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Bracing for a volatile bull market

The Philippine stock market has performed well so far, allowing it to enter a bull market which is defined as an increase of more than 20 percent from last November’s low of 6,843.83.

Its strong performance is not surprising as factors that pulled the market lower last year have reversed.

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For example, inflation is clearly on the way down, falling to only 2.7 percent in June after hitting a peak of 6.7 percent in September 2018, thanks largely to lower oil and rice prices.

Interest rates are also much lower and the peso stronger. Note that the 10-year bond yield is now down to 4.7 percent from a high of 8.3 percent last October, while the peso is currently at 51.07 after depreciating by as much as 9.1 percent to a low of 54.33 last year.

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Due significantly to lower inflation rate and the stability of the peso, the BSP has room to further loosen its monetary policy. Recall that last year, the BSP raised rates by a total of 175 basis points while it suspended the reduction in banks’ reserve requirement ratio (or the percentage of deposits banks are required to keep with the central bank) because of rising inflation. Earlier this year, the BSP already cut benchmark rates by 25 basis points and the banks’ reserve requirement ratio by 200 basis points. BSP Governor Benjamin Diokno also said the central bank could further cut rates as soon as August provided that economic indicators such as inflation continued to move favorably.

Finally, the US Fed’s shift to a more accommodative monetary policy, including a potential cut in interest rates, put an end to the foreign fund outflow that hurt emerging markets globally, including the Philippines, in 2018.

Despite the said factors, the Philippines’ bull market will most likely be volatile given the numerous risk factors that still exist.

Global economic growth is expected to weaken this year due to various reasons including the US-China trade war, Brexit and poor business sentiment. The IMF forecasts world output growth to slow from 3.6 percent in 2018 to 3.3 percent in 2019, while the World Bank forecasts world GDP growth to slow from 3 percent in 2018 to 2.6 percent in 2019.

Although global central banks led by the US Fed are now adopting more accommodative monetary policies to prevent a significant slowdown in the global economy, equity markets such as the US could go down assuming that these policies are unsuccessful. The Philippine stock market would be negatively affected, even though our economy is not vulnerable to the same factors hurting the global economy.

The MSCI Emerging Market Index, which is tracked by numerous foreign funds managing trillions of dollars, is scheduled for its third quarterly rebalancing this August. For the upcoming rebalancing, MSCI announced it would continue to increase the weighting of stocks in Saudi Arabia and China. Consequently, funds tracking the MSCI Emerging Market Index are expected to reduce their exposure to other emerging markets, including the Philippines, to make way for the higher weighting of Saudi Arabia and China.

Finally, the Philippines continues to suffer from a budget deficit and a current account deficit. These are commonly known as the twin deficits and were largely responsible for the depreciation of the peso last year. Note that the government is maintaining a budget deficit ceiling equivalent to 3.2 percent of GDP despite posting a lower first quarter deficit as it plans to ramp up spending in the second half. Meanwhile, the BSP expects the current account deficit to widen to $10.1 billion or 2.8 percent of GDP for the whole year, also due to the expected pick up in government spending in the second half.

In summary, given the favorable outlook of the Philippine economy, we expect the bull market to continue. However, since numerous risk factors could lead to heightened volatility, now is not the time to be aggressive. Remember to manage risk by controlling size, investing only long-term money, and focusing on attractively valued stocks.

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