The Global Market Overview

Asia ex-Japan stock markets rose in April on a renewed pledge by the Federal Reserve Board to keep US interest rates low. Sentiment also benefited from pleasant surprises among US quarterly results. In Asia, however, concerns emerged about a first-quarter squeeze on company margins.

However, most equity markets in Asia ex-Japan slipped in May on the back of rising risk aversion and weaker economic data. In general, investors continued to focus on quarterly earnings results, the imminent end to quantitative easing measures (QE2) and China’s weaker-than-expected April economic numbers. Elsewhere, the Eurozone sovereign debt concerns resurfaced and weighed on sentiment with anti-austerity riots seen in Spain and Greece and the potential of a second financial aid package for Greece.

In June, most Asia ex-Japan stock markets continued its downward trend as investors worried about three key issues: a tightening of monetary policy in the region, the rekindling of a sovereign debt crisis in Greece and weakness in select U.S. economic data.

On the monetary front, central banks in China, Taiwan, India and Korea raised benchmark interest rates in June. Bank reserve ratios in China and the Philippines also moved higher.

For quarter ended June 2011, Asian markets ex Japan slipped as measured by MSCI Asia Ex Japan which declined by 2.69% (in US dollar terms).

The Philippines Market Overview

• GDP: The rate of economic expansion slowed in the first quarter of 2011, registering 4.9% growth year on year (yoy).

Remittances from overseas Filipinos (OFs) coursed through banks reached US$7.9 billion in the first five months of 2011, registering an expansion of 6.2% from the year-ago level. For the month of May alone, remittances rose by 6.9% to reach US$1.7 billion, the second highest level since December 2010 when a record-high level was realized.

The Philippine government’s first five months of 2011 budget deficit narrowed to PHP9.54 billion (US$219 million) compared with PHP162.12 billion a year earlier as revenue rose and spending was curbed.

In June, Moody’s Investor Service upgraded the Philippine’s sovereign rating to Ba2 with a stable outlook, citing in part the progress made in fiscal consolidation by the administration of President Benigno Aquino who completed his first year in office in June. The rating was the highest Moody’s gave the Philippines since the start of 2005. Fitch Ratings also raised the country’s rating to one stop below investment grade.

• Inflation: Headline inflation increased yoy to 4.6% in June from the May level of 4.5%.

• Currency: The peso’s performance was muted against the US dollar for the quarter ended June 2011.

• Politics: The next presidential election is not due to be held until 2016. Under the constitution, Mr Aquino will not be permitted to stand for re-election. Elections will be held in May 2013 for one-half of the seats in the Senate and the entire House of Representatives.

• Equity Market: The Philippine Stock Exchange Index (PSEi) registered positive returns of 5.8% in local currency terms for the second quarter 2011 compared to a decline of 3.5% in the previous quarter.

• Bond Market - Local currency bond: Philippines local currency bond markets as measured by HSBC Philippines Local Currency Government Bond Index (in local currency) increased 2.8% for the quarter ended June 2011 versus the drop of 1.0% in the previous quarter.

Overall, the improving fiscal conditions and flush onshore liquidity contributed to a rally in the Philippines local bond market in April. Given the sustained inflationary pressures, expectations of further rate hikes led to a significant increase in shorter term interest rates in May. The Philippines Peso-denominated government bonds declined as bond yields rose, particularly at the short end of the yield curve. In June, the Philippines government bond yields declined broadly, led by the short end of the yield curve. The fall in yields of shorter-tenor government bonds were supported by the central bank’s decision to keep overnight borrowing rate unchanged at 4.5%. Additionally, increased inflows into emerging market bond markets, as well as the sovereign rating upgrade by Moody’s and Fitch, also boosted demand for the Philippines government debt.

• Bond Market – USD bond: The JP Morgan USD EMBIG Philippines index rose for the quarter ended June 2011.

Credit spreads of the Philippines USD-denominated government bonds were relatively stable in the month of April. Despite concerns over the ongoing macro uncertainties, global risk appetite remained relatively resilient, boosted by a string of positive corporate earnings results in the US and Europe.

However, against the backdrop of higher risk aversion in May, US interest rates declined on the back of flight-to-quality flows, while credit spreads widened in general. The downward move in US Treasury yields boosted the returns of USD-denominated Philippines sovereign bonds in June. The Philippines sovereign bonds also benefited from a modest credit spread tightening. Despite the market jitters over the macro developments, credit spreads of the Philippines sovereign bonds tightened in tandem with the emerging market sovereign bond markets, helped by favourable technicals and fundamentals. Higher inflows into emerging market bond funds in June and the sovereign rating upgrade of the Philippines by Moody’s and Fitch also boosted demand for the sovereign debt.

Strategy & Outlook

Equity
Strong private consumption and OFW remittances will continue to underpin domestic
demand and corporate earnings growth in the Philippines. We remain mindful of the risk of
higher inflation and will continue to monitor the macro situation while maintaining our
bottom-up, valuation-driven investment approach.

Bond
USD – The fund manager is maintaining a slightly longer duration position versus the
benchmark and will look to reduce the tracking error of the Fund across the yield curve in
view that the onshore demand for the Philippines bonds continues to be sustained.

Peso – Going forward, the fund manager expects further policy normalization by the
central bank. However, even factoring in the potential rate hikes, valuations of the
Philippines local bond markets remain relatively attractive, particularly at the long end of
the curve. The fund manager expects the curve to flatten going forward and will increase
exposure to the long end via the upcoming debt exchange program.