Why the Philippine stock market will fall

Why the Philippine stock market will fall

/ 04:05 AM May 29, 2024

Philippine stock marketMANILA, Philippines — The stock market kicked off the year with a surge of optimism, helping the Philippine Stock Exchange Index (PSEi) gain as much as 9.6 percent in the first three months.

However, just like in previous years, this early momentum is beginning to wane, and the market is once again facing downward pressure, which appears to be tilting toward another potential loss this year.

If we look at how the benchmark index performed over the past four years, the stock market has consistently ended each year on a negative note despite strong beginnings.

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For example, in 2020, the PSEi quickly gained 1 percent during the first week of January, but ended the year with an 8.7-percent loss, exacerbated by the COVID-19 crisis. In 2021, it opened strongly in January with a 4-percent gain during the first two weeks, but then went downhill from there, ending the year with a negative 0.2 percent return.

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In 2022, the rise in market optimism and the reopening of the economy led the PSEi to close January with a 1.8-percent gain. Despite this positive start, it ended the year with a 7.8-percent loss. Last year, the PSEi started with a robust 7.4-percent gain, only to finish the year with a negative 1.8-percent return.

Risk of a down cycle

If we are to follow this historical trend and also consider the emerging risk of a down cycle in the market, investors are advised to exercise greater caution with their portfolios.

READ: Investing in the Philippine Stock Exchange

This pattern of initial gains followed by subsequent downturns suggests a need for a more conservative investment approach that focuses on diversification and risk management.

Several factors could contribute to a market downturn. One such factor is the rising risk of geopolitical conflicts, which could escalate and cause broader economic disruptions, such as a slowdown in international trade, higher energy costs, and strained global relations.

These disruptions can negatively impact the economic outlook, potentially shifting investor sentiment away from riskier assets like stocks and toward safer havens such as bonds.

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Currency fluctuations as a result of economic uncertainties can also significantly influence the Philippine stock market. Historically, the long-term negative correlation between the peso and the stock market, based on data since the year 2000, is about 26.5 percent. The strength of this relationship can vary over time, lasting anywhere from a few weeks to several months, depending on market conditions.

If the peso is trending strongly, whether upward or downward, the negative correlation with the stock market could reach as high as 82 percent. However, when the peso is stable, the correlation could drop to as low as 6.5 percent.

READ: Peso slides to 58 to $1

In this period of volatility, with the peso falling to P58 against the dollar, we can expect the stock market to be highly sensitive to fluctuations in the peso’s value.

Period of forex volatility

The risk of a volatile currency and a weaker peso could prompt the Bangko Sentral ng Pilipinas to raise interest rates further to combat speculative currency trading and a possible rise in inflation. The 10-year Philippine bond yield has already risen to 7.04 percent from 6.33 percent in one month, in anticipation of this scenario.

The resulting higher interest rates could amplify the financial risks in the market. The ratio of total debts of publicly listed companies in the PSE to total market capitalization has been rising through the years. During the 2007 financial crisis, the ratio was only at 12 percent.

Debt-to-total market cap

Over the years, the ratio of total debt-to-total market cap in the PSE has increased to 34.7 percent in 2017, and just before the pandemic struck at the end of 2019, it accelerated to 50.2 percent. Today, it is estimated at 63.2 percent.

Although many stocks, especially blue chips, have dropped to historically low levels, there’s no guarantee that the stock market won’t fall further. Given the historical performance of the Buffett indicator on the PSEi, it is highly likely that the market will remain “undervalued” for an extended period.

According to the Buffett indicator, the stock market is considered undervalued when its total market cap-to-GDP ratio falls below 75 percent. Conversely, if the ratio surpasses 90 percent, it could indicate that the stock market is overvalued.

However, market history has shown that when the Buffett indicator surpasses 90 percent, it doesn’t necessarily mean the stock market will start to fall because it is “overvalued.” Instead, a high Buffett indicator could keep the stock market “overvalued” for a period of time, as long as its fundamentals can justify and sustain its high stock price valuations.

For example, during the early stages of the bull market in 2006, when the PSEi more than doubled its value since 2003, the market cap-to-GDP ratio was already at the 90-percent threshold.

However, instead of correcting, share prices continued to rise for almost a year until the Buffett indicator peaked at 106 percent in 2007.

The same pattern can also be observed when the Buffett indicator falls below 75 percent. A low total market cap-to-GDP ratio does not necessarily mean that stock prices will recover soon. A low Buffett indicator could show that prices may fall further if the fundamentals have not improved.

For example, during the global financial crisis in 2008, the PSEi was on a downtrend for over a year, losing more than 30 percent of its value. This decline caused the Buffett indicator to drop below the 75 percent threshold, indicating an undervalued market.

Buffett indicator

Rather than recovering, the stock market continued to fall, with the Buffett indicator reaching a low of 43.2 percent in 2009. This extended period of undervaluation lasted for the next two years until the market began to rise, pushing the indicator back above the 75 percent threshold.

In 2012, when the PSEi nearly tripled in value from its 2009 low, the Buffett indicator crossed the 90-percent threshold for the first time. Yet, rather than experiencing a significant correction, the PSEi continued to climb, maintaining an “overvalued” stock market for many years, eventually reaching 2019.

Today, the Buffett indicator has dropped to 71.9 percent. Historically, when the total market cap-to-GDP ratio falls below the 75 percent mark, it can keep the stock market “undervalued” for an extended period.

Given the historical trends and the numerous factors at play, the stock market faces a complex landscape in the years ahead. Geopolitical uncertainties, currency fluctuations, rising interest rates, and high corporate debt ratios all contribute to a challenging environment for investors.

They should approach this period of volatility with caution, prioritizing diversification, risk management, and a focus on financial fundamentals.

Although the Philippine stock market has shown resilience in the past, the road to recovery may be longer and more complex than anticipated. INQ

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Henry Ong is a registered financial planner of RFP Philippines. To learn more about investment planning, join the 107th RFP program this May 2024. To register, email [email protected] or text at 0917-6248110

TAGS: optimism, Philippine Stock Market

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