World’s worst stock market not cheap enough to buy?
Last week, Bloomberg came out with an article saying that “the world’s worst stock market (the Philippines) is not cheap enough to buy.”
The article said that although the PSEi was trading at only 15X estimated earnings for 2019 or P/E which was below its five-year average, it was not yet cheap enough to buy because of factors such as high inflation, the weakening peso, rising oil prices and increasing interest rates.
Although I agree that the numerous headwinds facing the Philippine economy will prevent the stock from going up and could in fact cause it to go down further, I disagree with the statement that the stock market is not cheap enough to buy.
In the past five years, the PSEi traded below 15X estimate earnings only once, in 2016. Assuming that history repeats itself, the probability that the market will go up once conditions improve is almost 100 percent, implying an attractive risk reward ratio for investors who are patient enough to wait.
Moreover, out of the 63 stocks that we monitor, 51 or 81 percent are already trading below their 10-year historical average P/E ratios. In fact, 33 or 52 percent are trading at P/E ratios that are at least one standard deviation below their 10-year average. This means that in the past 10 years, those stocks traded at higher valuations at least 84 percent of the time.
It is quite unfortunate though, as I have discussed in my previous columns, that the market only becomes cheap when economic conditions are poor. But despite all the gloom and doom prevailing, I am confident that economic conditions will eventually improve, allowing the market to trade at a much higher valuation.
Although inflation continues to go up, the BSP has already started raising rates aggressively. It will also most likely continue to do so assuming inflation stays elevated. Even if the government fails to address supply side issues such as the shortage of rice and other agricultural products, higher rates will reduce demand-driven inflation, eventually bringing inflation back to the 2- to 4-percent target range. This in turn should allow interest rates to go down, justifying higher valuations of stocks.
Meanwhile, the weakness of the peso this year is largely a result of the growing importation of capital goods as the government increases spending on infrastructure. Once these infrastructure projects are completed, there should be an increase in foreign direct investments that, in turn, should help the peso strengthen. Note that the Philippines’ poor infrastructure is one of the main reasons why there is very little foreign direct investments in the country. Better infrastructure should also reduce supply bottlenecks, helping bring down inflation on a longer-term basis.
Notwithstanding the Philippine stock market’s attractive valuations, I am not discounting the possibility that the stock market could still go down as uncertainty remains on when and at what level inflation will peak. Also, nobody knows when and at what level the peso will stabilize. It also doesn’t help that the Philippine stock market is being hurt by contagion as emerging market equities are currently out of favor.
The only way to be completely sure that the market will go up is when all economic indicators turn positive. However, it is very difficult to catch bottoms and once all indicators turn positive, prices of stocks will most likely be significantly higher. As such, it might be wise to consider buying stocks today despite the challenges facing the economy as depressed valuations imply that negatives are already priced in. Just remember to manage your risk by buying stocks slowly and limiting your exposure to an amount that you can hold on for a long period of time.
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