PSEi: Quo Vadis?

Okay, so here's what I have been constantly talking about this past month. No, it does not involve a newfangled way of using technical analysis, or any kind of investment analysis tool for that matter. What it is is an observation of how the local stock market, as measured by the PSEi, has been behaving these past few months, and how this observation, coupled with reasoning, a few suppositions, and a couple of guesses, leads to some sort of an investment strategy.

Image from Bloomberg.com

These colored, squiggly lines are the line graphs of four stock indices in the past six months. These four indices are:

• Philippine Stock Exchange Index or PSEi (PCOMP:IND) - YELLOW
• S&P 500 Index for the New York Stock Exchange (SPX:IND) - GREEN
• Hang Seng Index for the Hong Kong Stock Exchange (HSI:IND) - ORANGE
• FTSE 100 Index for the London Stock Exchange (UKX:IND) - RED

The vertical axis measures the percent change in the indices, which can also be interpreted as the percentage return of an investment made in these indices six months ago.

Two things you might notice from the graph at first glance:

1. Investing in the S&P 500, Hang Seng Index, and FTSE 100 indices six months ago would have left you a few percentage points poorer, while an investment in the PSEi would have resulted in a 13% gain in the same time frame.
2. Up until early May, the four indices have been generally moving in the same direction.

This divergence in trend of the PSEi is odd because the Philippine economy has traditionally been highly coupled with or dependent on the US economy: local imports continue to be heavily dependent on US demand, and the general economy on US direct investments and other forms of capital inflow. This significant, albeit short term, departure from long-term trends may mean any or all of the following things:

1. The beginning of the divergence almost perfectly coincides with the 2010 presidential elections, which suggests that it has a lot to do with the confidence of the nation and the rest of the world in the new Aquino government.
2. The Philippine economy is starting to have stronger economic fundamentals.
3. The Philippine economy is starting to depend less on the US and other developed economies.
4. Foreign investors are fleeing developed markets and heading towards more underdeveloped markets like ours.

I think most of us would agree with the veracity of the above reasons, to varying degrees. But it does not mean the trend will continue and we should invest in the local stock market now.

Based on several accounts, the worst is far from over for the US stock market: many economists and analysts still believe that we have not seen rock bottom yet, and that the US economy still has not fully recovered from the 2008 financial crisis. So, if we assume that the US economy will continue its downward spiral, does it make sense to believe that the local bourse will continue its current upward trend as well?

Here is where my suppositions and conjectures enter the picture. At the heart of it, we all know that we're still not completely independent of the US economy and its inputs to ours; this means the moment US stock markets enter deep bear territory, the local stock market is sure to follow. Also, deep inside we know that local stock prices cannot indefinitely continue to pursue its rebellious upward course, farther and farther away from US stocks which are going in the opposite direction. Finally, while I share the same confidence and optimism most of our countrymen feel about this new government, I'm still not convinced that it will be able to successfully shake things up in a short period of time. According to this article, while it is generally acknowledged that the new administration will not drive significant reforms and policy direction, the removal of political uncertainty has become enough reason to boost the performance of the stock market. Which means this run is driven less by fundamentals and more by the irrational exuberance of investors. Which means what we have here is just another bubble that's bound to burst in our faces any time now.

I'm not saying the PSEi will stop rising, far from it. In fact, because of articles like this, I'm betting that investors will become even more exuberant and perhaps drive the PSEi to its pre-crisis high of 3,800+. What I'm saying is that once it reaches this mark, it's not going to go anywhere but down. So be ready to sell your shares then. Of course, it could always turn out that I'll lose my bet and eat my words.

But seriously, be very very mindful of what's happening in the US: no matter what other people say, no matter how confident investors around you seem, we simply cannot completely isolate ourselves from what's happening down there. Just please remember that.