Markets regain their footing

In our article three weeks ago, we said that "we expect the US Fed to signal the end of its tightening process soon, which will provide an impetus for a rally in emerging market stocks (Fear Overcomes Greed, June 12, 2006)."

The US Fed raised its key interest rate by another quarter of a percentage point to 5.25 percent last week. But as we have anticipated, the committee report has been toned down to suggest a considerable softening to its tightening bias.

As a result, equities markets rose sharply last Thursday. In fact, the US market was already up 0.7 percent and Europe sharply higher at 1.9 percent ahead of the Federal Open Market Committee (FOMC) statement. The US markets jumped afterwards to end up 2.2 percent. The markets may have taken the cue from surveys showing that a majority of the respondents wanted the US Fed to stop hiking interest rates, thus putting some political pressure to the wording of the FOMC statement.

Base metal prices on the London Mercantile Exchange, ahead of the FOMC, were up 4.5 percent, breaking out of the sideways range for the last two weeks. Consequently, metals and mining stocks in the US jumped 5.3 percent, leading the overall market rebound.

Meanwhile, the US dollar tumbled to a three-week low against major currencies as the immediate interest rate-driven support for the dollar has been removed. The euro stood at $1.2791 at the close of the week, the highest since June 8. Meanwhile, Japanese yen strengthened to 114.42 against the dollar, the strongest since June 12.

Philippine stocks are not to be outdone. The Philippine Stock Exchange Index (PSEi) jumped by almost 94 points or 4.5 percent on Friday alone to close at 2,179. The Philippine peso, likewise, rebounded 0.3 percent this week to close at 53.11 against the dollar.

Fed less hawkish

The key change in the FOMC statement was that the guidance on policy replaced the lead sentence "Some further policy firming may yet be needed" with "The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information." This gives rise to a less affirmative stance on additional tightening, and implies that future moves of the US Fed would be more forward looking on economic strength and inflation.

Why is this change of wording significant? Because the Fed is basically saying that it has no clue on what to do during the next Fed meeting but that their next step will depend on coming economic and inflation data. While investors had already gone and discounted an 80-percent chance of another rate hike to 5.5 percent during the Fed’s next meeting in August, the recent FOMC statement caused the market to re-think. This is exactly the reverse of what transpired on May 10 when the market was only pricing a 40-percent chance of a rate hike but then the Fed inadvertently hinted a rate hike (this June meeting) following an impromptu interview by the press.

We expect equities markets and commodities to continue to strengthen in the near term and for emerging market currencies to recover. And after significantly reducing Philequity’s equity portfolio in May, we have gradually bought back our positions during the last two weeks. We continue to be bullish on Philippine fundamentals on the back of the undistracted momentum of economic reforms and attractive corporate earnings growth. Furthermore, the sharp sell-off in equities over the past two months has brought valuations back to undemanding levels. At this point, we see the downside risks to be significantly less than the potential upside.

Philequity’s annual stockholders’ meeting

We are pleased to report that the funds under Philequity’s management continue to perform well despite the recent surge in market volatility. Our flagship Philequity Fund is up 21.3 percent year-to-date as of June 30, well above the four percent return of the benchmark PSEi and ahead of the 8.3-percent average return of other equity & balanced funds. Likewise, our Money Market Fund performed well with a 5.4-percent gain over the same period, almost double the return of other funds in the same category. Meanwhile, our Dollar Income Fund is up 1.2 percent year-to-date compared to a negative 0.2 percent return for other foreign currency denominated bond funds.

A peso invested in Philequity Fund during inception in 1994 is now worth P9.01 or a compounded annual growth rate of 20.1 percent for the past 12 years.

Lessons for uncertain & difficult times

We have seen how excessive volatility in the markets can be very brutal, especially during the last two months. Even the blue chip issues were not resilient to the downturn, falling between 15 to 30 percent from their peaks. Despite the fallback, there is one important lesson to be learned: it is during these periods that investors should seek the full benefits of diversification, professional management and immediate access to superior research & information that is available when one invests in mutual funds. Note (from the table above) that managed equity/balanced funds easily beat a passive strategy of investing in the benchmark PSEi. And while our aim for this column is to educate and provide investors with the proper tools for successful investing, one can easily see the benefits of letting a fund manager handle the job for you. Indeed, investing in mutual funds can be a powerful tool during these uncertain and difficult times. And the good thing is that it is readily available to every investor.

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