Just as a rising market needs to pause and refresh, a falling market also needs to take a break and recharge before it reverses or resumes its trend.
The stock market has been trading within a limited 300-point range since the massive correction occurred four months ago.
On one hand, the market looks like it will bottom out soon as the PSE index finds strong support at the 7,500-level.
On the other, the market appears to be calming down just before another vicious downward spiral begins.
Whatever the scenario that will eventually prevail, it is apparent at this point that the market is uncertain and cautious.
While fears of rising inflation, high interest rates and possible disappointing quarterly earnings results continue to hound market sentiment, it is notable that the negative impact of these concerns on stock prices has been less pronounced as the market consolidates.
Selling activities have slowed down during this period as average value turnover declined by about 30 percent.
The median premium over 52-week low of stocks has also declined from 14.5 percent in February to only 9 percent.
Similarly, about 69 percent of all listed stocks in the market have also registered comparative losses.
Has the selling dried up? Is market pessimism starting to fade away? Will the stock market kick off a major rally soon?
One sign that the market may have found its bottom at least in the medium term is the recent inflation results for May where the annual headline rate registered its highest in six years at 4.6 percent.
Although the increase in inflation was historically high, it was below market expectation of 4.9 percent. Given the acceleration of the rate, it is most likely that further increase may not be sustainable. At some point, law of averages will take over and inflation will eventually move back to the mean.
Once inflation stabilizes, interest rate and the peso-dollar exchange rate should also follow, which should help improve market sentiment in the months ahead.
Another sign is the implied equity risk premium in the market, which has already risen to 7.2 percent from 5.5 percent in February. The risk premium is the additional return investors require on top of returns from fixed income to invest in equities.
The increase in risk premium was contributed by lower 10-year Philippine Treasury note yield of 6 percent and lower market median P/E of 16x. By rule of thumb, when a market is perceived to be overvalued, the equity risk premium normally rises, which bring down stock prices.
But when risk premium is relatively high, the market is seen to be undervalued. The higher the premium, the more undervalued the market becomes and the higher the minimum required return to invest in stocks, which currently stands at 13.3 percent.
While there are signs that the market may be ripe for a big comeback, there is no way to tell when the market will actually bottom out. Remember that based on the past three major corrections in the last five years since 2013, the shortest decline with the least damage the market had was in 2016 when the PSE index lost by 20 percent from its peak in just five months.
The lowest that the PSE index has reached recently was at 7,497, which represents only 17 percent loss from its peak four months ago. If the market were to follow this historical pattern, the current consolidation may end in a support breakdown that could send the market to lose by 300 points more towards 7,100-level in the next few weeks.
But then again, there is an old saying that history doesn’t repeat itself but it often rhymes. The market may not necessarily follow the same historical loss. It may have found its bottom and is on the way to a strong breakout.
Either way, it is seemingly clear that the market is already on the verge of a major recovery. It is just a matter of time before stability in the market returns. In the meantime, there are plenty of opportunities to prepare for next bull run by buying quality stocks at bargain prices for the long-term.