No V-shaped rally just yet for the PSEi

After hitting a low of 6,843.83 last Nov. 13, the Philippine Stock Exchange index (PSEi) rallied strongly, rising by a total of 7.7 percent in just two and a half weeks. Foreign buyers also returned to the stock market after being consistent net sellers for most of the year.

Signs of peaking inflation acted as the main catalyst for the ongoing rally as it alleviated concerns of further rate hikes. In early November, the government announced October inflation was 6.7 percent, flat compared to the September data. Moreover, the price of oil is now at $50.65 per barrel, falling from a peak of $76.90 per barrel in October, while the peso strengthened to P52.37 against the greenback from a low of P54.33 in October.

Although a tamer inflation is good for the market, I still maintain the view it will be difficult for the PSEi to sustain a V-shaped recovery since the Philippine economy still faces numerous risks.

One of which is higher interest rates. To control inflation, the Bangko Sentral ng Pilipinas (BSP) raised the key rates by a total of 175 basis points this year. Yields increased even more significantly in the secondary market, with the five-year and 10-year bond rates currently at 6.99 percent and 7.09 percent, respectively. Although the said levels are below their highs for the year, the five-year and 10-year bond rates are still 222 basis points and 191 basis points higher compared to their end-2017 levels.

We expect the impact of higher rates to be reflected in the real economy through slower economic growth in the next few months as banks recently repriced their loans to factor in the changes. From 5.778 percent as of end 2017, the average lending rate of banks is now at 6.602 percent. Higher borrowing rates should hurt corporate profits, especially those with a lot of debts as this would lead to higher financing costs. Higher interest rates should also discourage some companies from pursuing expansion plans as the risk of losing money on investments increases.

This situation should also discourage consumers from making purchases of big-ticket items such as cars and residential units as the size of monthly amortization increases. For example, from 6.5 percent during the start of the year, the interest rate on a housing loan (five-year fixed) is now at 8.5 percent. After factoring in a 200-basis point increase in housing loan rates, the monthly amortization on a 15-year housing loan will increase by around 13 percent. As purchases become less affordable, sales and profits of companies selling big-ticket items will also most likely be hurt.

Although falling oil price is good as it should help bring down inflation and boost consumers’ purchasing power, it could also indicate slower global economic growth. Note that aside from oil, prices of other industrial commodities such as copper and nickel are going down. Slower global economic growth could also hurt the Philippine economy as exports and OFW remittances weaken.

While I’m not expecting a V-shaped rally for the PSEi, I remain confident that the major support at 6,900 will hold since inflation—one of the economy’s biggest drags this year—is no longer a problem. Moreover, although economic growth could slow down in the next few months, this will be temporary as the BSP already has elbow room to cut rates and reduce banks’ reserve requirements.

Once the BSP boosts money supply, interest rates should go down and should in turn encourage corporates to pursue expansion plans that were previously put on hold. The resulting drop in rates should also encourage consumers to once again purchase big-ticket items. Corporate earnings growth prospects should improve, enabling stocks to go up on a more sustainable basis.