ON the day after the inauguration of Benigno Aquino 3rd as President of the Philippines in mid-2010, the benchmark Philippine Stock Exchange index (PSEi) dipped by a slight 0.18 percent. The market was undecided what to expect in the six years ahead.
Less than two years later, Philippine equities were outperforming every other stock market on the planet.
Midway through Aquino’s term, by 2013, the PSEi had grown over 120 percent – from the start of his term at 3,300 points to the 7,300-point level – an astonishing performance by any measure.
The economy was growing in the 7 percent territory where China used to be the only star performer. The Philippines was on its way to winning sovereign credit ratings upgrades from global ratings agencies, and Aquino was enjoying a high popularity rating at above 60 percent.
By May 16 of that year, the index had reached a high point. On what was ironically a downbeat day for the market (by the day’s close the PSEi lost 77 points, a little over one percent), the index came within an eyelash of topping 7,400, reaching 7,399.79 in late-morning trade.
Today, at the height of the controversy over corruption in the three branches of government and the lowest point in Aquino’s popularity at less than 30 percent with two years to go before the end of his term, the stock market stands alone as a bright spot in this scandal-rocked administration.
Solid fundamentals, global risk
There is consensus among equity analysts that growth in the Philippine market has been driven by solid economic fundametals.
“The strong performance of the PSE index over the last few years has been driven by a combination of strong corporate earnings growth and expansion of price-to-earnings multiple,” Michaelangelo R. Oyson, CEO and Managing Director of BPI Securities Corp. said.
Oyson explained: “Corporate earnings have seen a major recovery while investors have been willing to pay a high PE multiple for the quality of earnings.”
Joyce Anne Ramos, equity analyst at AB Capital Securities, shares the same view: “The performance of the Philippine Stock Exchange index, specifically starting last year, was driven by both improving economic fundamentals in the Philippines and global influences.”
“In March last year, we (the Philippines) received our first investment grade credit ratings from different international debt watchers, citing improved fiscal management by the government and strengthening consumption spending by the private sector, which contributes about 60 percent to GDP,” Ramos told the Manila Times.
Ramos also cited the inflow of portfolio funds from the United States as the Federal Reserve began ramping up its Quantitative Easing program.
“The quantitative easing policy of the United States a few years back also stimulated capital outflows from the US to emerging economies like the Philippines as foreign market participants were looking for investments that may yield them better returns,” Ramos said.
Impact of hot money
Immediately after reaching its May 2013 high, the PSEi began a steep decline—which is generally regarded now as having been a justifiable correction—as a result of the US Federal Reserve’s announcement that it intended to begin “tapering” its long-running quantitative easing (QE).
QE, which involved the Fed buying large quantities of bonds in order to feed money into the financial system and encourage spending, was the source of the massive amounts of “hot money” flowing into equity markets in emerging economies, including the Philippines.
Emerging economy markets were generally seen as being more stable than developed markets, and with QE pouring more cash into the system than investors knew what to do with, offshore equity investment was considered a safe and profitable alternative.
The beginning of the end of QE signaled a retreat of hot money, and the performance of the PSEi certainly seemed to bear that out: In a little more than three months after its May 16 high watermark, the PSEi shed more than 1,500 points – a little more than 21.5 percent – reaching a new “low” of 5,738.06 on August 28 and erasing all its gains for 2013 up to that point.
While hot money flight did contribute to the market’s decline, its impact may have been overestimated, according to the PSE’s Corporate Planning and Research Department in a presentation at the 12th National Convention on Statistics in October 2013.
According to PSE data, growth of foreign trading value in the market between 2010 and the third quarter of 2013 was only about 11 percent, and domestic trading value at its lowest point (August 2013) still accounted for at least 50 percent of the market.
A reactive market
Although the overall value of the PSEi declined during the “severe correction” between May and October 2013, the proportion of hot money in the market actually increased; what that market reaction – a steep drop followed by a period of extreme volatility through the end of 2013 – to the start of the Fed’s QE taper suggests is that the Philippine stock market is natively highly reactive to outside stimuli, perhaps too much so for its own good.
Recent comments by analysts, as we have reported over the past week, certainly seem to reinforce that notion, as the recent flat performance of the market is almost unanimously attributed to investors “waiting for signals.”
“Stock markets are all interrelated,” BPI’s Oyson said. “When the US sneezes, the Philippines catches a cold. When the US plays a nice tune, the Philippines dances.”
One risky effect of market reactivity is the tendency in emerging markets like the Philippines to be driven by large block trades, as the investment and analysis firm Euromoney pointed out in a report in late 2012.
On the positive side, this bodes well for initial public offerings (IPOs), as these have a good chance of being oversubscribed; in October 2012, Coal Asia sold 800 million shares and surged in value by 50 percent in its first day on the PSEi – and it was only the fourth-largest IPO that year (GT Capital Holdings was the largest by value, followed by EastWest Bank and Calata Corporation).
Taking advantage of the trend, more companies have planned IPOs in the Philippines (at least 10 so far this year), although the market still has a long way to go to catch up with IPO powerhouses like Malaysia and Indonesia, which have each seen 30 to 50 IPOs in each of the last four years.
But there are obvious risks. The fickle nature of hot money cannot be overlooked, even if it does not have quite the impact it was once thought to have; investment giant State Street, for example, advised its clients just last month to underweight emerging market stocks, and specifically noted the Philippines as a better bet later (three years or more from now) rather than sooner.
And given the small size of the market – PSE’s October 2013 profile pointed out that only about 0.03 percent of the Philippines’ more than 800,000 registered corporations are actually traded on the market – financial adversity for just one or two companies, or even just a big trade resulting from a merger or acquisition, could have a profound effect on share prices.
Likewise, the PSEi, much like other markets in the region, has shown a tendency to track the movements of developed-economy markets like the Dow Jones; the PSE report reveals that only twice in the past two decades – first during the Asian Financial Crisis in 1997, when the local market performed more poorly than its US counterpart, and second during the Financial Crisis of 2008-2009, when it performed better – did the PSEi’s performance diverge from parallel with the developed markets.
That makes the local bourse susceptible to the same sort of psychological triggers that affect the rest of the world; most recently, conflicts in the Ukraine, Iraq, and Gaza and their perceived effects on oil prices and transport sectors.
More worrisome is the possibility of unstable conditions much closer to home, such as political turmoil as a result of the DAP and PDAF scandals, or the troubled Bangsamoro peace agreement.
Resilient market maturing
In the presence of domestic and global shocks, there is not an overwhelming concern for the market’s health because there is a clear sense of maturation taking place.
The market’s size, still relatively small, while presenting some risks has also been a great advantage; the majority of listed companies are among the healthiest in the country financially, with blue chips such as Meralco, Ayala Land, PLDT, and SM routinely posting double-digit revenue and earnings growth.
Without discounting risks such as capital flow shocks, currency fluctuations, and domestic economic concerns like higher-than-expected inflation, AB Capital’s Ramos agrees with the notion that fundamentals are the key drivers of the market.
“The PSEi is recovering and is driven by economic fundamentals of the country, which have remained strong despite the growth slowdown last Q1. The improving economy was also reflected in the corporate earnings performance which were either beating estimates or exceeding targets, thereby attracting more investors into the stock market,” she said.
Ramos also stressed that fundamentals are more important than external factors in guiding the market. “Many [investors]are depending on domestic leads such as BSP’s monetary policies and corporate earnings. When there is no significant local market-moving news, investors then rely on outside influences,” she explained.
The management of the PSE, working in close cooperation with the Securities and Exchange Commission, has also contributed to market stability through a conservative regulatory approach.
For example, close enforcement of a 10 percent public float requirement has led to the delisting of a number of companies (most notably PAL Holdings, the parent company of financially-troubled flag carrier Philippine Airlines), and a plan proposed last year to combine the country’s stock and bond markets – a plan that made sense in some respects, as the local bond market is overwhelmingly driven by corporate bonds – was pushed back because of a general sense that the markets simply “weren’t ready” for the move.
Likewise, the PSE has been reluctant to pursue high-risk trading products like derivatives; the country’s first exchange-traded fund (ETF), packaged by First Metro Investment Corp., was only introduced last year.
While the conservative approach perhaps trades some earning power for stability, it can be characterized as mature because it seems geared to a longer-term approach. Since the beginning of this year, the market has again resumed its climb, but at a more staid pace; through July 24, the market has gained 885.68 points, or a bit less than 15 percent – but has taken six months to expand the same amount it did in half the time during the heady days of 2012.
More tellingly, analysts now have narrowed the range between support and resistance to 150-200 points, still providing ample room for considerable fluctuation but in reality a margin for uncertainty of only 2 to 3 percent.
With few expectations that those general conditions will change any time soon – AB Capital’s forecast for the index by year-end is 6,900, virtually the level where it is at right now – the local equity market seems poised for a stable run.
BPI Securities’ Oyson has a more upbeat forecast, but sounds out some caution for the short term. “Near-term, we should see market consolidation. The stock market is already pricing in a big chunk of 2015 numbers. It is no longer cheap at 19 times PE; historically, this market has traded at an average of 16 times. Meanwhile, there is a risk that consensus 2014 GDP growth forecast could be revised downwards as a result of government underspending,” Oyson explained.
“Having said that, I believe the bullish story of the Philippines remains intact. Liquidity is supportive and our economic numbers are rosier than in other parts of the emerging markets world. We are also starting to see rotation out of bonds and SDAs into equities. In the absence of macro shocks, this market could trade above 7,100 next year.”
(The last of this three-part report will discuss Fiscal Management and will appear on Friday, August 1.)