Uncertainties preventing stocks from going up

We have repeatedly said that Philippine stocks are attractive because local companies are fundamentally strong and are trading at very cheap valuations.

Right now, the PSEi index is trading at 10.6X P/E, which is more than two standard deviations below its 10-year average of 16.3X.

However, stocks remain weak due to the abundance of uncertainties that remain to this day. Here are some:

Rising PH inflation—only temporary? As feared, inflation stopped trending lower in August, increasing to 5.3 percent from 4.7 percent in July.

Rising inflation is worrisome as it hurts economic growth, which already showed signs of weakness during the second quarter. It would also prevent the Bangko Sental ng Pilipinas (BSP) from cutting rates, further dampening growth.

Addressing the rice supply problem will have a significant impact on inflation given that it accounts for around 9 percent of the country’s inflation basket.

Fed rates—higher for longer? Rising rates and the weak peso are among the main reasons why the local stock market remains weak. These were largely a result of the US Fed’s aggressive rate hiking cycle, which began last year. Since March of 2022, the Fed has raised rates by a total of 525 basis points to control inflation in the United States, which peaked at 9.1 percent in June last year.

Because of the significant increase in interest rates, more funds are shifting to US dollars, leading to the strengthening of the greenback and the weakening of the peso. Since the Fed started raising rates, the peso has depreciated by 8.5 percent.

To keep the peso from weakening further, the BSP raised rates aggressively, bringing total rate increases to 425 basis points since 2022.

Consequently, investors are eagerly waiting for the Fed to start cutting rates. This will reduce the threat of a sharply weaker peso. It will also give the BSP more leeway to cut interest rates domestically.

However, the timing of a Fed pivot remains uncertain. In fact, the Fed may increase rates by another 25 basis points before the year ends. It also plans to keep rates higher for longer.

The Fed seems to believe that it needs to do more to slow down economic growth so that it can permanently reduce inflation.

US economy—Hard landing or soft landing? If the US economy stages a soft landing as the Fed expects, then the stock market can sustain its strong year to date performance. If, on the other hand, the economy suffers from a hard landing, then the stock market will go down.

As far as valuations are concerned, the US market has room to go down. Note that the S&P 500 index is trading at 18.2X P/E, above its 10-year historical average P/E multiple of 17.7X. Moreover, a lot of investors agree with the Fed that the US economy will stage a soft landing. This makes the market even more vulnerable to a selloff if economic growth disappoints.

I personally think there is a greater likelihood that the US economy will suffer from a hard landing. Historically, periods of high inflation followed by aggressive Fed rate hikes always end with a recession. What is difficult to determine is the timing of the recession because higher rates work with long and variable lags.

Can PH stock market decouple from the United States? If US stocks go down due to a recession, Philippine stocks could also go down. That has been the case during the past few bear markets as global investors reduced their exposure to risky assets including Philippine stocks and shifted their funds to safe haven assets such as US treasuries.

I am hopeful though that any potential selloff will not be too severe since Philippine stocks are already very cheap.

Moreover, foreign investors have been consistent net sellers of Philippine stocks since the middle of 2019 so they probably don’t have much left to sell. INQ