When risks turn into opportunities

The PSEi started 2019 with a bang, rallying by a total of 3.9 percent during the first three trading days of the year.

The market’s strong performance came as a surprise to many because aside from the better-than-expected Philippine inflation report for December, news reports from outside the country were largely negative. In fact, there are increasing signs that global economic growth is slowing down which normally isn’t good for the equities markets.

For example, in late December, the US Fed raised rates by another 25 basis points despite the disappointing performance of the US stock market.

On Tuesday, a survey showed that China’s manufacturing sector contracted for the first time in 19 months last December amid a trade war with the United States. Although analysts were already expecting the manufacturing sector to weaken, the survey result was worse than expected.

The US government also remains in a partial shutdown as President Trump refuses to sign any spending package that does not include a budget for a border wall.

Ironically though, the growing risk of slower global economic growth turned into an opportunity for emerging markets such as the Philippines.

Because of the increasing likelihood of slower global economic growth, prices of commodities including oil fell steeply. From a peak of more than $70 a barrel in October, oil is currently trading at less than $50 a barrel.

The drop in oil prices is good for the Philippines because it frees up income for consumers, allowing them to spend money on other goods. Lower oil price is also favorable to the government, enabling it to increase excise taxes on oil without pushing up inflation. This, in turn, should help the government generate more revenue to fund its infrastructure spending programs. Lower oil and commodity prices should also benefit the private sector as it reduces the cost of doing business, helping boost profits.

The likelihood of slower economic growth in the United States resulted in the significant decline in the US 10-year bond rate. From a peak of over 3.2 percent in October, the 10-year bond yield is now down to 2.7 percent. The dollar has also stopped strengthening after rising steadily for the most of 2018. A weaker dollar and a lower US bond yield should benefit the Philippine economy as these should help the peso and domestic interest rates remain stable despite our government’s rising budget deficit and the country’s widening current account deficit. This should prevent a repeat of what happened to the peso and domestic interest rates in 2018.

The increasing likelihood of slower global economic growth also increases the possibility that the US Fed and the central banks of other developed economies would stop raising rates and put on hold their plans to end their quantitative easing programs. This in turn should put an end to the fund outflow that was responsible for the steep sell-off of emerging markets in 2018.

Although slower global economic growth is logically not good for any country, including the Philippines, the main reason why our stock market is rallying is because investors were bracing for something even worse as implied by depressed valuations of stocks. Now that numerous risk factors have abated, there is room for prices to go back to more normalized levels.