The early Q2 signs point to a definite recovery from the measly 5.2% GDP growth in Q2. Although there are still some negative signals, on balance, the outlook looks more promising. Headline inflation should decelerate further to 1.3% in Q3 supported by weak crude oil prices and stable to lower food prices. Rice inventory is at 5-year highs. However, base effects and some early El Niño effects would likely bring up average inflation in Q4 to 2%, still at the bottom of the government's inflation target of 2-4%. The festering Greek debt crisis and corresponding Eurozone weakness highlight the steadily improving US economy. This, together with the expected rise in Fed policy rates by Q4 this year, should boost the US dollar and continue to provide a depreciation bias to the peso.
The bond markets are likely to be dull in Q3 as investors fret over the Fed rate hike and the Greek debt crisis. US long-term bond yields showed a lot of volatility in June, but with a downward bias, as money flowed from the Eurozone to the US. This trend will likely continue in Q3 but the drift would likely be soft due to the expected Fed policy rate hike by September at the earliest. US futures markets have tilted slightly in favor of a December rate hike. Domestically, liquidity remains ample despite the exit of foreign investors from the local stock market. Domestic savings driven by robust OFW remittances and BPO earnings should keep yields in check. Besides, the entry of GSIS and SSS (government sponsored pension funds) into the secondary market provides additional large demand for long-dated tenors and would also contribute to limiting upticks in the long end of the curve.
We maintain our view that market volatility will persist for the remainder of the year. We see the market getting increasingly nervous over growth, earnings, and Fed rate hike concerns. Valuations de-rated on the recent pullback but still remain rich. There could be further de-rating if Q2 2015 GDP and earnings disappoint further in the upcoming quarters. We do not see robust foreign fund inflows in the interim unless there is a strong rebound in GDP and earnings. Nevertheless, we remain positive on the market, especially on certain stocks but wait for attractive entry points. Given our view of increasing volatility and the difficulty in predicting the direction of foreign fund flows in the upcoming quarters of 2015, we prefer defensive stocks over index glamour names. We think index glamour names are still trading at rich valuations and are double edged swords as their performance tends to be driven by the flow of foreign funds. Defensive stocks with strong near re-rating catalyst could outperform.