The Philippines is back on global radar screens for the first time since the mid-1990s due to its “compelling structural story” but the stock market is now “overpriced” relative to regional peers, Japanese investment banking group Nomura said.
“The economy is certainly in a sweet spot. Reform momentum in terms of improving competitiveness and reducing corruption has radically altered the macro-outlook. In addition, the Philippines has recently been utilizing new-found room for fiscal and monetary easing, further boosting activity,” said a Nomura equity research issued on Dec. 3.
The Asia-Pacific equity strategy report titled “A break in the overcast: Firmer demand, rising liquidity” said a number of clouds were lifting for the region, with US and Chinese political transitions complete, growth in both economies finally picking up (and in Asia more broadly), and Europe getting its ‘tail risks’ sorted.
Overall, the report said capital inflows to Asia have significant scope to accelerate in the months ahead, enticed by the demand recovery and expected appreciation of most Asian currencies—and fueled by both US Federal Reserves’ third phase of quantitative easing (QE3) and a sizeable shift out of low-yielding US treasury bonds.
But for the Philippines, the report said the valuation premium assumed a worsening environment in the rest of the region. Nomura said Philippine stock valuations were among the highest in the region, as market capitalization-to-GDP (gross domestic product) ratio was over 100 percent and credit spreads even lower than those in Thailand and Malaysia).
Given Nomura’s “generally opportunistic” medium-term view on equities, the Japanese firm recommended “underweight” positions (a suggestion to reduce exposure relative to the benchmark index) for emerging Southeast Asian markets in general, citing comparatively pricey valuations and the “defensive” characteristics inherent in these markets’ smaller size, low operating leverage and what it saw as a “typically more visible government propping-up of share prices.”
For 2013, the strong economic momentum is likely to continue, with Nomura economists looking for GDP growth at an above-potential 6 percent, driven by more progress in infrastructure projects under the public-private partnership (PPP) scheme and higher fiscal spending ahead of the mid-term elections in May 2013. Private consumption is also seen to remain robust, with resilient remittances and buoyant consumer sentiment.
Similar to several countries in the region, Nomura expects Philippine inflation to rise in the second half of 2013 to average at 4.4 percent for the whole of next year from 3.2 percent this year as demand-side pressures strengthen.
“While this is still within the Bangko Sentral ng Pilipinas’ (BSP) 3-5 percent target, risks are to the upside, in our view, with above-trend growth and measures pending such as legislation to increase taxes on ‘sin’ products (such as alcohol and tobacco),” the report said.
A likely slowdown in momentum by the second half of next year was seen making the Philippine market relatively unattractive, Nomura said. “Already large capital inflows are also a risk, with macro-prudential measures currently under consideration to curtail the rapid pace of foreign buying,” the research said.
But overall, Nomura said the Philippines scored well on each of what it saw as important drivers of medium-term emerging market equity performance—strong reform momentum, reducing cost of capital, strong foreign exchange fundamentals, structural productivity gains and positive foreign investor sentiment.
“After two years in office, President Aquino’s reform agenda continues to remain popular,” the report said, citing high satisfaction ratings on the government.
Nomura also favorably noted that the cost of capital had come down rapidly in the Philippines as rating agencies and foreign investors came to appreciate reduced risks and higher potential growth.
“Space on the foreign exchange front is also helpful. Moderately higher and stable inflation is probably one of the biggest sources of emerging market stock performance. Given the Philippine peso is still undervalued (by more than 25 percent as per IMF’s latest purchasing power parity calculations), we think it can likely withstand an extended period of relatively higher inflation without depreciating significantly. With a small funding gap in terms of balance of payments and external borrowing, the peso is also less vulnerable to external shocks,” the report said.