Writings on the Wall: Rate Cut + Meralco

Buy when the writings are on the wall.

That's the best advice my mentor gave me while I am still a budding analyst learning my craft. As always, the best time to buy is when the writings are on the wall. No amount of technical or fundamental analysis can beat this advice.

Two things have emerged, the US Federal Reserve (US FED) is bent on cutting rates to prevent the US economy from slipping into a recession and the movement of Meralco (MER). I see these events as "triggers" in going back to the market.

Last week, US Fed Vice Chairman Donald Kohn said that policy-makers must be "flexible" and "pragmatic". This triggered a 331 points rise in Dow Jones Industrial Average as Wall St. see this as a signal that the US FED will cut rates when it meet on Dec. 11. Already, the futures market is pricing in a 100% chance that the US Fed will cut rates by 25 basis points and a 50% chance that it will cut rates by 50 basis points.

However, the surprise will likely come from a concerted effort by central banks to simultaneously cut rates in order to shore up the US dollar. More than the looming US recession, the weak dollar is creating havoc in the financial markets. As they say, what goes around, comes around. Previously, it was the US FED that acted as the savior for Japanese Yen and Euro.

In 1998, then Treasury Secretary Robert Rubin initiated a US$2.0bn purchase of Japanese Yen to prevent the Yen from falling below Y150.0 to US$1.0. The move stabilized the currency markets and brought the Yen back to Y135.0 to US$1.0 within days. Interestingly, the Japanese banking system was reeling from a US$600bn bad debt that was accumulated during the go-go years of the late 80's. Please read Can This Yen Be Saved?

In 2000, the US Fed and the Bank of Japan (BOJ) stepped in to buy Euros in order to shore up the currency. At that time, the Euro fell by almost 25% to US$0.85 to 1 Euro from its opening rate of 1.16 Euro to US$1.0 in 1999. Since then, the value of Euro has almost doubled to 1.48 Euro to US$1.0 Please read Euro Crisis

In the local market, I guess the movement of Meralco (MER-P82.50) is a sign of things to come. What's good for Meralco is good for the market. From its low of P68.0 last week, the stock has rallied by almost 22.0%. Meralco, is a bell-weather stock. The move tells us that money will be flowing to the utility/power sector. Two weeks ago, the Dept. of Finance (DOF) sold the 60% stake of the government in PNOC-EDC (EDC - P7.00) for P58.0bn. The winning bidder paid P9.75 per share, effectively paying a 40% premium over the market price of EDC. Next week, the government will bid out the concession of National Transmission Co. (Transco). Proceeds from the sale is expected to reach US$3.0bn. So from the looks of it, utility stocks will likely outperform the market. As always, go where the money is.

The bullish case for Meralco is defensible. Last week, Finance Secretary Margarito Teves indicated that the government is bidding out its combined 29.0% stake in Meralco early next year. Meralco is currently trading at 12.0x PER to 12/08 earnings. On the other hand, EDC, was sold at 18.0x PER to 12/08 earnings. Comparatively, Meralco should be priced within the same valuation range. This should put the indicative selling price of Meralco at around P102.0-115.0 per share.

If my assumptions are correct and the market indeed bottomed out at 3,400 levels, then there is a strong chance that the PSEi will make new highs by 1Q08. Note that the PSEi managed to establish higher lows versus the 2,800 (low) that it reached last August. So how high will the market run? Again, will just have to watch for the writings on the wall .....

For comments, you can send me an email at jack.galt888@gmail.com