Emerging Markets Analysis – Friday, May 13, 2016

Country Focus: Philippines


This emerging markets analysis examines the recent performance of Philippine equities and its outlook, with an emphasis on sector analysis, and provides some thoughts on stock selection from the perspective of an analyst/trader that utilizes fundamental, technical, quantitative, and intermarket analyses. Lastly, a Philippine Sector Dashboard is provided.

Philippine Presidential Election Results

After much anticipation, the Philippine presidential elections completed relatively smoothly. To be sure, reports of vote buying and voting equipment not working at some stations came in, but absent was Wild West, nation-wide violence that seems to mar some developing country democratic elections. By all accounts, Rodrigo Duterte, the seven-term mayor of Davao City (fourth most populace city in the Philippines), will be the 16th president-elect of the Republic of the Philippines. Running on a platform of zero tolerance, anti-corruption and anti-crime, Duterte, nicknamed “Digong”, “Duterte Harry”, and “The Punisher”, has vowed to eliminate drug traffickers, criminals, gang members and other perceived “lawless elements”. While crime reduction is always a positive, the former lawyer’s plans for the economy, fiscal policy, monetary policy, trade policy, diplomatic policy, and geopolitical policy are among the list of items that investors will be most focused on.

PSEi: Up, Up and Away!

As discussed previously, the blue-chip PSEi has formed a flag-pattern starting in March, trading in a band between 7376 and 7160 (Chart 2). As a continuing indicator, the flag suggests the PSEi would likely run to about 8600-8700 before the first significant correction. On May 11, two days after the election, price penetrated the upper resistance zone on the highest daily volume in over eight months to close at 7396 (also, an eight-month high), then fell back to 7325 on lighter volume the next day, only to jump to 7493 on May 13. If the flag/bullish trend-pattern setup holds up, price should continue its ascent, perhaps, re-testing the 7370-7380 former resistance (now support) level again, with an initial target of 7500 and a secondary target of 8000, once the 7910 May-18 2015 swing-high is taken out. Ultimately, an intermediate high of 8600-8700 would be expected, before a significant correction. Penetration of a significant swing-low would nullify the bullish trend…of course, a trailing stop loss at just below the significant swing-low would provide protection in the worst case. Unfortunately, no direct method of trading the PSEi exists, unless someone wants to buy or sell a free float market capitalization-weighted number of shares of the 30 stocks in the PSEi, cumbersome and costly (In Feb 2015, the Singapore Exchange (SGX) launched the SGX-PSE MSCI Index Futures, a USD-denominated contract which tracks the MSCI Philippines Index that includes 22 constituents representing roughly 85% of the PSE market cap). Luckily, there’s another way.

Sector Analysis and Sector Rotation Model

20160513 Chart 3
Chart 3. Sector Rotation Model. Source: John Murphy, Trading with Intermarket Analysis.

Normally, sector analysis provides a methodology to identify turns in the four-to-five year economic cycle, generally three to six months ex ante.  As a leading indicator, stocks tend to bottom and turn upwards while the economy is still struggling (and bonds usually turn several months ahead of stocks). By the time the economy enters recovery mode,  the general stock market is already racing northwards. In the sector rotation model in Chart 3, the stock market is represented by the red line, while the economy by the green line. Cyclical stocks, highly sensitive to  the economy, such as consumer discretionary and transportation shares, typically lead the recovery. This author likes to monitor selling volume of corrugated boxes (paper industry) to gauge when business activity is about to pickup (boxes are needed before any final products are actually sold and boxes for tools and heavy equipment often go first). Eventually, factories begin to turn out finished products that increases demand for intermediate goods, basic materials, and energy. However, as written ad nauseam in previous reports, continuous central bank intervention over the last decade has distorted the capital investment and business decision-making process to create a new normal environment. Nevertheless, sector rotation still does occur, but not necessarily in the neat order depicted in Chart 3.

Philippine Cyclicals Lead the Way

Difficult to tell, but cyclical stocks bottomed at the end of August (green circle in Chart 4), five months ahead of all other sectors, with the exception of utilities. Interestingly, the PSEi, property, services, industrials, mining, energy, and holding firms all reached their lows on Jan 21 (financials bottomed ten days earlier). Defensive utilities was the last sector to trough on Mar 9. As examined in a prior report (Emerging Market Analysis for April 28 2016), mining stocks (+31%) have put in a stellar performance, along with holding firms (+32%), property (+29%), and energy shares (+29%) over the last 16 weeks. In the 4-week lead up to the May 9 presidential elections, holding firms, property developers, miners, energy cos, and financials institutions bumped up 2-4% as a Duterte win seemed more probable. As several news outlets have reported, President-elect Duterte would likely entertain investments from China to help build up infrastructure. Again, stocks are the ultimate leading indicator and appear to be shouting that a construction boom is at hand.

Picking the Winners

Once desired sectors are identified, the next step is to select stocks to be added to your watchlist. As an aside, not all stocks are included, for obvious reasons, in a given sector index. Thus, often, small and medium-sized high beta stocks, not included in an index, could turn out to be multiple-baggers, high returners (5x or even 10x, to borrow a baseball analogy from Peter Lynch, the legendary manager of Fidelity’s Magellan Fund).

For each stock the fundamentals should be examined to avoid any potential landmines (senior management problems, multiple consecutive quarters of diminishing sales, declining capex to boost earnings, new reporting methodologies (especially, pertaining to revenues and inventory), new entrants and disruptive technologies, regulatory changes, supply chain problems, trade restrictions, auditor concerns, and foreign exchange rate impact, to name a few). After weeding-out the dogs, an investment/trading strategy and set-up needs to be executed that includes trade signal, confirmation, trade trigger, initial stop loss and trailing stop loss strategy, position sizing, money/risk management, exit strategy, and portfolio management (all of which, of course, is written down in your investment/trading plan and kept on your desk). Obviously, this author does not subscribe to a long-term buy-and-hope strategy, preferring a three-month to twelve-month investment horizon employing a strict, disciplined, and replicable rules-based investment/trading strategy with a library of bullish, bearish, and swing trading set-ups (and a handful of short-term quantitative momentum set-ups).

Very importantly, should new information counter the original premise for a given trade, it is imperative that risk be reduced by either exiting the trade completely (preferable for most) or partially exiting open positions and narrowing trailing stop loss orders. Also, position sizing may be the most critical feature of a well-honed trading plan – keeping loss-exposure of individual trades to 0.5%-2% of trading capital significantly reduces probability of catastrophic blow-ups (low maximum draw down), enabling you to remain in the game (all of which requires sufficient amount of initial trading capital). Finally, do not rely on specific recommendations without doing a proper investigation as risk appetite, investment horizons, and investment goals vary. Good skill!

Philippine Sector Dashboard

Property Sector

Cyclicals Sector

Services Sector

Industrials Sector

Mining Sector

Energy Sector

Utilities Sector

Financials Sector

Holding Firms Sector