rs20 could attract more investors, enhancing liquidity and potentially driving up trading volumes. The wait-and-see approach is understandable, given the market’s cautious optimism. However, if the company can deliver on its growth strategies and those initial indicators show promise, it could create a favourable environment for re-rating the stock.
Asanka: By looking at the performance of the City of Dreams Manila as a benchmark, you can estimate the potential GGR for the City of Dreams Colombo based on similar metrics. Given the similarities in operations and market conditions, that modelling can provide a clearer picture of the expected revenue stream. Projecting the revenues into 2027 and then discounting them back to present value will give a more grounded, fair valuation.
Trisha: Give us some insight into what these numbers are like. That conservative estimate of $200 million from Melco’s partnership with JKH did seem like a cautious approach. Especially when compared to other integrated resorts in Asia that often exceed initial projections in their first year, if they manage to outperform that guidance, the upside could be significant. Considering the potential for increased foot traffic and market penetration once the integrated resort is fully operational, along with the expected rise in tourism, those numbers could be higher, driving revenue beyond initial forecasts. Additionally, while depreciation and amortization increase as capital expenditures ramp up, there will be a substantial upside.
Any final thoughts?
Dimantha: The next six to nine months are looking great. I would advise investors to switch funds from fixed income to equity and use this opportunity.
Trisha: The macroeconomic outlook for 2025 is positive, with indicators such as a stronger currency, declining interest rates, increasing credit, and low inflation suggesting a recovery. This environment is expected to benefit corporate earnings and translate into growth in the equity market.
Asanka: In summary, 2025 has the potential to be the first year of stable economic conditions in a while. With current interest rates, equity markets are likely to remain appealing. It is advisable to build positions before the market catches on, which can help limit downside risk and enhance performance.