What to do since the worst is not yet over?
Last week, COL Financial hosted a webinar titled “Is the worst over?”
As a panelist, I said I didn’t think the worst was over because the US Fed’s commitment to bring down inflation at any cost could lead to a policy mistake and a hard landing of the US economy which in turn could lead to a global recession. When this happens, corporate earnings will suffer and I don’t think the possibility of a steep recession is already reflected in the valuations of US stocks.
Unfortunately, when the US sneezes, everyone catches a cold. This includes Philippine stocks.
I admit that last July I said that the worst could be over soon. This was based on indications that inflation was peaking. Because of this, I thought interest rates would go down and the peso would stop depreciating, benefiting the stock market.
Sadly, despite more and more signs pointing to the peaking of inflation, the Fed remains unconvinced and relentless in raising interest rates.
Although the market already expected the Fed to raise rates by 75 basis points in September and for the Fed fund rate to peak at 4 percent to 5 percent next year, what spooked investors was the intention of Fed officials to keep rates at an elevated terminal rate of around 4.6 percent for the whole of 2023.
Note that prior to the September FOMC meeting, the market was expecting the Fed to start cutting rates in the middle of next year, once the inflation rate dropped below the Fed fund rate.
Understandably, the Fed wants to keep rates high to make sure that inflation would no longer be a problem. However, its extra measure of precaution puts it at risk of overtightening, especially since interest rates work with a lag.
Moreover, the Fed’s hawkishness triggered the further appreciation of the dollar. Global central banks including our very own BSP were forced to raise rates to maintain a comfortable interest rate differential with the US and to prevent their own currencies from depreciating even more substantially.
Because of the negative impact of tighter financial conditions on the global economy, equity markets around the world fell. During the last two weeks, the United States benchmark S&P 500 index lost 7.4 percent, while the PSEi index dropped 12.3 percent.
Despite the gloomy near-term outlook, I don’t think panic selling is the right strategy. If you are an investor with a long-term investment time horizon, you should stay invested and even continue buying Philippine stocks.
The main reason why I think investors should remain optimistic is valuations.
Although Philippine stocks were already cheap prior to the September Fed rate hike, they are much cheaper now, with the PSEi index trading at only 12X 2023 P/E. This is significantly below the index’s 10-year historical average P/E of 17X. In fact, because of local stocks’ cheap valuation, many companies and their insiders are buying back shares of their own companies.
The Fed also has a track record of changing its mind quickly.
For example, in December of 2018, the Fed said that it would raise interest rates by two more times in 2019 after raising rates by a total of eight times since 2016. However, a month later, it hinted that it would pause raising rates. In fact, it cut rates thrice in 2019. Because of this, I won’t be surprised if the Fed doesn’t push through with plans to raise the Fed fund rate and to keep it steady next year, especially if economic conditions in the United States deteriorate substantially leading to a steep decline in inflation.
The Philippines is also in a better position compared to the US since not a lot of companies and consumers benefited from the steep drop in interest rates during the pandemic. Moreover, because local bank lending rates are higher compared to the United States, even if the BSP raises rates by the same magnitude as the Fed, the percentage increase in financing cost is much lower compared to the United States.
Finally, although local stocks won’t be spared from the steep drop in the United States. market, the country’s better fundamentals can allow it to outperform the US once conditions normalize. Note that the Philippine market outperformed the US market consistently for four years after the global financial crisis in 2008 because Philippine banks were stronger and the country didn’t have a housing bubble. This could happen again in the next few years.
Although buying stocks today will allow you to take advantage of bargain prices, the caveat is that the market might still go down first since the worst is not yet over. As such, manage your risk by accumulating stocks slowly as this would allow you to improve your average cost.
Also, limit the size of your investment to an amount that you can afford to keep for a long time. This will allow you to earn significant profits once conditions normalize and the market turns around in the future. INQ
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