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How exchange rates affect stock market

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Money Matters

How exchange rates affect stock market

/ 05:10 AM July 13, 2017

It has always been observed that the peso-dollar exchange rate has an inverse relationship with the stock market so that whenever the PSE index rises or falls, the price of dollar in pesos decreases or increases, or vice versa, by end of the day.

Recently, the stock market has fallen by up to 3.8 percent after the exchange rate breached the P50 level for the first time in many years. When the dollar rises vis-a-vis the peso, it means the value of the peso is depreciating. If you take the traditional view, you would say the peso depreciation is causing the stock market to fall.

A weaker peso may hurt companies with dollar denominated debts because this will not only increase the peso equivalent of their obligations, but may also result in currency losses. Share prices fall because of the fear that a falling peso may hurt profitability and growth.

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If taking the portfolio view, you would say the correction in the stock market is the one that leads to peso depreciation.

The inflows and outflows of foreign funds in the stock market affect the demand and supply of the dollar. When the market is trending upward, the increasing inflow of foreign funds will cause the peso to appreciate against the dollar. Conversely, when the market is falling, the increase in demand for dollar by outflow of foreign portfolio will cause the peso to depreciate.

Does the prospect then of further peso weakening, possibly to 51.50, indicate that the stock market may fall further?

It depends. Historically, the relationship between the peso and the stock market has been short-term. The strength of relationship varies, which lasts from a few weeks to several months. The negative correlation is highest when the market is strongly trending, but once the markets have stabilized, the correlation weakens.

Based on the historical data of 2017, there is hardly a relationship between the peso and the equities market as the correlation to date is only 3.8 percent. But if you focus on the time when the market started to correct after June 14 on fears of interest rate hike prospect in the US, the correlation was 64 percent.

Similarly, last year when the stock market started to fall in October, losing 11 percent by the end of the year, the peso also fell from 48.20 to 49.77. The correlation at a time when the market was trending lower was high at 80 percent.

In general, the long-term correlation between the peso and the stock market based on historical data since year 2000 is about 26.5 percent. In a span of 17 years, there were years when the correlation was relatively low. In 2014, the correlation was only 6.5 percent but in 2015, it was as high as 82 percent.

Using this historical correlation as investment framework, a rebound in the stock market to the 8,000 level on changing market sentiment may slow down the peso fall while continuous selling in the market may bring the peso to historic lows.

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While the stock market may be negatively correlated with the peso-dollar rate fluctuations, not all stocks exhibit the same behavior. Some are highly sensitive to peso movements. Some are negatively correlated while others have positive correlations.

A way to see how sensitive the listed stocks are in relation to the volatility of the peso is by measuring the beta of the stock. If the beta is 1.0, it means the stock will decline by 1 percent for every 1 percent rise in the price of the dollar in pesos. Stocks with beta of more than 1.0 are considered highly sensitive while those with less than 1.0 are less volatile.

Based on this, among the PSE index stocks found to be historically sensitive to the peso are Megaworld (1.97), Robinsons Land (1.78), Petron (1.52), PLDT (1.51), ICTSI ( 1.49) and Globe Telecoms (1.33). Others that are historically stable against the volatility of the peso are BDO (0.92), Aboitiz Equity Ventures (0.92), First Gen (0.77), Jollibee (0.51), Universal Robina (0.42) and Meralco ( 0.30).

Knowing how the peso-dollar exchange rates affect the stock market helps you assess your investment risks. It is important that you can distinguish a short-term risk brought about by the volatility of the peso on share prices and long-term risks where changes in fundamentals may affect the value of a stock.

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TAGS: peso-dollar exchange rate, PSE index, Stock Market
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