Why the stock market is not cheap enough to buy

Consumer spending has long been a cornerstone of economic growth in the Philippines, constituting about 75 percent of the country’s gross domestic product. This high proportion underscores the important role that consumer expenditure plays in driving the economy.

Even after the initial impact of the COVID-19 crisis, which had seen the economy suffer a 9.5-percent decline, consumer spending showed resilience, bouncing back with 8.4 percent gains in 2021 and 14.5 percent in 2022.

However, amid the recovery, the market was less positive about the overall economy due to rising inflation and interest rates, driven by widening supply-demand imbalances and increased production costs caused by postpandemic demand.

When inflation and interest rates rise, it takes time for consumers to adjust their spending behavior accordingly. This adjustment period can vary depending on the financial situation of the consumer and the availability of alternative options.

For example, when interest rates make borrowing more expensive, consumers may be discouraged from taking out loans to buy property. If they have existing loans, which typically have fixed interest rates, consumers may not feel the immediate impact of rate increase until it’s time to reprice the loans.

When prices of goods and services are high, consumers may initially dip into their savings or use credit to maintain their standard of living. However, over time, they may need to adjust their spending habits as savings dwindle or debt accumulates, which lead to a lagged response in consumer spending patterns.

Last year, the economy slowed down, with growth rates declining from 7.5 percent in 2022 to 5.5 percent. This deceleration was mirrored in consumer spending, which also decreased to an 11.5 percent growth rate from 14.5 percent the previous year.

Weakened household expenditures

If we examine the data closely, we find that the total household expenditures notably weakened in the latter half of the year where consumer spending only saw a 9.8 percent increase, down from 14.9 percent in 2022.

This trend is also reflected in the earnings growth of companies listed on the Philippine Stock Exchange Index (PSEi). In 2021, the median earnings growth rate stood at 47.8 percent. However, in 2022, this rate decelerated to 25.3 percent before further declining to 13.8 percent by the end of 2023.

The slowdown in consumer spending in the fourth quarter of last year also reduced the average earnings growth rate of PSEi companies to 13.4 percent from 32.5 percent in 2021. Several consumer-related companies registered negative earnings growth during this period, including Universal Robina, Wilcon, Monde, Puregold, Emperador and even Max’s and Shakey’s.

This year, the total household expenditures for the first quarter grew only by 8.2 percent compared with the 14.7 percent growth rate in the same period last year.

If consumer spending growth slowed down in the first quarter of 2023 versus the previous year, there is a compelling reason to expect a corresponding slowdown in the average earnings growth rate of listed companies.

By using the price-to-earnings (P/E) to growth (PEG) ratio, we can assess how the stock market should be priced in relation to its earnings growth potential. A PEG ratio below 1 typically indicates that a stock may be undervalued, while a ratio above 1 may suggest that a stock is overvalued.

Market now more expensive

In 2022, when the earnings growth rate stood at 47.8 percent, the median P/E ratio of the PSEi was 13.4 times, resulting in a PEG ratio of only 0.28. This low PEG ratio indicated that the market was underpriced relative to its earnings growth.

In 2023, although the median P/E ratio of the market barely changed at 13.37 times, its PEG ratio doubled to 0.58 because its earnings growth rate declined to 25.3 percent, making it more expensive.

This year, the decline in the PSEi has caused analysts and fund managers to view the market as potential bargain, given that its market P/E ratio has fallen to a low of 12 times.

However, if we compare this with the lower earnings growth rate of 13.8 percent last year, it becomes apparent that the market has actually become more expensive, with a PEG ratio of 0.87 compared with previous years.

If consumer spending continues to slow down this year, we can anticipate a decline in the average earnings growth rate in the market. A lower expected earnings growth would justify a lower P/E ratio for the market, resulting in a lower PSEi.

While the market’s P/E ratio may seem low, the slowing consumer spending and declining earnings growth reveal a deeper issue. The rising PEG ratio indicates that the market may actually be overvalued relative to the expected earnings growth. INQ