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Investment e.Perspective

Current Issue | April 27, 2017

Election Angst: Lessons from the Philippines

By: Brendan O'Sullivan-Hale, MBA, CFA, Senior Investment Strategist & Oxford Investment Fellow


The market reaction to Donald Trump's surprise presidential win has been swift and varied. The American stock exchanges are upbeat – with the Dow, NASDAQ, and the Russell 2000 index of small cap stocks all reaching a record high on the same day – an incident that last occurred near the peak of the tech bubble. Financials and industrials have led the way in anticipation of less regulation and more infrastructure spending. There is general exuberance about the prospect of lower personal and corporate income taxes, and maybe, just maybe, some glimmer of hope that business-friendly policies will give a boost to the steady but frustratingly slow growth of the last eight years.

Perhaps, but other parts of the market are more circumspect. Within health care, even as pharmaceutical stocks have soared, hospitals have sold off on the prospect that repeal or revision of Obamacare will mean they will soon be treating more uninsured patients. The FANG stocks, last year's darlings, have flatlined because the efficient content delivery on which parts of their businesses depend are threatened by an administration hostile to the concept of net neutrality. Wal-Mart's initial surge has evaporated as investors contemplate what protectionist trade policies might mean for its global supply chain. Emerging markets, the most critical links in that supply chain have experienced significant declines.

It is not worth wasting much digital ink on two weeks in the market as being particularly meaningful – after all, during the two weeks following President Obama's election in 2008, the S&P 500 fell 11%. Over the course of his presidency, it has risen 206%. If anything consequential has actually appeared in recent market activity, it's more likely to be found in the bond market, where there are signals that we might at last be at the beginning of the end of the era of ultra-low interest rates, at least in the United States.

I could be wrong – remember 2013's short-lived "Taper Tantrum?" But there are at least two things that make this time different. First, the last time rates rose like this, in the spring and early summer of 2013, inflation expectations were actually declining. This time, they're on the rise. Second, in 2013, the White House and Congress were at odds on nearly anything having to do with budgetary matters, making any fiscal boost from government spending all but impossible. While Trump's policy agenda is yet unclear, his promises of tax cuts and infrastructure spending are inflationary, and he has a Congress likely to be cooperative on economic matters. The bond market is responding in kind.

That will probably mean some modest declines in the values of bond portfolios in the months ahead, but investors should keep them in perspective. Bonds' income stream helps them to heal themselves from market declines over a relatively short span of time, and higher yields mean that as shorter maturities within bond portfolios roll off, cash is available to reinvest at the new prevailing rate. Higher rates may also lead to a more rational pricing of risk in stocks and credit markets as income-oriented investors finally find low-risk alternatives with reasonable yields. All else equal, higher rates are ultimately a good thing.

Of course, all else is not equal. In late September, in the service of Oxford's initiative to identify undiscovered opportunities in overlooked markets, I visited another country with a president notorious for his brash style and unfiltered rhetoric. Philippine President Rodrigo Duterte's post-election stock market bounce lasted not quite three months. But, showing how ephemeral a politics-led rally can be, it plateaued and ultimately disappeared as US rates moved higher, beginning in July and accelerating in October and November. I'll return to Duterte and interest rates in a moment.

In some respects, what happens in the United States does not affect the economy of the Philippines very much. While the two countries have had a long relationship – beginning with colonialism following the Spanish-American War, eventually transforming into a longstanding post-war security partnership, our economy and theirs have little to do with each other. The Philippines is unusual among other emerging and frontier markets peers in that it lacks significant natural resources or export-oriented manufacturing.

Rather, the archipelago exports its largely English-speaking, reasonably well-educated labor force. Nearly 10% of the country's population works overseas, in settings from construction sites to nursing homes to cruise ships. Those workers send money back. It's rare in my profession that one gets to see global capital move in any form besides electronic blips, but when I was in Hong Kong the following Saturday morning, I saw the remittances in action as hundreds of young housekeepers thronged the downtown branch of the Bank of the Philippine Islands, each sending small handfuls of Hong Kong dollars home.

Figure 1 "Experience the level-up!" Consumers are encouraged to climb the economic ladder in a Manila supermarket.

The result is that though the country is relatively poor, a great many families have a secondary income stream that permits them some disposable income. Thus the Philippines economy is dominated by household consumption, and for our purposes as investors, the investable universe includes the stocks of companies with an incredibly sophisticated approach to the consumer market for a country of this income level.

For instance, owing to the widespread lack of refrigeration, canned meat and fish are a major grocery category. The dominant manufacturer in this space has literally dozens of sub-brands. These start with cans of sardines targeted at families who might share a single can over dinner, all the way up to the premium product – canned tuna - targeted at the young man who finally has a job that may not afford him a refrigerator, but does allow him a gym membership. Between these two poles are many ranks of products that reflect different rungs of the economic ladder, with price difference that vary by as little as 2.5 US cents from rung to rung. Marketers see it as their job to help consumers see where they are on the economic ladder, and encourage them to "experience the level-up" accordingly. This dynamic plays out in everything from powdered milk to spaghetti to housing.

Figure 2 Canned tuna is positioned as a premium product in an ad campaign featuring a local celebrity.

The pinnacle of the housing ladder, of course, is represented by the Trump Tower at Century City, a project currently under construction in Makati, one of Manila's high-end neighborhoods. President Duterte's rhetoric toward the United States has been undisguisedly hostile – while I was there he announced that "I am about to cross the Rubicon between me and the US," as he was making moves to shift away from the long alliance with the US toward Russia and China instead. In a fascinating overture, President Duterte has just appointed Jose E.B. Antonio, the builder of the Trump Tower in Manila, as the Philippines trade representative to the United States.

Time will tell how that plays out, but I'll return now to what the impacts of Trump's election are more immediately. The rise in US interest rates is a near-term negative for the Philippines and most if not all other emerging markets. Higher rates make dollar-denominated assets more attractive, causing currency depreciation in anticipation of foreign capital draining from the country. For some countries this is a significant negative – Brazil and Turkey, which have suffered from chronic inflation problems, stand out as examples. For a country like the Philippines, the impacts are likely to be more passing. A reduced value of the Philippines peso will be inflationary, but the flow of hard currency remittances into the country acts as a shock absorber that makes the economy more resilient and interesting for investors.

For the Philippines and other countries in its region, Trump's policies may accelerate the ascendancy of China as a regional political power. If we take Trump's pledge to scrap the Trans Pacific Partnership (TPP) at face value, there is a backup trade deal, the Free Trade Area of the Asia-Pacific (FTAAP). That deal is backed by China, which was excluded from the TPP, and includes most of the countries covered by the TPP, but not the United States. The US will still be important in the region, but the balance of power will shift.

To a certain extent, for a country like the Philippines, this pivot makes sense anyway. Including Hong Kong, China is about twice as large a trading partner as the US. Manila is a short two-hour flight from China’s prosperous Pearl River Delta Megaregion, home of Hong Kong, Shenzhen, Guangzhou, and some 60 million people. Chinese tourism to the archipelago is booming, especially to Manila’s glitzy casinos, which have become more attractive as Xi Jinping’s anti-corruption drive has made gambling in Macau risky for anyone connected to the government. US protectionism or isolationism encourages an economic partnership that has been deepening since well before Trump’s election.

At this writing we are just two weeks past the election of a candidate whose campaign was short on specifics, so any projections are in some measure speculation. As usual, it is appropriate for investors to be attentive but not to overreact. The shifts that are underway will present risks and opportunities in nearly every asset class and we will be alert as they arise. Meantime, investors should remain committed to their long-term discipline and avoid erratic moves. As always, any of my Oxford colleagues and I would be pleased to speak with you personally.

The above commentary represents the opinions of the author as of 12.06.16 and is subject to change at any time due to market or economic conditions or other factors.