Q: Stock markets around the world fell last weekend because of the decision of Britain to exit from the European Union. I don’t understand why this is affecting the Philippine stock market when many are saying that our economy has little exposure to the UK market. Will this crisis lead to further correction in the PSEi? Should I avoid the market for now? – Kaycee Almajose by e-mail
No one expected the United Kingdom (UK) would vote to leave the European Union (EU). Global markets were shocked and reacted negatively because of fears of economic and political consequences.
The impact of such consequences may create serious risks of economic damage in the Eurozone, which may eventually disrupt the economies of the United States and the rest of the world.
When there are uncertainties in the market, investment risk premium tends to increase. A higher risk premium means higher cost of capital. When cost of capital increases, the rate of return required from investing in stocks also rises, prompting investors to take profits on overvalued stocks with the intent of buying it back later at lower share prices.
The PSE index (PSEi) has been rising strongly since the elections, gaining 11 percent until the Brexit happened. Threats of rising risks from the emerging crisis gave the market a valid excuse to sell and keep their cash for safety temporarily.
How low can the market go?
In April 2010, global stock markets tumbled on concerns that several EU members such as Greece, Ireland and Portugal were unable to refinance their government debt. Uncertainties brought about by the crisis hounded the PSEi, resulting in a 6.2 percent loss in three weeks.
The following year, in August 2011, global markets again crashed, this time, on concerns the European sovereign debt crisis may spread to other EU members.
The global selling wave caused the PSEi at that time to lose 8.6 percent in one week. It recovered immediately in the following week only to lose more by 13.6 percent a few days after.
Perhaps the worst crisis in recent history was the global financial crisis. In September 2008, many large financial institutions in the US almost collapsed due to the heavy exposure to subprime loans. The crisis quickly evolved into a global crisis.
During that time, the PSE index suffered a 14.6-percent loss in two weeks. The market rallied back though toward the end of September, but persistent concerns of global recession dragged the PSEi lower, losing 34.8 percent in one month.
Past stock market crises show the Philippine market will always be affected no matter how economically unattached it is because market uncertainties will always breed negative sentiments. Historical experience also showed such uncertainties could linger for weeks and even months.
With the current market uncertainty, it is expected the market will be highly volatile. It is possible the PSEi could retrace as much as 7 percent more towards the 7,150 level in the next few weeks. Such correction should be a temporary interruption of the current market uptrend unless this crisis is prolonged.
A market correction brought about by the current uncertainties should be a good opportunity to accumulate stocks at relatively low prices. Once the pessimism is priced into the share prices, the market should begin to recover. The Philippines after all remains to be one of the most promising economies.
Investing at a time like this, when stocks are sold out of fear, can be very profitable. The market has always recovered strongly after a crisis.
After the resolution of the European sovereign debt crisis in May 2010, the PSEi started to recover and rallied by 40 percent in the next six months. The same also happened in 2011 when the expanded bailout plan was approved to address the debt crisis. The PSE index resumed its uptrend and rallied by 40 percent again in the next seven months.
When the global financial crisis ended in October 2008, the market traded cautiously within limited range without so much activity, apparently because of persistent fears of global economic slowdown.
But in March 2009, barely five months after the crisis, when many least expected it, the PSE index begun to rise and never looked back. It was the start of the multi-year bull market which pushed the PSE Index to increase over 400 percent.
The prospects of a market correction brought about by global uncertainties should be a great opportunity for you to start buying.
Stocks with solid fundamentals that have fallen significantly from their recent highs will always be a good buy.
Henry Ong is a Registered Financial Planner of RFP Philippines. To learn more about stock analysis and value investing, attend the 9th Accredited Financial Analyst (AFA) program this Aug 6-Sept 10. To register, e-mail info@rfp.ph or text <name><e-mail> <AFA> at 0917-9689774.