Risks to the stock market’s strong performance this year
The Philippine stock market is starting the year strong, with the Philippine Stock Exchange index (PSEi) up by almost 6 percent in the first two weeks of January.
Catalysts for the market’s strong performance include the weakening of the US dollar, leading to the strengthening of the peso, the reopening of China which is expected to push down global inflation, and foreign fund flow into emerging markets (EMs).
Although I am happy that the stock market is performing well, there are several risk factors that could prevent it from sustaining its strong performance for the whole year.
PH economy facing challenges
Although the Philippines is less vulnerable to external factors since it is a domestically driven economy, growth is still expected to slow down this year as high inflation hurts consumer spending and higher interest rates hurt investment spending.
The government will also not be providing much in terms of fiscal stimulus as its budget this year is higher by only 4.9 percent. Moreover, a large portion of the increase will go into finance expenses and not productive uses due to higher interest rates and the government’s elevated debt levels.
The Fed does not pivot
Global markets, led by the US, started to recover in the latter part of 2022 due to signs that inflation was peaking, raising hopes that the Fed would stop raising rates and potentially even cut rates or pivot.
However, Fed Chair Jerome Powell seems unconvinced that inflation has peaked and continues to focus on the employment numbers, which in his opinion remain very strong.
Moreover, although most economists are already expecting the US economy to enter a recession, many are only expecting a “soft landing.” If that is the case, then there is a risk that the Fed may only pause and maintain rates at an elevated level for the rest of the year, which is not good for stocks. The Fed pivots because of a hard landing. If the US economy suffers from a hard landing or a deep recession, then the Fed will most likely pivot as unemployment numbers go up sharply. However, a hard landing is also bad news since it would lead to a significant decline in corporate earnings, which is not supportive of a bull market in stocks.
US stocks have room to go down
Despite being down 17 percent from the peak, US stocks aren’t cheap, with the S&P 500 trading at par with its historical average P/E. Moreover, although economists are anticipating a recession this year, consensus is still projecting corporate earnings to grow by 7 percent, which makes it vulnerable to potential downgrades. Finally, in the past, all bear markets bottomed only after the economy officially entered a recession and the Fed started cutting rates, not before.
EMs do not decouple from the US
Foreign funds are flowing into EMs due to their cheaper valuations. Some countries, including ours, also have a better outlook compared to developed countries such as the United States. Historically though, EMs have never decoupled from the United States and the US market’s negative outlook is a risk to Philippine stocks. As they say, when the United States sneezes, everyone catches a cold.
The dollar strengthens despite a Fed pivot
The main reason for the US dollar’s strength last year was the Fed’s aggressive rate hikes. Although the Fed continues to talk tough, the market is expecting it to pivot soon, explaining the decline in bond yields and the weakening of the US dollar lately. Nevertheless, during times of crisis, the dollar always strengthens even if the Fed cuts rates and bond rates go down because of the flight to safety. This could happen again if the United States suffers from a hard landing and risk assets go down as a result. A strong dollar is not good for Philippine stocks.
Risk management is critical
Because of the numerous risks threatening the sustainability of the market’s strong performance, investors need to manage risks. You can do this by limiting the size of your investments in the stock market.
Moreover, stay disciplined and only buy stocks that are still trading at cheap valuations. Finally, sell some stocks as prices go up to lock in gains. This will also give you some dry powder, allowing you to buy stocks at much lower levels when prices go down in the future. INQ
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