Is high inflation enough to turn bearish on PH stocks?
After performing strongly in January, the PSEi (Philippine Stocks Exchange index) gave back almost all its gains in February, bringing its year-to-date return close to zero.
One of the reasons for the stock market’s weak performance recently is the country’s higher-than-expected inflation. Recall that last month, the Philippine Statistics Authority disclosed that inflation for the month of January rose to a much higher than expected level of 8.7 percent from 8.1 percent in December. Aside from surprising negatively, the January number defied expectations that inflation already peaked in December.
Inflation also showed signs of stickiness as nine out of the 13 commodity groups that were part of the index showed faster year-on-year increases compared to December. Since the economy was strong, businesses passed on higher costs to consumers, leading to second round effects. Consequently, instead of just matching the 25-basis point (bps) rate hike of the US Fed (which is what it used to do), the Bangko Sentral ng Pilipinas (BSP) raised rates by a more aggressive 50 bps in its February meeting. It also said that it would most likely keep on raising rates in its next meetings to control inflation.
Higher interest rates are not good for the stock market since the resulting increase in bond yields would make fixed income assets more attractive relative to stocks.
Another reason high inflation is not good for stocks is because of its negative impact on consumer spending. Note that in 2018, consumer spending growth slowed to 5.8 percent from an average of 6.2 percent from 2013 to 2017 as average inflation increased to 5.2 percent from 2.2 percent during the past five years. Weaker consumer spending would lead to lower sales and profits for listed companies, negatively affecting their share performance.
Despite the negative impact of high inflation on the economy and the stock market, I believe that it is too soon to turn bearish on stocks for the rest of 2023.
Although local inflation was higher than expected in January, I am still confident that the inflation problem will be resolved in the near term. Although the BSP’s aggressive rate hikes will hurt economic growth in the short-term, the resulting drop in demand should reduce pricing pressure and help bring inflation back to a more sustainable level of 2 to 4 percent.
The government’s plan to maintain lower tariffs on imported commodity products such as rice, corn, pork and coal for the rest of 2023 should also help. In fact, there is anecdotal evidence that prices of food items are already going down as more imports have arrived the country.
Falling commodity prices globally, the weaker US dollar, and the easing of supply chain bottlenecks with the reopening of China should also help ease inflation. For example, the CRB index, which measures the price of a basket of commodities, is now 15 percent down from its peak. Meanwhile, the peso is back to the 54 to 55 level against the dollar after hitting a peak of 59 last year.
Finally, unlike in 2018 when inflation was rising, valuations of stocks are much cheaper today. Before inflation started shooting up in 2018, the PSEi was trading at 22 times P/E, significantly higher than its 10-year historical average multiple of 18.7 times. Today, the index is trading at only 14.7 times P/E, more than one standard deviation below the mean. In other words, if history were to repeat itself, the probability that prices of stocks will eventually go up is around 84 percent.
Most economist expect inflation to peak in the first quarter and slowly trend lower for the rest of the year. If this happens, the BSP will most likely cut interest rates, which is good for stocks.
Aside from lower interest rates, there are many reasons why the Philippines together with other emerging market stocks can outperform developed market stocks such as the US. These include our country’s lower dependence on the global economy, our better economic growth outlook, our market’s cheap valuations and low foreign investor ownership. As such, I don’t think the disappointing inflation number is a good enough reason to turn bearish on Philippine stocks. INQ
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