Intelligent Investing

Will 6,900 hold?

/ 05:09 AM October 29, 2018

Volatility has returned to the market with the Philippine Stock Exchange index (PSEi) threatening to break the 6,900 support again after failing to break it earlier this month. Despite the negative sentiment prevailing, we think there is a strong chance that the 6,900 support will hold.

The main catalyst for the latest selloff of the Philippine market was the poor performance of the US market. After rallying briefly following its steep decline in early October, the S&P 500 resumed its descent last week, dragging along equity markets around the world.


Nevertheless, the ongoing correction of the US market is actually a positive sign. According to COL’s chair and long-time investor of global equity markets Edward Lee, “global markets have been weak since the start of the year. The US market was the only one that remained strong. The fact that the US market is now falling is an indication that we are at the tailend of the downward cycle for emerging market equities (including the Philippines). If the US market falls sharply and capitulates in the next few days, then this should mark the end of the decline in terms of magnitude.”

The reason why the selloff of strong stocks such as US equities marks the tailend of market corrections is that during market corrections, fund managers prioritize selling their worst performing stocks, which are usually smaller companies or those with less attractive fundamentals. Fund managers usually try to hang on to their favorite stocks, which are typically top blue-chip issues unless they are left with no choice but to sell. For example, in the Philippines, stocks like MER and SM continue to outperform the market this year, with MER up by 6 percent and SM down by 13 percent for the year-to-date period. In contrast, the PSEi is down by 19 percent for the year to date period.

Fundamentally speaking, there is also reason to be more optimistic as there are signs that inflation could peak in the fourth quarter. After increasing sharply since the start of the year, the price of regular milled rice is now stabilizing between P45 and P46 a kilo. This could be an indication that government efforts to control the price of rice are finally paying off. On Sept. 21, President Duterte signed Administrative Order No. 13, removing nontariff barriers in the importation of agricultural products, including rice. Memorandum Order (MO) Nos. 26, 27 and 28 were also signed on the same day, improving the government’s ability to supply essential agricultural commodities at reasonable prices. The government is also looking at a government-to-government importation of 703,000 metric tons of rice to ensure sufficient supply. Note that rice accounts for 9.6 percent of the consumer price index (CPI) and the 20.6-percent increase in its price for the year-to-date period was one of the main factors that drove the significant increase in inflation.

The government also recently announced that it would temporarily suspend the implementation of an additional P2/liter excise tax on fuel originally scheduled for 2019. Coupled with the recent decline in oil prices in the international market, this should help keep inflation down.

Aside from the peaking of inflation, valuations of stocks are already very attractive. As discussed in one of my previous columns, 83 percent of the stocks that are part of COL Financial’s coverage list are currently trading below their 10-year historical average P/Es while 54 percent are trading at P/Es that are at least one standard deviation below their 10-year historical average. This means that these stocks traded at higher valuations 84 percent of the time during the past 10 years.

Stocks’ attractive valuations coupled with the increasing likelihood that inflation will peak in the fourth quarter strengthens our conviction that the 6,900 support of the PSEi will hold. Recall that rising inflation is one of the main reasons for the market’s weak performance this year. Therefore, the end of this problem should also mark the end of the stock market’s decline.

Admittedly, I am making a bold call by saying that the 6,900 support will hold. However, even if I am wrong and the 6,900 support breaks, any decline will most likely be temporary as there is no reason why the PSEi should continue to fall if inflation is no longer a problem.

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TAGS: Business, Philippine Stock Exchange index (PSEi)
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