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Reasons to be optimistic and cautious about the stock market

/ 05:10 AM March 25, 2019

The stock market is performing well lately, rallying by a total of 4.8 percent from its its low on March 1 to its close at 8,013.42 last Friday. The technical picture has likewise improved, with the Philippine Stock Exchange index breaking above the 7,850 resistance.

The main catalyst that triggered the market’s strong performance is expectations of lower interest rates.

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During the Federal Open Market Committee (FOMC) policy meeting last week, the Fed kept interest rates unchanged as economic growth in the United States slowed. Although the market was already anticipating a lack of movement, Fed officials were more dovish than expected as they indicated there would be no rate hikes this year and only one in 2020. In contrast, during the December 2018 meeting, they indicated there would be two 25-basis point rate hikes this year. The Fed also reduced its 2019 economic growth forecast for the United States to 2.1 percent from 2.3 percent previously. It also said it expected gross domestic product (GDP) growth to stay below 2 percent up to 2021.

The US 10-year bond rate fell in response to the outcome of the FOMC meeting and is now at 2.4887 percent, 9.8 basis points lower on a week-on-week basis.

Also last week, the Bangko Sentral ng Pilipinas (BSP) had a monetary board meeting and announced there would be no reduction in banks’ reserve requirement ratio (RRR) nor in the policy rates. Although the BSP did not take any action to increase money supply, it cut its inflation forecast for 2019 to 3 percent from 3.1 percent previously, implying that a cut in the RRR and policy rates remained possible going forward.

Similar to the US 10-year bond rate, the Philippines’ 10-year bond rate fell also by 21.4 basis points week-on-week to 5.967 percent.

The peso likewise strengthened to P52.33 against the dollar. This was after initially weakening to a low of P52.85 due to concerns the BSP might prematurely cut the RRR and/or policy rates following the appointment of a more dovish central bank governor, former Budget Secretary Benjamin Diokno.

Although the outlook for the stock market has improved given the lower interest rate scenario, the continuous delay in the passage of the budget, which we initially thought would be passed this March, is a risk factor that should be monitored.

Lawmakers’ failure to pass the 2019 budget this month means the government will continue to operate on a reenacted budget until August. This, in turn, is expected to hurt economic growth as new projects cannot be rolled out. According to Socioeconomic Planning Secretary Ernesto Pernia, operating on a reenacted budget until August could lead to GDP growth slowing to only 4.2-4.9 percent this year from 6.2 percent last year. The interagency Development Budget Coordination Committee also slashed its 2019 GDP growth forecast to 6-7 percent from 7-8 percent originally because of the continuous delay in the passage of the budget.

The delay has already resulted in a 7-percent decline in government spending for the month of January, which will definitely have a negative impact on the first quarter GDP growth.

Slower economic growth also has a downside risk to the earnings growth of listed companies.  For 2019, earnings growth is projected to recover to 11 percent from only 6 percent in 2018. However, the recovery might not be as strong because of the disappointing GDP growth.

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Slower economic growth in the United States is another risk that should be monitored. As discussed earlier, the main reason why the US Fed has become more dovish is due to concerns of slower economic growth. If economic growth really disappoints, then earnings of US companies would also weaken, negatively affecting the performance of the stock market. Historically, global equity markets, including the Philippines, respond negatively to weakness in the US stock market.

In conclusion, although the Philippine stock market is expected to perform strongly in the near term, expect to see volatility as economic indicators and corporate earnings could disappoint. As such, a buy-low, sell-high strategy might be the best strategy to adopt for those who can actively monitor the market.

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TAGS: Business, Philippine Stock Exchange, Stock
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