Stock market opportunities and risks in 2020

The year 2020 looks promising for the Philippine stock market given the numerous opportunities facing the country. These include the following:

Timely passage of the budget

The government’s P4.1-trillion budget for 2020 was passed on time. Moreover, President Duterte extended the shelf life of the unused portion of the P3.7-trillion 2019 budget until the end of this year. These developments should help boost GDP (gross domestic product) growth back above 6 percent. Recall that GDP growth in the first half of 2019 slowed to 5.5 percent. This was largely due to the delayed passage of the 2019 budget that resulted to the weaker growth of government spending.

Low interest rates

Interest rates are expected to stay low in 2020 as inflation is expected to stay benign. Although inflation should increase from only 2.5 percent in 2019 given the absence of the high base effect, it is expected to stay within the ideal 2-4 percent range as the country continues to benefit from the effect of the rice tariffication law and weak global economic growth. Given the benign inflation outlook, BSP (Bangko Sentral ng Pilipinas) Governor Benjamin Diokno already said the central bank might reduce benchmark rates by another 50 basis points this year after cutting it by 75 basis points last year.

Low interest rates are good for the stock market as this makes riskier assets

more attractive. It also reduces corporate borrowing rates, which should help encourage more investments.

Improving global economic outlook

Although global growth is expected to stay weak, the threat of a global recession in 2020 has diminished significantly. Numerous factors are responsible for the improving outlook of the global economy. For example, in 2019, central banks around the world adopted looser monetary policies by cutting interest rates, reducing reserve requirements and buying back bonds. These include the US Fed, the European Central Bank and the People’s Bank of China. Several countries also implemented fiscal stimulus by cutting taxes and increasing spending as governments recognize that lower interest rates are not enough to fight a recession. There is also less uncertainty on Brexit after the snap general election in the United Kingdom last December allowed the conservative party to win a majority of the parliamentary seats, paving the way for the United Kingdom to leave the European Union by the end of January under the terms of the deal renegotiated last autumn. Finally, and most importantly, the United States and China are scheduled to sign the phase one trade deal this week, lifting the uncertainty on how high tariffs could increase. This in turn is expected to encourage more businesses to pursue investments.

Attractive valuations

Philippine stocks are trading at very cheap valuations. At 7,800, the PSEi is trading at only 15.0x 2020 P/E. During the past five years, the index traded at a higher valuation more than 84 percent of the time. In fact, 23 out of the 30 stocks that are part of the index are currently trading below their historical average P/E multiples.

Despite the numerous opportunities facing the Philippine stock market, there are some challenges that are preventing the market from performing better. These include the following:

Heightened geopolitical risk

On Jan. 3, the United States killed one of Iran’s highly respected commanders, Qassem Soleimani. On Jan. 8, Iran retaliated by firing missiles at two US bases in Iraq. Oil prices increased as a result and will most likely stay elevated if tensions between the United States and Iran continue to escalate. Higher oil prices will push up inflation, hurting economic growth in the Philippines. Heightened tensions between the two countries is also expected to hurt sentiment for all risk assets, including Philippine stocks and increase demand for safe haven assets such as gold and US dollar bonds.

Heightened regulatory risk

Late last year, the Philippine government decided to revoke the extension of Manila Water and Maynilad’s water concession from 2022 to 2037.

The President also threatened to sue the water firms for economic sabotage, and to nationalize the water concessions if the water firms do not accept a new contract that the government will prepare. As a result, even though the Philippines’ economic growth prospect is very attractive and valuations of stocks are cheap, concerns that the government can change regulations and provisions of contracts anytime is causing investors to stay away. Given the attractive fundamentals of the Philippine economy and the improving outlook of the global economy, all eyes will be focused on developments in the Middle East and on the local water concessions. A successful de-escalation of tensions between the United States and Iran, and the signing of a new contract that is mutually beneficial for the Philippine government and the two water concessionaires are the catalysts needed for risk appetite to return to the Philippine stock market, allowing it to resume its uptrend. INQ