Aging bull riding out the global storm

IT’S THAT time in the cycle when the conviction of the bulls is under stress-testing as the external headwinds have intensified into a global storm. The bull is aging and with it comes greater volatility.

At the beginning, investors already had the prospective US Fed “liftoff” or the first US interest rate increase in a decade—and the recurring concerns about Greece exiting the eurozone or “Grexit” to worry about. Then, Greece struck a last-minute bailout deal with the European Union and Grexit fears have eased for now.

Closer to this side of the world, China turned out to be a bigger concern. (See Turmoil Behind the Great Wall on page I-2). Risks of an economic hard-landing after a decade of growing by more than 10 percent, although not a consensus view, were something to be worried about. China’s woes, after all, has weighed down the commodity cycle and its surprise devaluation of the yuan in August only escalated investor jitters. Currency matters a lot to investors as a sharp local depreciation would diminish their return once they liquidate their investments so they would want to sell out ahead of further depreciation.

On Aug. 24 or the so-called “Black Monday,” the Philippine Stock Exchange index (PSEi) pulled back by 487.97 points or 6.7 percent to close at 6,791.01. In terms of number of points, this was the biggest decline in a single day, resulting in a loss of P764 billion in market capitalization in a single day. In the month of August alone, there was close to P18 billion in net foreign selling from the local market.

In terms of percentage decline, this was the 11th sharpest in history. The market had seen worse declines during the US-epicentered global financial crisis, for instance, when the PSEi lost 12.27 percent on Oct. 27, 2008. But “Black Monday” was enough to rattle investors, especially foreign funds that have made a lot of money in emerging markets in earlier years and many of whom now deem it timely to head back to developed markets.

To top it all, the stock market rout has forced the US Federal Reserve to defer the interest rate liftoff, which many were expecting to have been sanctioned by September, except that China’s stock market rout prevented it. That would have been one concern taken off investors’ minds but this deferral only effectively prolonged the waiting game and therefore would only fuel more volatility moving forward.

Overall, a US Fed tightening cycle is not good for emerging markets because this typically siphons off global funds back to developed markets and results in local currency depreciation versus major Western currencies like the US dollar. After the US Fed’s decision not to raise the rates in September, many were expecting the liftoff to happen this December, but given the sluggish US jobs data in September, there are rising expectations that this may be pushed back to March 2016, at the earliest. This only means further uncertainties and continuing volatility.

American banking giant Citigroup sees the turmoil in China leading the world into recession. “The US economy is expanding at a healthy pace, but the risk of an emerging market-led global recession and the attendant deterioration in financial conditions likely will dampen domestic growth somewhat,” the bank said in a September research note.

The Philippines, of course, had its own domestic concerns. Growth in the second quarter was at 5.6 percent, picking up pace from the disappointing 5 percent in the first quarter but lower than the 6.7-percent growth in the same quarter last year. The consensus forecast for this year is a growth of 5.8 percent, firming up to 6 percent in 2016. These are slower than last year’s 6.1 percent and below the 7- to 8-percent annual growth targets of the government, but is not too bad in relation to its peers and considering external headwinds. The Philippines will still beat the consensus forecast growth for Asean 4—or Southeast Asia’s four emerging markets: Indonesia, Malaysia, Philippines and Thailand—of 4.5 percent this year and 4.9 percent next year.

Except for a few issuers, local corporate earnings were also mostly unexciting during the second-quarter reporting season. Leading online stockbrokerage COL, for instance, has downgraded average earnings per share (EPS) forecast for monitored Philippine corporations this 2015 to 4 percent from 15 percent previously. Meanwhile, local stocks are already trading at rich valuations: They are paying around 19.5 times the kind of money they expect to make from this market, much higher than the historical price-to-earnings average of only 15x. The local market is still more expensive than peers elsewhere in Southeast Asia.

2016 polls

While external jitters are rising, domestic political noises are likewise starting to get louder as the presidential race heats up. The three top candidates to be the next CEO of the land are neophyte Sen. Grace Poe, former interior secretary Mar Roxas and Vice President Jejomar Binay.

Risks of policy reversals in the Philippines might decline if either Poe or Roxas wins the 2016 presidential elections as both are likely to continue President Aquino’s themes of good governance, infrastructure spending and poverty alleviation, Citi economist for the Philippines Jun Trinidad said. In a research commentary titled “Amazing Grace?” dated Sept. 17 or a day after Poe declared her intention to run, Trinidad said Poe’s policy preferences had been honed over the Aquino regime, during which the country saw a resurgence in growth and investments, revitalized support for the government and reforms in the bureaucracy. “However, growth inclusiveness remains missing that may require another six years of good governance, including more reforms as well as strong public and private investments. So if the prevailing policy agenda has led the country this far, perhaps ’finetuning’ is what’s appropriate,” Trinidad said.

“Key takeaway is that policy continuity risk may diminish with either former interior secretary Roxas (Aquino’s anointed one) or Sen. Poe, who are both inclined to sustain Aquino’s agenda,” he said.

Foreign investors look forward to Filipinos electing a president with “integrity” and a clear-cut economic agenda. “We would want to have a leader with integrity. I think that kind of covers a lot of things that you would want to see in a leader,” ING country manager Consuelo Garcia said.

In every country holding national elections, Garcia said there was always a period of uncertainty and “pause” for investors. “But at the end of the day, what they try to look for is if there’s a front-runner, if they understand what the economic policies are, then that uncertainty is reduced,” she said. “So the market or investors just don’t want to be surprised.”

Garcia added that the market would want to see a front-runner. “If it’s a close fight, the uncertainty comes,” she said.

Aging bull

The PSEi had risen for six straight years and was earlier widely believed to be on its way up for a seventh year this 2015.

This held true for the first semester. In April 7, the local stock barometer breached the 8,100 level for the first time, establishing a new peak at 8,136.97. As of the end of the first semester, the PSEi was still ahead by 333.93 points or 4.6 percent versus the yearend level.

But the third quarter was another story. Like other emerging markets, which saw their worst quarter in recent history, the PSEi was heavily battered. It ended giving up all gains seen at the beginning of the year. For the third quarter alone, the PSEi lost a total of 670.52 points or 8.86 percent from the end-June level of 7,564.50.

“Concerns over China, which triggered a global stock selloff, will be the main source of volatility given the difficulty of predicting its outcome,” said First Metro Investment Corp. and University of Asia and the Pacific (UA&P) in the September issue of their joint publication The Market Call.

“This is one of the toughest times for the stock market that I’ve been through. It reminds me of the Asian crisis, the global crisis of 2008 and some semblance of what happened in 2013,” said stock market veteran Michaelangelo Oyson, chief executive of BPI Securities Corp. Until there was clear guidance on the US Fed lift-off, Oyson said the PSEi would likely trade within a wide range of between 6,600 and 7,200.

Once the Fed starts raising interest rates, Oyson said the local barometer could stabilize and eventually revisit its fair valuation of around 7,600 moving toward 8,200 next year.

“But suffice to say, a lot of the tourist inflows have left,” he said, noting that the local bourse was seeing the second largest outflow of foreign portfolio—also known as “hot money” due to its volatile nature—in the last eight years.

Oyson said the stock market was not yet out of the woods because the exchange rate has yet to stabilize. During the global financial crisis of 2008, he recalled that the peso depreciated by at least 15 percent from 41 to 50 against the dollar as foreign funds dumped emerging-market assets. In 2013, he noted that the height of the “taper tantrum,” the peso depreciated by about 10 percent from 41 to 45. While foreign selling has already happened, Oyson said the peso was still shaky and would likely overshoot 47:$1 and beyond until there was clarity on the US Fed’s rate increase.

Another reason why the local stock market was not over the hump yet, Oyson said, was that other markets have not stabilized in terms of valuation. He noted that relative to other markets, Philippine stocks remained relatively more expensive.

Fundamentals

Once the dust settles, Oyson said the market would remain attractive to global investors and regain high valuations. The conventional strategy, he said, would thus be to buy on dips high-quality issues. “Investors have to realize it’s very difficult to catch the bottom of the market so the strategy must be based on risk tolerance to the downside,” he said.

FMIC-UA&P said there could be further downside risk as valuations remained elevated, coupled with the lack of “re-rating” catalysts in the near-term. “However, we continue to be on the lookout as this also creates opportunities. Our market outlook for the next 12 months remains brighter due to our perceived election spending boost,” FMIC-UA&P said.

It would be best to take advantage of any market weakness to increase exposure in Philippine equities at lower valuations, FMIC-UA&P added, noting that the Philippine economy remained a bright spot relative to its Asean neighbors and economic growth would likely be sequentially better in the next four quarters with some boost from election spending.

“Key themes remain unchanged. We like defensive stocks (high dividend yield is preferred) and stocks that can leverage on the election spending. We think earnings of listed companies with exposure to staples (groceries), beverages (alcoholic and non-alcoholic), tobacco and fuel should be supported by election spending,” FMIC-UA&P said.

April Lee-Tan, head of research at COL Financial, said there was little chance that the local market would slip into “bear” territory despite continuing jitters from China and uncertainties over the US Fed liftoff. When a stock barometer falls by 20 percent, the market is deemed in bear territory.

“This is just a major correction, not a bear market,” Tan said, adding that even if her forecast would turn out to be wrong, investors could take comfort in the fact that bear markets historically did not last too long. While there was still risk that contagion would push the local stock market to a freefall, Tan said any visit to bear territory would likely be “short and shallow.”

“We believe that investors can already start accumulating stocks, although we advise them to use peso averaging,” Tan said, referring to the strategy of regularly buying the same stocks or set of stocks—usually blue chip issues—regardless of price over a long period of time. COL’s recommendation is for investors to “focus on quality larger-capitalized liquid stocks trading at attractive valuations as these are expected to lead the market’s eventual recovery.”

The Philippines still offered a very attractive story to investors, given that its economy is still growing faster than most of its peers while government finances remained healthy, investment spending was picking up, sound banking system and strong current account surplus, Tan said.

On Sept. 24, London-based Fitch Ratings has revised its outlook on Philippine sovereign rating to “positive,” suggesting that a rating upgrade on its BBB-, currently the minimum investment grade, could be raised in the next 12 to 18 months. All three major global credit watchdogs have given the Philippine sovereign an investment-grade rating but Moody’s and Standard & Poor’s ratings are a notch above the entry-level investment grade that Fitch keeps.

“Governance standards and competitiveness indicators, as measured by international organizations, have shown steady improvement through the Aquino administration. Global competitiveness, as ranked by the World Economic Forum, has risen to a level comparable to ‘BBB’-rated peers. Indicators for corruption, transparency and economic freedom have also improved substantially. Evidence that governance improvements can be sustained beyond the next election cycle would be positive for the credit,” Fitch said.

Aside from outperformance in economic growth and its strong external finances, Fitch has also noted the Philippines’ low and falling public debt—a stark contrast to fears of “debtopia” elsewhere in the region. General government debt is at 36.4 percent of GDP in 2014 compared with the median of 42.4 percent ratio among BBB-rated peers.

The main factors that individually or collectively might lead to positive rating action are:

Evidence that improvement in governance standards over the Aquino administration can be sustained after the elections;

Continued strong GDP growth without the emergence of imbalances, and

A broadening of the general government revenue base that lends greater stability to the government finances.

Many stock pundits are still hopeful that there will be the usual Santa Claus rally before yearend. When the PSEi touched bear territory in 2013, for instance, the local stock barometer managed to rebound later in the year and managed to gain 1.33 percent for the year. For the remainder of 2015, investors hope to confirm expectations of a domestic growth pick-up in the second half and better earnings performance for the third quarter alongside a clearer direction from the US Fed and better news flow out of China.

Globally, the bull market is under siege and emerging markets are at the losing end as risk aversion rises. “We think this bull market is maturing and volatility is rising but it is too early to call its end given where we are in the profits cycle,” Citi said in a Sept. 24 research on macro asset allocation.

For Philippine Stock Exchange president Hans Sicat, the recent market shakeout is an “overreaction” to China’s economic woes and volatile commodity prices and ignore the underlying strength of Philippine corporations and the domestic economy. “The real economy is not much different from what we saw, so financial market should calm down at some point, hopefully sooner rather than later,” Sicat said.