What could prevent stocks from exiting the bear market in 2024?

It’s easy to be bullish about the Philippine stock market this 2024.

Inflation and interest rates are showing signs of peaking, which in turn should boost consumer spending and encourage businesses to pursue their expansion plans. Government spending is also set to grow by a faster pace as the 2024 budget is higher by 9.5 percent. Finally, stocks are very cheap as the Philippine Stock Exchange Index (PSEi) is trading at only 11.5X price to earnings ratio (P/E), significantly below its 10-year historical average of 16X.

Still, there are factors that could prevent an exit from the bear market that has been going on for four years.

Inflation and interest rates might not go down till the second half of 2024 because the El Niño phenomenon could keep food prices high. Recall that rising food prices brought about by poor weather conditions was the main reason for inflation rebounding in the third quarter of 2023.

Because of the risk that inflation will stay elevated in the first half, the Bangko Sentral ng Pilipinas had said it might not cut rates till the second half.

Government spending might also disappoint if it continues to underspend. Note that government spending fell by 7.1 percent in the second quarter of 2023 and was largely responsible for the significant deceleration in gross domestic product (GDP) growth to 4.3 percent from 6.4 percent in the first quarter. After rebounding to 6.7 percent in the third quarter, government spending contracted again by 1.8 percent in the fourth quarter.

There is also a risk that the government will miss its revenue collection target this year, further increasing the likelihood that it will underspend. For example, to fund the 9.5-percent increase in spending without pushing the deficit beyond the 5.1-percent target, the government is targeting a 14.6-percent increase in revenues. This is based on the assumption that GDP would grow by 6.5 percent to 7.5 percent while the government would raise another P120.5 billion from new tax measures.

However, the government’s target is very optimistic. Aside from being significantly higher than the consensus forecast of 5.7 percent, the government is forecasting growth to accelerate against a backdrop of weaker global economy. After the budget was passed, newly appointed Finance Secretary Ralph Recto also said there would be no new taxes this year as the government would focus solely on improving tax collection efficiency to boost revenues.

Finally, the US economy is at risk of suffering from a hard landing or recession and a bear market.

Even though the Fed already stopped raising interest rates and is expected to start cutting rates soon, almost every rate hiking cycle in the past was followed by a recession and a bear market. The chance of it happening this time around is even greater as the spread between the 10-year and the 2-year bond turned negative beginning in July 2022.

Historically, the inversion of the yield curve always resulted in a recession and a bear market.

Note that in the past, the median number of months it took from the start of the inversion to the beginning of the recession was 18 months. Since it has been more than 18 months since the yield curve first inverted in July 2022, a recession could happen anytime soon.

Even though our economic fundamentals and the valuations of local stocks are more attractive compared to the US, we have always suffered from a contagion every time they enter a bear market. I don’t see any reason why it won’t happen this time around.

Because of the risk that the local stock market could suffer from a contagion, shares could stay volatile in 2024.

Because of this, investors who buy stocks today should focus on more defensive issues that are both attractively valued and pay cash dividends. These qualities will make them more resilient despite the heightened level of uncertainty.

Instead of being fearful, investors should view any potential decline in the market as an opportunity to buy stocks at an even cheaper price. As such, it would be wise to keep some cash or dry powder that can be deployed in case the market goes down because of a contagion. INQ