Still sunny skies ahead?

Just weeks after I decided to more than dip my toes in the local equities market, dark clouds hovered, proving once more that the best indicator of a market downturn is to wait for me to put good money into it. But panic is no longer an option after all these years. Instead, I asked the experts, the guys who told me it was time to move in, what the heck is going on? Not to worry, I am told. The forecast overall is still for sunny skies with occasional showers… or so we wish!

The American financial market has apparently caught a bad cold. It had been sneezing for a while now, brought about by worries on the depth and reach of the financial disaster involving sub-prime housing mortgages. How fast the recovery is, depends on how bad the hit is on the American economy, which is after all, still the engine driving the world’s economy.

But how sick is the American economy? Not even The Economist knows for sure. “Is America’s economy like a Victorian tuberculosis patient, with blooming cheeks and rotting lungs? Or has it merely caught a slight cold? It is hard to tell.”

As it happened, the epidemic has spread to the credit market, making everyone more risk averse than usual. And because there are less risky options than the stock market, the US and major world markets suffered worrisome downturns. And because emerging markets like ours are even riskier than the US market, those hot money portfolio investors have started to flee from the Philippine stock market. On July 27 when the PSEi suffered its third-worst point loss in a single day this year (at 140.92 points), net foreign selling reached P1.19 billion (leaving P15-billion net foreign buying position after this on a YTD basis).

A factor that made the local situation susceptible to the American virus is the renewed concern over the government’s fiscal health. As of June 2007, the fiscal deficit stood at approximately P42.0 billion, 67 percent of the full-year target of P63.0 billion. But a large part of government cash flow in the first half is non-recurring… P26.0 billion proceeds from the sale of PLDT shares. Without it, the 1H07 deficit would have been at P68.0 billion, already beyond full year target. That’s worrying guys like those number crunchers at the rating agency Fitch.

Why should concern over sub prime mortgages spook the world’s stock markets so much? Well, for one thing, the fear generated by the failure of sub prime mortgages made the cost of credit go up as investors and financial institutions start re-pricing risk.  

For stock market investors, higher cost of credit would impair equity valuations. Note that prior to the passage of the E-VAT law in the Philippines, the Philippine stock market traded at Price-to-Earnings (PE) multiples of only 13.0x – 14.0x compared to the recent PE high of 18.0x. While government’s fiscal problem should not affect the earnings of our blue chips, a re-rating of our issues that are trading at higher PE multiples is happening and thus depressing their stock prices even as their fundamentals remain solidly the same.

Market experts believe the decline in the local stock market was driven more by off-shore concerns, given the large influence of foreign traders in our market. When experts tell me not to worry about the local market, they point out that the local economic and corporate fundamentals remains solid — (1) interest rates at low levels, (2) a strong peso (3) a forecast for firm economic growth, and (4) strong corporate earnings.

Good economic fundamentals aside, markets may at best move sideways over the near-term. Given all the crying on Wall Street, the bias has got to be on the downside. Experts surmise that taking out the re-rating of PE multiples and bringing it back to 14.0x 2007 earnings, market support is likely to be found between the 3,400-3,500 index level... a best case scenario which could be wishful thinking too given today’s market sentiment.  

Positive news on local corporate earnings has been overshadowed by worries about the global credit squeeze and its impact on stocks, especially mortgage and financial companies. Those credit worries in the US are affecting sentiment in the local market since foreign buyers drive our market. This means the forecasts for the short term are for a further decline. However, many analysts are also hopeful of a quick market recovery on the basis of good fundamentals.

“If you take a step back and look at fundamentals, they’ve actually improved in this shake-out,” Michael Darda, chief economist at MKM Partners LLC in Greenwich, Connecticut was quoted by Reuters. “Equities are getting more attractive on a valuation basis, courtesy of the drop in long-term interest rates, the rise in profits and weaker stock prices.”

In fact for the Philippines, the good news about our economic fundamentals was reiterated by a recent paper prepared by Global Source, a subscription based network of independent analysts. According to Global Source, “a prospective combination of relative political calm and improved macroeconomic fundamentals may enable the economy’s growth pattern to take on a more Asian character, i.e., a more extended period of high growth spared from the familiar fiscal or external payments busts.”

And that’s because, you guessed it… the growing remittance inflows from over eight million overseas Filipino workers (OFW). Global Source pointed out that “these flows have not only financed consumption and housing investments, they have supported the balance of payments against recent oil price run-ups, contributed to the peso’s continuing strength and complicated monetary management.”

As for the fiscal situation, Global Source is nothing less than reassuring. Worries two years ago of a fiscal crisis, it asserts, “have subsided, recent slippages notwithstanding.” It also said “financial sector risk has receded with banks having unloaded a large portion of their bad assets and a spate of bank mergers having created stronger institutions. These developments have resulted in a low interest rate environment and created the conditions for bank lending to grow more robustly to further boost growth.”

On political stability, Global Source is confident the “scheduled Presidential elections in 2010 will result in an orderly contested election and installation of a new administration.” Global Source argues that those aspiring for the presidency from the Opposition “have no incentive in impeaching a sitting President, only to confront a successor (the current Vice President) who will have a fresh mandate, bear none of the popularity issues of the incumbent and is constitutionally allowed to run in 2010 with the resources of the office of the Presidency behind him.”

Complaints about the strong peso aside, Global Source thinks that “the peso’s strength is supported fundamentally and that there is some more room for it to strengthen further without the country losing competitiveness considering that neighboring currencies have also been appreciating in value.”

Global Source noted that government “has adopted other strategies to ease the upward pressure on the peso, including pre-payment of external debt and relaxation of various foreign exchange regulations ( e.g., outward remittances, permitting higher foreign exchange holdings). Compared to 1997, another plus to the country’s ability to absorb these flows is the strengthened position of financial institutions following a clean-up of bad assets and a spate of mergers among banks.”

So there we are… this passing shower may be giving us a bath now but I guess, it is to our interest to believe, to hope and to pray that the downturn is a momentary blip. Were it not for globalization, we shouldn’t have to go down with a bad case of flu, just because the American market is sneezing badly. That’s why if America’s affliction turns out to be the resistant form of financial tuberculosis, who really knows what happens next?

Stockbrokers and yachts

A visitor from out of town came to a tour in Manhattan. At the end of the tour they took him to the financial district. When they arrived at Battery Park the guide showed him some nice yachts anchored there, and said, “Here are the yachts of our bankers and stockbrokers.”

“And where are the yachts of the investors?” asked the naive visitor.

Boo Chanco’s e-mail address is [email protected]