Unleash the Bull
Shrugging off its recent setback, the Philippine equity market is on the road to a strong recovery
by Jojo Gonzales
The Philippine Stock Exchange Index was up 11% in end-August from the end-2005 level. This expansion, however, masks the roller-coaster rise in the Philippine equity market so far this year.
At one point through early May 2006, the market was actually up as much as 23% from end-2005. However, these gains were wiped out in succeeding weeks in what became the steepest six-week decline in the stock market in recent memory.
Looking back, both the early gains and the subsequent sell-off were not without basis. We believe, however, that the bullish case for Philippine equities will win out over the bearish case. The reason for the optimism is much of the positives are rooted in the domestic economy and earnings environment, while the bearish factors are mostly external and largely confined to U.S. interest rate fears.
Nevertheless, as distant as U.S. interest rate policies may sound, they have significant impact on Philippine equities. U.S. policies help determine foreign flows into the local stock market. Foreign investors comprise nearly 60% of turnover at the Philippine Stock Exchange.
Lower Interest Rates
Central to the positive case for Philippine equities is the thought that domestic interest rates could stay lower for a longer period of time. This thesis, though, was interrupted in May when it sounded as if U.S. monetary policy makers would have to raise rates. Those U.S. interest rate fears have since eased, thereby restoring focus on domestic factors that conspire to keep interest rates down, namely:
• Inflation is gradually decelerating. From 6.7% in January 2006,
inflation dropped to 6.4% in July.
• The fiscal position has greatly improved. At the current rates where revenues grow by 21% and spending is growing only half as much at 11%, we estimate the fiscal deficit to settle at a low of P78 billion in 2006 or 1.4% of the gross domestic product.
• Dollar flows—trade, overseas Filipino workers’ remittances, portfolio and direct investment— have all been positive and are behind much of the strength of the peso.
• GDP grew 5.6% in the first half of 2006 and appears to be
sustainable, and it is a rate that is unlikely to exert demand-pull pressure on consumer prices.
Indeed, if these factors persist in the second half of 2006, the Bangko Sentral may even consider cutting policy rates by late 2006. The last time monetary authorities cut rates was in July 2003. Strong Corporate Earnings
Recurring profits among publicly listed companies grew by roughly 22% in the first half of 2006. This was based on a universe of 22 companies that comprise 90% of the Philippine Stock Exchange Index by way of market capitalization.
Although earnings growth in the second quarter of 2006 alone was only 9% compared with 29% in the first quarter, it was not as poor as we initially feared. We thought that inflationary pressures and added taxes would undermine corporate profits by much more.
Still, there were a few disappointments. Bank earnings were worst in the second quarter of 2006, falling 13%. The volatility in financial markets during the quarter erased foreign exchange and bond trading gains. The strong fluctuations exposed the weakness in loan growth and net interest margins.
Except for the banks, earnings in other sectors were in line with, if not slightly better than, expectations.
Winning Streak
The Philippine stock market has not recorded four straight years of gains in the last two decades. If 2006 ends in positive territory, this will be the first such four-year winning streak in modern times.
Although the gains appear to be less than in 2003–2004, it is important that the market establish a record for more consistent returns, no matter how modest. This sustained growth could attract domestic institutional investors that are looking for alternatives to declining returns from fixed-income investments.
And even if it may seem that the market is on track towards a four-year winning streak, earnings growth has been robust. As a result, broad market valuations remain relatively inexpensive at around 12x earnings.
Jojo Gonzales is head of research of Philippine Equity Partners, a top-tier broker and among the largest in turnover among independent and locally owned brokerage houses.
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