Not expecting a return to 9,100 soon

The Philippine Stock Exchange index (PSEi) is up 7.8 percent year-to-date, making it one of the best performing stock markets in the world thus far for 2019. Foreign investors have also returned—recently buying a total of P10.9 billion worth of stocks—after consistently shrugging off Philippine stocks in the past 11 months.

Although there are good fundamental reasons for the stock market’s strong performance, I don’t expect to see the PSEi exceeding its 9,100 record high anytime soon.

The Philippines’ twin deficits—the budget deficit and the current account deficit—are expected to remain a problem this year.

The government’s budget deficit increased by 96 percent to P477.2 billion at end-November 2018 and is on track to hit the full-year limit of P523.68 billion or 3 percent of the gross domestic product (GDP).

For 2019, the government set a deficit target of P624.4 billion, or 3.2 percent of GDP, and this is projected to stay at 3 percent up to 2022 to sustain the momentum of the government’s “Build, Build, Build” program.

Meanwhile, the Bangko Sentral ng Pilipinas (BSP) expects the current account (which measures dollar coming in versus dollars going out) to stay in a deficit position of 2.3 percent of GDP in 2019 from 0.7 percent of GDP in 2017 and 2.7 percent of GDP for the nine months of 2018. This, as the government continues to import capital equipment to support its aggressive infrastructure spending program.

Aside from the twin deficits, the Philippines’ GDP growth could slow down this year as investment and government spending could disappoint. Both have been consistently growing faster than the GDP since 2015 and now account for a combined 36 percent of GDP.

Note that average bank lending rates have gone up substantially to 6.64 percent in November 2018 from 5.78 percent in December 2017. Higher bank lending rates could discourage some businesses from pushing through with their investment plans.

Although the interest rate of the 10-year bond has gone down to 6.5 percent from a peak of 8.3 percent last year after inflation showed signs of peaking in the fourth quarter, we don’t expect it to return to its 2017 level of around 4.5-5 percent. Aside from the government’s twin deficits, banks are now less liquid, with around 77 percent of total deposits already lent out to the public.

Meanwhile, the 2019 budget is only expected to be passed by the second week of February at the earliest. Delays in the passage of the 2019 budget will most likely hurt government spending growth as it operates on a reenacted 2018 budget. This will cause delays in the roll-out of new projects. The election ban makes matters worse as the release of public funds is suspended beginning Jan. 13 up to June 12.

Finally, slower global economic growth will have some impact on the Philippines through slower exports and potentially flat OFW remittances. Although remittances were resilient during the global financial crisis, it might be less resilient this time around as the base is much higher at P28 billion currently from around P15 billion some 10 years ago.

Given the said factors, it would be difficult this year for the PSEi to rally all the way back to its previous high of 9,100. At the said level, the PSEi would be trading at 18.9X (price-earnings ratio) P/E, which is the upper end of its five-year historical average P/E.

To return to 9,100, interest rates will need to go down or corporate profits will have to surprise in a positive way. The likelihood of either one happening this year is not very good in my opinion.