Is this the start of a bull market?

The stock market has gone up by 13 percent since the middle of June, with some stocks going up even more.

Aside from indications that the US economy is slowing down, the main catalyst for the market’s strong performance is news that July inflation in the United States fell to 8.5 percent from 9.1 percent in June and was below consensus estimate of 8.7 percent. This implies that the Fed’s tightening efforts are starting to work against inflation, increasing the likelihood that it would stop raising rates sooner rather than later, which investors cheered.

Nevertheless, the question on everyone’s mind is how sustainable is the market’s strong performance? Is this the start of a bull market or just a bear market rally?

There are compelling reasons why Philippine stocks could be at the start of a bull market. Aside from indications that inflation is peaking, the local economy is doing well as the favorable impact of economic reopening is more than offsetting the negative impact of rising inflation.

For example, GDP (gross domestic product) growth reached 7.4 percent in the second quarter of this year and is forecast to reach 6.8 percent in 2022 and 5.8 percent in 2023, according to Bloomberg consensus estimates. President Marcos’ pledge that there would be no more lockdowns despite rising COVID-19 cases is also good news since it reduces the risk of an economic relapse.

Moreover, listed companies delivered very strong second quarter earnings, with most companies beating expectations on higher-than-expected revenues and margins. Although companies experienced higher costs due to rising inflation, this was largely offset by price increases, cost cutting initiatives implemented the last two years and scale benefits brought about by higher sales.

Finally, from a peak of 7.1 percent, the 10-year bond rate has gone down to 5.9 percent and is now below stocks’ earnings yield of 6.1 percent, making stocks more attractive compared to bonds.

However, there are also compelling reasons why stocks are just experiencing a bear market rally. The main reason is the growing likelihood that the US economy is headed into a recession. Although the US economy is not yet officially in a recession, GDP growth already turned negative for two consecutive quarters (-1.6 percent in 1Q22 and -0.9 percent in 2Q22), which is the technical definition of a recession. A recession would negatively affect corporate earnings, which is not good for the stock market.

Moreover, even if the United States enters a recession, the Fed doesn’t have the option to loosen its monetary policy as inflation remains elevated. Recall that the Fed aggressively cut rates and implemented quantitative easing during the global financial crisis in late 2007 and the start of the COVID-19 pandemic in early 2020, and these helped the stock market recover right away.

Finally, China had a much stronger economy during the time of the global financial crisis, and this helped the United States and other economies recover faster. However, this is no longer true today, with China’s GDP growth expected to reach only 3.7 percent this year and 5.2 percent next year, brought about by the government’s zero-COVID-19 policy and the property market slump. Retail sales and production are already showing signs of weakness. And while most central banks globally are raising rates to fight inflation, China is cutting rates to boost economic growth.

Although the Philippines can continue to grow even with a weaker global economy since it is a domestically driven economy, the local stock market has never decoupled from the US market. As such, the strong possibility that the US market is only in a bear market rally could prevent Philippine stocks from entering a bull market.

Only time will tell whether Philippine stocks are at the start of bull market or just in a bear market rally. However, it might be wise to lighten up first by locking in gains to raise some cash. If the market starts to weaken, then you can buy back stocks at more attractive levels, helping boost returns. If you are wrong and the market shows more convincing signs of strength, at least you still own some stocks that will allow you to participate in the market’s strong performance. You can also start to redeploy the cash with better conviction.