Preservation of capital is primary. Profits are acutely important but secondary, and, before you make any investment decision, you should first ascertain the risk inherent in that investment vehicle and decide in your own mind what the worst possible outcome could be. Only when you have gone through this type of ‘‘risk reflection,’’ can you make an informed decision of whether the particular investment is right for you. The human condition is to look at ‘‘best case’’ not worst case—Harry D. Schultz
In this issue:
PSEi 30: Bear Market Rallies in the Era of Stagflation
I. PSEi 30 Oversold Rally: Concentration of Gains on Biggest Market Cap Issues
II. Contra BSP’s Tightening, Rallying Stock Market Redound to Financial Easing
III. PSEi 30 Earnings Boom amidst Raging Inflation?
IV. Relative to the PSEi 30: Banks Outperformed, Property Sector Lagged
PSEi 30: Bear Market Rallies in the Era of Stagflation
Bulls believe that the downcast domestic stock markets should soon rise. They anchor their hopes on a changeover from "transitory" to "peak inflation," which should prompt the BSP to respond with a "pivot." The other rationalization is that the Philippines will "decouple" from global developments.
The BSP and the PSE fuels such hopes by indicating that the downdraft in the bellwether has made domestic equity assets "cheap."
What's more, while the principal benchmark, the PSEi 30, dropped below the 6,000 level anew last Friday, the performance of the property and bank sectors has diverged, favoring the latter, giving the impression that banks are least affected by spiking interest rates.
I. PSEi 30 Oversold Rally: Concentration of Gains on Biggest Market Cap Issues
Figure 1
At the start of last week, a three-day spike pushed returns of the PSEi 30 to 4.13%! However, the declines of the next two days wiped out about 68% of such gains, so the primary equity bellwether closed the week higher by 1.33%.
Though the weekly average main board volume of Php 4.52 billion showed a 36.1% improvement after skidding to Php 3.32 billion a week ago, a May 2020 low, this gain was more about the base effect.
It would be easy to infer this rally as a reflexive recoil from an oversold market. But as it happened, the individual performance and the eye-popping mark-the-close developments showcased the concentration of activities, which came at the expense of the PSE universe. (Figure 1, topmost pane from Technistock)
It was a mixed performance, even for the index components of the PSEi 30, with advancers slightly ahead (16-14). (Figure 1, middle window)
Gains of Ayala Land (+10.43%) and Ayala Corp (+8.4%) shored up the index as their combined share of weekly trading volume relative to the index increased to 14.16% from 11.6% a week ago.
The determined attempt to push the index higher could have diverted the volume away from the PSE universe, which led to the latter's dismal activities.
Briefly, the index rallied while the broader markets sold off marginally.
Nota Bene: The skewed distribution of the weights, where the top 5 issues hold a commanding 44% of the aggregate market cap, barely represents the stock market.
II. Contra BSP’s Tightening, Rallying Stock Market Redound to Financial Easing
To contain inflation, the BSP has raised rates at an unprecedented speed and scale. By raising rates, it targets to curb demand through the 'credit channel,' which means the BSP hopes to drain excess liquidity from the economy.
But instead of hitting its target, a substantial rise in the equity markets extrapolates to an "easing of financial conditions," which may further fuel inflation. It could encourage bank credit flows toward equity speculation that funnels money supply indirectly to the economy.
Previously, the bull market in the PSEi 30 started with a downtrend in the CPI (2009-2015). Nonetheless, the aging equity bull market surfed with a rising CPI (2015-18) but climaxed ahead. (Figure 1, lowest pane)
But the BSP can't allow further asset value deterioration because it should affect the financial industry and the economy through the escalating risks of credit deterioration, which will be manifested primarily through liquidity, collateral, and counterparty channels. And though the BSP prefers to see both conditions (a rising market and a contained CPI), that's their dilemma. They can't have their cake and eat it too.
And that's not all. Aside from the addiction to an easy money regime, popular politics is about the free lunch of deficit spending. Yet, the further the economic turmoil, the greater the demand for political subsidies and various interventions.
Here's an example.
Inquirer.net, October 22: National Economic and Development Authority (Neda) Chief Arsenio Balisacan on Saturday stressed on the importance of shielding the poor from the effects of high inflation by giving them financial aid. “Moving forward, we need to speed up providing financial assistance to the poor [and] most vulnerable groups,” said Balisacan in a press release from the Office of the Press Secretary.
The intensifying use of political controls, exemplified by the lockdowns, and the thrust towards centralization (recent example: the ratification of the SIM card registration), should also add to these accrued imbalances.
As it is, such activities only entrench the structural forces of inflation, which reinforces its long-term uptrend. And yes, the uptrend won’t be linear, which means there will be countercyclical fluctuations.
For these reasons, unless there should be a reversal of the present policies, the economy should endure an era of stagflation fortifying the current bear market cycle.
And yes, markets operate on cycles too.
III. PSEi 30 Earnings Boom amidst Raging Inflation?
The belatedly released BSP-PSE data showed that the PER of the PSEi 30 dropped to 13.93 from a combination of depressed prices on the back of rising earnings! (Figure 2, topmost window)
Even with companies yet to release their report, earnings per share zoomed 29.1% YoY in September and 7.4% MoM. With this, earnings have recouped to the 2018 levels. (Figure 2, middle window)
Yet when seen from the 2021 eps, even at Friday's close, the average PER remains pricey at 21.07! (Figure 2, lowest window)
The BSP/PSE data barely discloses the calculation for the EPS.
As previouslyshown, firms of the PSEi 30 have grown debt more than eps in Q2. This dynamic is likely to have extended in Q3.
Figure 3
Next, with the current inflationary episode, various government data suggest a profit margin squeeze via negative spreads between the CPI and General Wholesale Prices, the CPI and Producers Price Index (PPI), and the Construction Material Retail and Wholesale Prices, which should cover most of the industries. (Figure 3)
The discernible negative spreads reveal that either the CPI is understated or firms reported inflated margins, thereby, the possible overstatement of the eps.
The estimated margin squeeze also partly explains the ballooning debt levels of these firms, which manifest attempts to fill the liquidity gap on their balance sheets.
In any case, the era of stagflation is about to compress margins further, magnify credit and other risk factors and increase pressures on unemployment which should result in economic stagnation.
IV. Relative to the PSEi 30: Banks Outperformed, Property Sector Lagged
Thinning trading volume has served as a crucial factor in the slump of the PSEi 30 and the PSE. But the distribution of decline and trading volume per sector has not been the same.
Figure 4
Relative to the PSEi 30, the foremost gainer has been the financial sector, which gained a foothold and sprang forward since the BSP infused unparalleled liquidity in 2020. Or, the BSP's rescue of the banking system caused its stocks to outperform.
The financial index has risen along with the 10-year Treasury bond, which provides a seemingly misleading picture that the sector benefits from rising rates. (Figure 4, topmost pane)
On the other hand, compared to the PSEi 30, the property index signified the laggard among the sectors. Rising bond yields have magnified its downturn. (Figure 4, second to the highest pane)
Interestingly, the property sector is the largest bank borrower/client. (Figure 4, second to the lowest pane)
Though its share of bank lending has dropped from a record in August 2022, it was at 4Q 2021 levels. The sector has accounted for over one-fifth of bank loans. And this excludes consumer real estate bank loans.
Finally, while the financial sector beat the PSEi 30, it came in the light of lackadaisical volume.
On the other hand, accompanying the steep descent of the property sector has been a surge in the sector's share of gross traded volume. (Figure 4, lowest windows)
The market could be misreading the strength of the financial sector, or like the peso, "shadow" institutions have provided a cushion to project "stability."
