The Effect of Interest Rate Hike to Philippine Stocks

Interest rate hike, the monster in every investor's cabinet, was finally started yesterday as announced by Bangko Sentral ng Pilipinas. An increase of 25 BSP(basis point) or 0.25% was implemented.  So are we expecting another panic in the stock market now?

Some of my friends were asking me what will possibly happen after this. Well, some people will sell, that is for sure, and it is normal with or without interest rate hike. Interest rate, though surely has a negative effect on the stock price, is only one factor. It's effect can be complex though sometimes negligible specially if you are a long term investor.

There are many theories about how interest rate affect the stock market and the economy as a whole. A high interest rate will lower the liquidity of money in the market and thus will curtail consumption. Lower consumption means bad for the economy though I don't fully believe in the Hyperspending Theory of the Western because in order to accumulate wealth, one must practice frugality like what China did.

Borrowing money is of course will be more expensive because of higher interest rate. In effect, companies who borrowed and will borrow money will have to pay a higher interest expenses and thus will reduce its profitability. Those companies with high debt to equity ratio and who will need to raise capital will be surely affected.

However, if you compute for the average Net Profit Margin of all the companies in the PSE index , excluding LC because it is a losing company, the value is 23.32% for 2010(I estimated 4th quarter earnings) and 19.97% for the past 5 years. In addition, the average debt to equity ratio(DE ratio) of these companies for 2010 is only at 70.66. Literature says that DE ratio of less than 100 is a good value, meaning the debt level of a company is not severe. This means that these companies can absorb the effect of the interest rate hike and I'm quite sure that the smart boys/girls of these companies will find a way to make their business profitable even more.

Remember that before the 2008 Financial Crisis, our country's interest rate is at 200 BPS or 2% higher than the 4% and 6% rates during the crisis until yesterday. In short, we should have expected this a long time ago. In my case, I'm not worried because I based my stocks valuation at 10% interest rate which is higher than the pre-crisis level. Of course valuation is a subjective thing and just like Prof Aswath Damodaran of New York University says in one of his lecture in Valuation "every asset has a value but no one can exactly compute it" (I love his lecture by the way). 

I maybe wrong in my opinion but who has certain idea anyway? However there's one solution for these uncertainties that we have learned from the late Benjamin Graham and the old Warren Buffet, that is to always put a margin of safety in your investment like buying stocks at 35-50% below your valuation of the price. The lower the purchasing price the better. If stocks tumble down as an effect of interest rate hike panic then it must be a good opportunity to buy.