High inflation, interest rates temper optimism

The country’s leading online stock brokerage COL Financial has tempered its optimism on the local stock market on risks of higher inflation and interest rates but told investors not to fear the ongoing market correction.

COL now sees the Philippine Stock Exchange index (PSEi) ending this year at 8,750, downgrading its forecast from its earlier yearend outlook of 9,300.

The new forecast suggests a modest increase of 2.2 percent or 191.58 points from PSEi’s end-2017 finish of 8,558.42.

“We expect interest rates to stay elevated as inflation could remain higher for the rest of the year,” COL Financial head of research April Lynn Tan said in a research note on Tuesday.

Inflationary pressures have risen due to higher excise taxes on several basic commodities as a result of the tax reform program, second round effect of the higher oil prices, the continuous weakness of the peso and strong global and domestic economic growth, Tan said.

The analyst noted that the 10-year US treasury bond rate now hovered at a four-year high of 2.9 percent from 2.4 percent at end-2017, triggered by a pick-up in inflation.

Locally, Tan noted the spike in the January inflation rate to a three-year high of 4 percent, exceeding the consensus forecast of 3.5 percent.

Despite the significant increase in inflation, the Bangko Sentral ng Pilipinas (BSP) has kept its key interest rates unchanged and even slashed the reserve requirement on banks by 1 percentage point.

Since hitting all time closing high of 9,058.62 on Jan. 29, the PSEi has pulled back in line with the bloodbath in the US markets.

“Despite our concern on inflation and interest rates, we would like to remind investors not to be afraid of this correction. In fact, we view this correction as a great opportunity to enter the market,” Tan said.

“We don’t think inflation will stay elevated on a permanent basis as some of the factors pushing inflation up are nonrecurring in nature,” she added.

She also said the BSP had the necessary tools to control inflation.
“History has shown that equity markets still go up even with higher rates. This is because stronger economic conditions allow companies to earn better profits, even with higher rates,” Tan said.

Looking at PSEi corrections in the past 30 years, Tan noted that based on the seven episodes of corrections during the period, the median magnitude was 13 percent while the median duration from peak to troughs was four months. She noted shallower corrections of 11 percent that took only two months to complete.

“Assuming that history repeats itself, the PSEi could bottom anywhere from 7,900 to 8,100 and this could happen anytime from March to May this year,” she said.

At 7,900 to 8,100, the PSEi is seen trading at 17.5 times projected earnings for 2018, slightly below the five-year historical price to earnings average of 18 times earnings.