Philippine Markets Daily

MONDAY MACRO: Low interest rates should help boost Philippine corporate profitability… it ought to also support a still-high Uniform P/E of 24X

January 27, 2020

Nearly 60 central banks all over the world made adjustments to their interest rates in 2019–not much difference with the number in 2018 that made interest rate changes.

In 2018, two-thirds of interest rate changes made were interest rate hikes. But in 2019, 86% of the activities were rate cuts.

The Philippines also followed this pattern of rate hikes in 2018 and then rate cuts in 2019.

It’s the overall movement that investors should watch out for. Knowing what this means for both the economy and the stock market will prove crucial in making investment decisions.

Philippine Markets Daily:
The Monday Macro Report
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Similar to other central banks around the world, the primary objective of the Bangko Sentral ng Pilipinas (BSP) is to “promote price and financial stability conducive to balanced and sustainable economic growth.”

To achieve this optimal stability, central banks have the power to modify interest rates to manage inflation as part of their monetary policy.

When the Tax Reform for Acceleration and Inclusion (TRAIN) Act was put into effect, inflation rate in the Philippines began its ascent to historical highs. From just 3.4% in January 2018, it reached nearly double that in September 2018.

The BSP increased interest rates 5 times that year, ending the year at 4.75% interest rates, which is 1.50% higher than in 2017.

As inflation rate returned to its previous norm, it was as good a time as any to bring interest rates back down.

The BSP cut interest rates 3 times in 2019, ending the year at 75 basis points lower than 2018.

By 2020, the BSP expects to reduce interest rates by 50bps.

Interest rates are not only important for inflation concerns. Interest rates also play an important part in the availability of capital for businesses in a country.

Higher interest rates mean higher cost to borrow, causing businesses and consumers to cut back on spending.

With prospects for growth looking quite unlikely for businesses, it is not surprising that the Philippine stock market index (PSEi) declined from over 9,000 to a little over 7,000 when rates were high in 2018.

Conversely, lower interest rates mean lower cost to borrow. This is ideal for boosting business expansion and consumer spending. That partly explains the recovery in the stock market in 2019, although still not to the highs reached before the high inflation environment.

While the market is still a little worried about Philippine businesses’ growth prospects, our Uniform Accounting shows that aggregate returns are expected to remain where they are.

The market, on the other hand, is pricing in further decline in corporate profitability (red bar). In reality, Uniform ROA (blue bars) highlights that Philippine corporate profitability is still at par with global corporate averages at 6%.

As we mentioned last week, Uniform P/E still shows that valuations have not come down yet. Though corporate profitability is expected to be better than what the market thinks, Philippine corporations are still not trading as cheaply as they appear to be.

Uniform ROAs for regional peers like Singapore and China are also at 6%, but they are trading at lower P/E levels.

To justify its Uniform P/E levels, Philippine corporate profitability has to improve without foregoing growth.

This is likely in a low interest rate environment.

About the Philippine Markets Daily
“The Monday Macro Report”

When just about anyone can post just about anything online, it gets increasingly difficult for an individual investor to sift through the plethora of information available.

Every Monday, we publish an interesting chart on the Philippine economy and stock market. We highlight data that investors would normally look at, but through the lens of Uniform Accounting, a powerful tool that gets investors closer to understanding the economic reality of firms.

Understanding what kind of market we are in, what leading indicators we should be looking at, and what market expectations are, will make investing a less monumental task than finding a needle in a haystack.

Stay tuned for next week’s Monday Macro report!

Regards,

Angelica Lim & Joel Litman
Research Director & Chief Investment Strategist
Philippine Markets Daily
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