pse model portfolio

Lessons from past corrections and bear markets

After studying the characteristics of two previous bear markets and three major corrections that took place in the Philippines, we have two major insights, namely This is just a major correction, not a bear market and There is a good chance that we have already seen the low.

When the Philippines suffered from the Asian Financial Crisis in 1997, the Philippine economy was clearly overheating as evidenced by inflated asset prices, high borrowing levels, and abundance of foreign debts. None of those problems are present today.

Admittedly, the Philippines also did not have economic problems in 2007, when the Global Financial Crisis hit. Nevertheless, the Philippines also suffered from a bear market during that time as problems in the U.S. spilled over to the rest of the world. However, we dont think that problems resulting from a slowdown in the Chinese economy would spill over to the rest of the world given that China is not dependent on foreign debts, and that the Chinese government is strong enough to absorb losses from potential loan defaults and a weaker economy.

We believe there is a strong likelihood that we have already seen the worst. Based on the past three major corrections that took place, the size of the markets drop from its peak to low ranged from 15.5% to 24.9%. It also took the market two to four months to correct from peak to low. Right now, the PSEi has already corrected by 18.8% from its April peak of 8,137 to its August low of 6,603. It has also been five months since the PSEi started to correct.

Last month, we said to raise some cash by selling on rallies. After doing a careful study of current market conditions, we think that now would be a good time to start deploying that cash. In accumulating stocks, remember to choose quality names, to space your orders over a span of six months (or practice peso cost averaging), and to determine an entry price that will allow you to capitalize on downward swings in the market. In case you are still fully invested right now, you can choose to just stay invested. After all, there is a strong likelihood that we have already seen the low. One change that you may consider doing is switching to larger capitalized actively traded issues as these issues are expected to lead the markets eventual recovery.

Last month, we said that the ongoing market sell-off will create the opportunity to buy quality stocks that normally trade at expensive valuations. After reviewing our stock picks and the list of stocks that our research team covers, we have decided to remove FLI and add MEG and BDO to our COLing the Shots stock picks list. While there is nothing wrong with FLI, we believe that professional fund managers would find MEG and BDO more attractive because of their size and liquidity.

Key Highlights

COLing the Shots is a monthly publication by COL which provides insights on investment opportunities based on global and local developments that could affect the market. COLing the Shots aims to provide timely and relevant information and analysis as well as a model portfolio for successful investing.

Head of ResearchApri l Lynn Tan, CFA

AnalystsGeorge Ching

Richard Laeda, CFACharles Wi l l iam Ang, CFA

Jed Freder ick Pi larcaGarie Ouano

Meredi th Hazel CuaAngelo Lecaros

Michel le Yu

TUESDAY, 08 SEPTEMBER 2015

TUESDAY, 08 SEPTEMBER 2015 page 2COLING THE SHOTS

How deep and how long?

Being an investor myself, I believe that the most pressing questions in investors minds right now are the following:

Is this the beginning of a bear market or just a major correction? How long do bear markets and major corrections last? Have we seen the worst?

The best way to answer these questions is by studying the characteristics of past bear markets and major corrections. Recently, we studied the characteristics of two previous bear markets (the Asian Financial Crisis and the Global Financial Crisis) and three major corrections (the two 2011 corrections and the 2013 taper tantrum) that took place in the Philippines. Based on our studies, we have two major insights.

1. What we are seeing today is just a major correction, not a bear market.

In 1997, the Philippines suffered from the Asian Financial Crisis. During that time, the Philippine economy was clearly overheating. Asset prices were inflated (property and stock prices) and debt levels were high. In 1996 for example, the PSEi was trading at more than 21X P/E. At that time, it was also normal for banks to have a loans to deposit ratio of 120%. What made matters worse was the popularity of borrowing in US dollars since the peso dollar exchange rate was relatively steady at US$1.00:Php25.00 to US$1.00:Php26.30 starting 1995, thanks to the abundance of hot money from abroad that bought Asian assets to earn higher yields. Interest rates on US dollar loans were also much lower compared to peso loans. Numerous borrowers also used the funds to buy properties as they showed significant price appreciation.

Exhibit 1: Peso Dollar Exchange Rate (1995-1996)

Source: Bloomberg

Consequently, when the U.S. Fed started raising interest rates, hot money flowed out of Asia back to the U.S. This led to the significant depreciation of Asian currencies including the peso. As a result, the peso value of US dollar debts ballooned, while property prices fell, leading to a significant increase in loan defaults. The BSP also had to increase interest rates significantly to stem the depreciation of the peso.


Today, there are no signs of out of control asset inflation. Inflation rate in the Philippines for example remains low at only 0.8%. Moreover, although the PSEi is trading at around 18X 2016E P/E, interest rates are much lower today, with the 10-year bond rate at around 4.5% vs. 16.0% in 1996. Finally, although property prices have been increasing since 2003, land value in the Makati central business district (CBD) is only slightly higher than its 1997 peak level, while land value in the Ortigas CBD is still lower than its 1997 peak.

Exhibit 2: Manila CBD Land Values

Source: Colliers International Philippine Research

Debt levels are also highly manageable, with banks loans to deposit ratio at only 65.9% and listed companies median net debt/equity ratio at only 0.28X.

Finally, Filipinos no longer borrow in U.S. dollars since the cost of borrowing in pesos is also very low (note that top corporates are currently able to borrow at only 3.0%). The Philippines is also no longer heavily dependent on hot money for dollars. This is evidenced by the countrys strong current account surplus which is being driven by resilient OFW remittances and the growing BPO sector. This makes the Philippines less vulnerable to a sharp depreciation of the peso brought about by fund outflows. The BSP is also less likely to increase interest rates to prevent the peso from depreciating sharply.

Exhibit 3: Philippines Current Account Position

Source: BSP, Bloomberg


Admittedly, the Philippines also did not have economic problems in 2007, when the Global Financial Crisis hit. Nevertheless, the Philippines also suffered from a bear market during that time as problems in the U.S. spilled over to the rest of the world. Concerns that problems resulting from a slowdown in the Chinese economy would spill over to the rest of the world is the most likely reason why we are seeing a sell-off in global stock markets today.

Exhibit 4: China GDP Growth

Source: Bloomberg

Exhibit 5: China Debt/GDP

Source: McKinsey & Co.

Although concerns that China would suffer from a massive default given inflated property prices, high debt levels and slowing economic growth are valid, the main difference between China today and the U.S. in 2007 is that China is not dependent on foreign borrowings. Note that a lot of the sub-prime loans that defaulted in the U.S. during the global financial crisis were financed by foreign lenders as evidenced by the U.S.s very high level of current account deficit (6% of GDP in 2007). In fact, there were banks in the Philippines, and corporates and individuals, who owned U.S. dollar bonds that were in one way or another linked to sub-prime loans.


In contrast, China is a net lender to the world. This is evidenced by its very healthy current account surplus equivalent to 2.8% of GDP.

Exhibit 6: China Current Account Position

Source: Bloomberg

The Chinese government also has a very strong balance sheet, with Chinas debt/GDP ratio at only 41.1%, even lower than that of the Philippines (45%) and the average of developed economies (101%). This means that the government can easily absorb potential losses from loan defaults if required.

Due to the said factors, we think there is a small likelihood that problems in China would spill over to the rest of the world, similar to the Global Financial Crisis in 2007.

Exhibit 7: Comparison of Past Bear Markets (Philippines)

There will be major losers though of a weak Chinese economy. These include exporters (assuming that China continues to devalue the yuan), mining and gaming companies (as less demand for minerals lead to lower mineral prices and as the weaker yuan result to a drop in the number of mainland Chinese tourists).


Nevertheless, the impact on the whole Philippine economy is expected to be limited. Unlike our South East Asian neighbors, our economy is not really dependent on the exports of goods, especially of mining and petroleum products.

Exhibit 8: Mining and Petroleum Exports (% of TIPs GDP)

Source: Bank of Thailand, Bank of Indonesia, NSO, NSCB

2. There is a good chance that we have already seen the bottom.

Moving on to the second and third questions which are how long do major corrections and bear markets last? and have we seen the worst? we believe that there is a strong likelihood that we have already seen the worst.

Based on the past three major corrections that took place, the size of the markets drop from its peak to low ranged from 15.5% to 24.9%. It also took the market two to four months to correct from peak to low.

Right now, the PSEi has already corrected by 18.8% from its April peak of 8,137 to its August low of 6,603. It has also been five months since the PSEi started to correct.

Exhibit 9: Depth and Duration of Past Three Major Corrections


6,600 is also a good level fundamentally and technically speaking. In our COLing the Shots report last month, we said that levels close to 6,500 would be a good area to start accumulating. At 6,500, the PSEi would be trading close to 16X 2016E P/E, which is the PSEis average P/E during the past 10 years. 6,500 is also the next level of support using technical analysis based on a slower rising channel. Assuming that market conditions normalize, we have a high level of conviction that the PSEi will trade above 6,500, providing patient long term investors with an attractive capital appreciation potential.

Admittedly, markets remain volatile and we still need to see the local economy and listed companies deliver above expected numbers for the market to go up in a convincing way. However, we believe that it is not a question of if but rather when the market will recover. As such, we believe that now would be a good time to start accumulating stocks.

Assuming though that we are wrong, and the Philippine market does go into a bear market, I dont think we will see a repeat of the Asian Financial Crisis where it took the market a total or 56 months or almost five years to hit bottom. As discussed earlier, the main reason why the Philippine market is falling today is contagion. In 2007, the bear market was also caused by contagion, and it only took 12 months to hit bottom. If ever we do go into a bear market, I dont think we will take longer than a year to hit bottom. Moreover, investors who had bravely bought during the 2007 bear market are the major winners today as the PSEi is currently more than 4X its 2008 low of 1,700!

Exhibit 10: Depth and Duration of Past Two Bear Markets

A game plan for accumulating stocks

Last month, we advised investors to raise some cash by selling on rallies. After doing a careful study of current market conditions, we think that now would be a good time to start deploying that cash.

Here are some tips that you can use when accumulating stocks during the next few months

1. Choose quality stocks to buy

As we have discussed in our COLing the Shots report last month, when buying stocks given the current market condition, focus on quality stocks that are larger in size and are more actively traded. Since these are the stocks that professional fund managers normally buy, we expect these blue chip stocks to go up first when the PSEi recovers. In the later part of the report, we have our COLing the Shots stock pick list, which is a list of stocks that we think will be among the first to go up when the market recovers. You may also choose to buy equity funds instead, especially if you only have a small investment portfolio which makes it difficult to diversify. COL now carries major funds managed by the largest asset management companies in its online platform under the COL Fund Source brand.


2. Space your orders over a span of six months

As we have mentioned earlier, the market will most likely stay volatile in the next few months. Consequently, it would be best to space your orders over a span of six months. That way, if the market continues to fall, you will be able to improve your buying price and increase your long term capital appreciation potential.

3. Determine your entry price

Given our expectation that the market will remain volatile, investors will have the opportunity to buy cheap. As a result, you can place your buy orders at lower prices. This could be based on COLs buy below price or close to the stocks recent low. For example, if you were to buy the PSEi which hit a low of 6,600, you could place an order to buy the index at any level below 6,900 which is around 5% away from the low. To help those who would like to determine a possible entry price for our COLing the Shots stock picks based on the said stocks previous low, we will be adding another column to our COLing the Shots stock picks table later showing our stock picks most recent low.

Since it would be difficult to continuously monitor the market, you may want to enter a GTC or Good Till Cancelled order. Since it is already pre-programmed, a GTC order will allow you to buy the stock that you like once it hits your desired buying price even without you being physically present to enter the order.

In case you are still fully invested right now, you can choose to just stay invested. After all, there is a strong likelihood that we have already seen the low. One change that you may consider doing is switching to larger capitalized actively traded issues as these issues are expected to lead the markets eventual recovery.

COLing the Shots stock picks Removing FLI, adding MEG and BDO

Last month, we said that one of the opportunities that will be created by the ongoing market sell-off is the opportunity to buy quality stocks that normally trade at expensive valuations when the market is not correcting. After reviewing our stock picks and the list of stocks that our research team covers, we have decided to remove FLI and add MEG and BDO to our COLing the Shots stock picks list. While there is nothing wrong with FLI, we believe that professional fund managers would find MEG and BDO more attractive because of their size and liquidity.

MEG has been one of the major underperformers of the stock market in 2015, falling by 9.8% vs. 3.8% for the PSEi. We believe that the sell-off of MEG was triggered by the companys disclosure of weaker than expected first quarter earnings. We also didnt like MEGs first quarter earnings results because of 1. ) The lack of growth in residential revenues from the Megaworld brand on a standalone basis; and 2.) The unexplained increase in operating expenses.


Nevertheless, the steep drop in MEGs share price is over done in our opinion. MEG already disclosed better than expected second quarter earnings results last month, thanks to strong rental income and lower operating expenses during the quarter. Moreover, at its current price of Php4.18/sh, MEG is trading at a steep 44% discount to NAV and only 13.5X FY15 P/E, less than half ALI current FY15E P/E of 29.9X. This is despite that fact that MEG is slowly growing its more defensive rental income portfolio which should strengthen the companys ability to withstand economic downturns going forward. In fact, MEG has the landbank and the capacity to execute its plan to almost double its office leasing portfolio in five years from 621,000 sqm as of end 2014 to 1,173,000 sqm by end 2019. EBIT from rental income and hotels already account for 44% of EBIT. We recommend accumulating MEG at prices below Php4.70/sh.

Banking stocks have also significantly underperformed the market in 2015, with the financials index falling by 10.8% vs. 3.8% for the PSEi. Several factors have led to the underperformance of banking stocks including 1.) Concerns of slower loan growth; 2.) Continuous declines in net interest margins; and 3.) Concerns that banks trading and lending portfolios would be significantly affected assuming that a contagion similar to the global financial crisis takes place.

However, we believe that concerns are overblown. Although lending growth has slowed to 16% in 1Q15 and 14.5% 2Q15 from 20% in 2014, we believe that current growth numbers are still healthy. Net interest margins have likewise recovered to 3.1% during the second quarter after falling to 3.0% during the first quarter from 3.2% in 2015.

We also dont expect loan growth to collapse over the longer term. In our strategy presentation entitled Shifting Gears, we shared our positive view on the sustainability of investment spending in the country and the growing number of PPP projects that will be awarded in the future. These in turn should continue to fuel demand for loans.

Finally, we discussed earlier on that we dont expect the ongoing problems in China to spillover the rest of the world similar to the global financial crisis. As such, we dont expect banks to suffer from significant losses in their trading and lending portfolios.

As a result, we believe now would be a good time to start accumulating shares of BDO after the stock has fallen by 24% in price from its peak in March. At Php94.40/sh, BDO is trading at only 1.7X 2015E P/BV, in line with its historical average during the past 10 years despite the improvement in its ROE. BDO has also consistently generated above average profitability among banks in our coverage list, posting an ROE of 13.5% in 2015. Bulk of BDOs revenues also comes from recurring sources such as lending and fees (not trading) making them more stable.

One of the risks that we see as far as BDO is concerned is a potential rights offering in 2016 as BDOs CET1 and total capital adequacy are already at 11.5% and 13.6% respectively, which are only slightly above the minimum requirements of 8.5% (11% estimated once DSIB is implemented) and 10% under Basel III. However, as with MBT in 2014, any weakness in share price brought about by concerns of potential rights offerings is expected to only be temporary. We recommend accumulating BDO at prices below Php102/sh.


Exhibit 11: COLing the Shots Stock Pick List

Price 15 FV Buy Date Buy Price Current Return Buy Below Price Recent LowAC 748.5 877 8/5/2013 600 24.80% 763 695MBT 83.35 102 1/23/2014 78.94 5.60% 89 75SMPH 19.06 25.3 1/23/2014 14.48 31.60% 22 18.1FGEN 23.4 35.7 1/20/2015 26 -10.00% 31 21.3CEB 86.1 156 1/20/2015 86.5 -0.50% 136 83.95ALI 35.8 44.6 8/1/2015 NA NA 38.8 32.5MEG 4.18 5.67 9/8/2015 4.18 0.00% 4.7 3.76BDO 94.4 118 9/8/2015 94.4 0.00% 102.6 90.9


Investment Rating Definitions

Stocks that have a BUY rating have attractive fundamentals and valuations, based on our analysis. We expect the share price

to outperform the market in the next six to twelve months.

Stocks that have a HOLD rating have either 1.) attractive fundamentals but expensive

valuations; 2.) attractive valuations but near term earnings outlook might be poor or vulnerable to numerous risks. Given the

said factors, the share price of the stock may perform merely inline or underperform the market in the next six to twelve months.

We dislike both the valuations and fundamentals of stocks with a SELL rating.

We expect the share price to underperform in the next six to twelve months.

Securities recommended, offered or sold by COL Financial Group, Inc.are subject to investment risks, including the possible loss of the principal amount invested. Although information has been obtained from and is based upon sources we believe to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute the judgment of COLs Equity Research Department as of the date of the report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a security. COL Financial ans/or its employees not involved in the preparation of this report may have investments in securities or derivatives of securities of securities of the companies mentioned in this report, and may trade them in ways different from those discussed in this report.

Important Disclaimers

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