By Patturaja Murugaboopathy and Gaurav Dogra
(Reuters) - A weakening currency and rising inflation rate have made the Philippine equity market Asia's worst performer so far this year, and a rash of downgrades in earnings forecasts could prolong that underperformance.
Philippine stocks (PSI) hit a record high in January, extending 2017's 25 percent rise on the back of optimism over the government's tax reform and infrastructure spending plans.
But the rise in capital imports due to infrastructure investment has also seen the country's trade deficit widen and put pressure on the peso.
Since the start of February, Philippine shares have dropped 9 percent, making them the worst performer in Asia after Hong Kong and China.
In dollar terms, the stock market is down 10 percent this year and is one of Asia's worst performers. Foreign institutions and hedge funds have been withdrawing money from the local stock markets.
"The depreciation of the peso against the dollar is one of the major factors which dragged down sentiment in the market," said Manny Cruz, an analyst with Asiasec Equities Inc in the Philippines.
The peso is also Asia's worst performer, having declined more than 4 percent against the dollar this year.
Historically, the fall in the peso has affected corporate earnings as it tends to put pressure on input costs and lower profit margins, analysts said.
Change in peso and earnings - https://reut.rs/2q4m6VT
The country's widening trade deficit is likely to undermine the peso further.
The trade deficit expanded to $3.32 billion in January from a gap of $2.47 billion a year ago, spurred by a sustained surge in the imports of construction materials and capital goods.
Also, rising inflation rates could dampen consumer demand and increase raw material costs.
Data showed inflation quickened to 3.9 percent in February, the fastest pace in more than three years under a revised price index.
"We expect that 1Q-2018 earnings may disappoint as both revenues and margins could be impacted by rising inflation," Nomura said in a report.
Philippines inflation - https://reut.rs/2J29yq8
Taking these concerns into account, analysts have slashed their 2018 earnings forecasts by 2.3 percent over the past three months - the biggest cut in Asia after India.
Asia earnings revision - https://reut.rs/2ElvAAj
Philippine shares' lofty valuations are also not helping them either. Thomson Reuters data showed the forward 12-month price-to-earnings ratio was 19.3 at the end of March, compared with a 10-year average of 16.3.
Philippine valuation - https://reut.rs/2GfWgnY
Foreigners have turned net sellers this year, offloading over $600 million Philippine equities after purchasing more than $1 billion in 2017.
Foreign flows into Philippine equities - https://reut.rs/2uNrOAr
Mark Baker, a fixed income portfolio manager at Aberdeen Standard Investments in Hong Kong, said he is pretty cautious on the Philippine market and needs to see the central bank (BSP) turn decisively hawkish and deliver rate rises.
"Domestic yields have gone up a lot in the last six months, so we aren't that far away from good entry levels on the rates side. On the currency, we think we do need that more forceful BSP action to come through before the peso can be considered a potential outperformer," he said.
Nomura analysts say they believe higher capital imports will improve the long-term productive capacity of the economy, unlike those that are used to finance more consumption imports.
"I still feel that Philippine stocks are worth looking at, considering the fundamentals of the economy remain intact. It will continue to post one of the highest GDP (growth) in the region this year," said Asiasec Equities's Cruz.
"We still feel the market will be able to surpass its all-time high. If not this year... next year."