TUESDAY, 08 SEPTEMBER 2015

Lessons from past corrections and bear markets

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.

Key Highlights

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.

Head of Research
April Lynn Tan, CFA

Analysts
George Ching
Richard Laeda, CFA
Charles William Ang, CFA
Jed Frederick Pilarca
Garie Ouano
Meredith Hazel Cua
Angelo Lecaros
Michelle Yu

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.

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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

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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.

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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).

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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

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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.

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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.

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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.

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Exhibit 11: COLing the Shots Stock Pick List

AC
MBT
SMPH
FGEN
CEB
ALI
MEG
BDO

Price
748.5
83.35
19.06
23.4
86.1
35.8
4.18
94.4

15 FV
877
102
25.3
35.7
156
44.6
5.67
118

TUESDAY, 08 SEPTEMBER 2015

Buy Date Buy Price Current Return

8/5/2013
600
24.80%
1/23/2014 78.94
5.60%
1/23/2014 14.48
31.60%
1/20/2015
26
-10.00%
1/20/2015 86.5
-0.50%
8/1/2015
NA
NA
9/8/2015 4.18
0.00%
9/8/2015 94.4
0.00%

COLING THE SHOTS

Buy Below Price

763
89
22
31
136
38.8
4.7
102.6

Recent Low
695
75
18.1
21.3
83.95
32.5
3.76
90.9

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Investment Rating Definitions

BUY

HOLD

SELL

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.

Important Disclaimers
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.

2401-B East Tower, Philippine Stock Exchange Centre, Exchange Road, Ortigas Center, Pasig City, 1605 Philippines
Tel: +632 636-5411

TUESDAY, 08 SEPTEMBER 2015

Fax: +632 635-4632

COLING THE SHOTS

Website: http://www.colfinancial.com

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