Last week, we promised to discuss how to make our savings work for us. Keeping money in a vault, in bedroom drawers, secret walls, or burying it under the ground won’t do it. Aside from not earning, you might forget where you put it or somebody might find and get it. It could pose a security problem. Money starts working when it is invested. And it has to be invested very carefully especially since the financial markets have been rather restless recently.
If you had P100,000.00 and bought 20 or 25-year government bonds in the last days of April, you will most likely get only P95k to P97k back if you sell the bonds now. The equities market has also not done very well, closing the week below 7,000. On the day the country announced an enviable 7.8% first quarter growth, the stock market went down 3.8%. We also saw the US Dollar gain strength, beating the Philippine peso back to P42.30. The question on everybody’s mind is, are local bonds and stock now out of fashion? Is this a program reformat to a tearjerker financial telenovela or just a short break of the great bonds and stocks show that has been going on for several years now? Or maybe a shift to a variety show that in every episode has serious, even sad, and funny and happy portions?
This question is currently the subject of intense study the whole world over. Many countries experienced the same fall in stock market, uptick in interest rates, and weakening of their currencies vis-à-vis the US Dollar. And the reason? It seems the US is on the way to a stronger economic recovery. And that could precipitate the US central bank to stop printing money that is currently on its 3rd run at $85 billion monthly. This money printing pushed US interest rates lower and along the way, brought billions of dollars searching better asset yields to countries like the Philippines. That is part of the reason for the strong peso, historical low interest rates, and very high stock prices in the last couple of years.
Is this the beginning of a reversal, a slowdown, or a temporary pause of money flows to emerging markets like the Philippines? Is the US recovery that is expected to bring with it a rise in US interest rates and a newfound strength of the US Dollar, for real this time?
The issues are not picnic topics. Our intention for now is to show that there are numerous forces affecting the local stock market, dollar-peso exchange rate, and domestic interest rates that are at play.
The Financial Markets in a nutshell
It is useful to situate investing in the context of the financial market landscape. We can invest our savings in financial assets or real assets. Financial assets are generally of two kinds, fixed income or equity securities. Fixed income includes bonds and long term deposits. It promises to give you guaranteed interest income. Equity securities or stocks represent ownership of a company and may not guarantee income but you own part of the income that it earns. You earn from dividends and/or increase in price of the stock.
Other forms of financial assets, like UITFs and Mutual Funds, contain fixed income and/or equities. Real assets are items such as house and lot, gold, jewelry, and real businesses like newspaper publishing, hardware, factories, rice and corn farms, etc. Some bright guys invented instruments that derive values from the price of financial and real assets. You most likely have heard such things as forward agreements, futures, options, and swaps. Collectively, they are called derivatives because they derive their values from the values of some underlying assets.
So assets are anything that represents some form of monetary value. Friends and relatives are not assets in this sense. They might give you money but that comes from the goodness of their heart and their love and concern for you. Skills and knowledge are also not assets in the way we are using it now. It may allow one to earn through its use but you can’t trade it. We are not talking about these more important assets. In investing, we confine ourselves to assets as a store of monetary value that can be traded or redeemed or collected. By definition, the value of an asset is equivalent to the total cash it is expected to generate over time in the form of interest, rent, or dividends.
No Free Lunch. Risk is part of the menu.
The first thing we should all keep in mind is whatever assets we invest in will have risks. There are two general risk categories. Credit risk and price risk. Credit risk is when the likes of Aman Futures or the Legacy Group or a certain Mr. Swindler entice you to invest then disappear without paying you. Market risk is when the stock you bought at P15 can only be sold for P10 today. Or when the 25-year bond you bought last month for P1.0 million is now only worth P950k. Credit risk, you don’t get your whole money back. Market risk is when price of assets go down.
Risk is not necessarily a bad thing. Taking risk is what investors get paid for. What investors should really avoid is uncompensated risk. Risk considerations are particularly important in today’s rather interesting if volatile markets. We will go into these in future pieces.
Tony Moncupa, Jr. is the President and CEO of East West Banking Corp. Please e-mail your questions, comments, suggestions to [email protected].
