Monday, July 31, 2006

FinanceAsia: Megaworld steps up with new high-yield debt deal

Megaworld breaks ice in the international high yield debt market! According to Finance Asia,

``Philippine real estate developer Megaworld on Friday (July 28) became the first high-yield issuer to take advantage of the positive sentiment left in the wake of last week’s hugely successful Philippine sovereign deal, pricing an un-rated $100 million Reg-S, five-year bond offering in line with guidance...

``The Megaworld deal was priced at 98.488% on a semi-annual coupon of 7.875% to yield 8.25%, which was spot on with the initial yield guidance provided by UBS. The yield is equivalent to 327.1bp over comparable US Treasuries.”

You may read on the entire article by clicking on this link

As Philippine companies get international exposure by tapping capital market abroad, so will its equities.

Sunday, July 30, 2006

Liquidity Driven Rally Amidst A US led Slowdown?

``Fear not for the future, weep not for the past." - Percy Bysshe Shelley (1792-1822), English Poet

As mentioned during the last edition, the Philippine benchmark composite Index has basically shadowed the movements of the US equity benchmarks. This has not been an isolated motion but rather a global dynamic as shown in Figure 4.

Figure 4: MSCI Emerging Free (red line) and MSCI World Index (black line)

Both the MSCI World Index and MSCI emerging market Index had moved almost in lockstep over the past quarter.

With a significant rebound in global bond prices or a meaningful decline in yields, a rally in broad based commodities, lower oil prices and a broadmarket decline of the US dollar Index, it appears that the global financial markets have thus far, reflected for the US Federal Reserve to go on a pause this coming August 8th, following evidences of a marked slowdown. The reappearance of stimulative conditions has temporarily provided global investors ammo to load up on diversified assets.

Figure 5: The Phisix (black candle) and the US/Philippine Peso (red line)

As shown in Figure 5, like clockwork, each time the Peso vis-à-vis the US dollar advances, the Phisix has been likewise buoyed. For the week, the Phisix stormed to a 3.94% advance following sizeable gains from Wall Street (Dow, Nasdaq and S&P 500 up over 3% a piece) to take the second spot behind India (+5.89%) as the best performing bourse for the week.

While foreign buying turned positive from last week, what bemuses your analyst is the extent of the exceptional signs of local bullishness as revealed by sentiment indicators, i.e. the wide gap between advancers and decliners (263 to 85) and the hefty jump in the number of issues traded over the week.

Meanwhile, alongside its ASEAN neighbors, the Peso climbed 1.16% to Php 51.56 against the US dollar in the backstop of the successful issuance of government debt instruments in the global financial bond markets last week. brands the issuance as ``one of the largest order books ever seen in Asia.” Why? Because ``the final book closed massively oversubscribed, the 10-year tranche closed at 5.7 billion on 228 accounts, an over subscription of 19 times (emphasis mine), while the 25-year tranche closed at 6.5 million with 248 accounts, an oversubscription ratio of 15-times.” Very opportune indeed.

Again I find it truly bizarre for the financial markets to climb amidst the expected economic “moderation” in the US, except for the notion that these could have been so due to liquidity leakages within the financial system.

One of my favorite analyst Mr. Doug Noland in his Credit Bubble Bulletin rightly observes, ``second quarter financial sector earnings reports offer scant evidence of any significant slowing of system Credit growth. The major “banks” maintain an aggressive business posture, with robust growth in lending and capital market activities. The push to satisfy Wall Street earnings growth demands is intense, and the ongoing huge stock buybacks are as well indicative of more aggressive lending and market activities to come. Financial conditions remain extraordinarily loose; Credit Availability remains easy and marketplace liquidity abundant.”

So in spite of the Fed raising interest rates the liquidity backdrop remains essentially loose.

Still, a growth slowdown basically translates to weaker demand, limited pricing power and prospective declines in profit margins. Canadian Independent Research outfit BCA, sees an inflection point or a peak in global earnings power as shown in Figure 5. Quoting the widely followed BCA (emphasis mine),

Figure 6: BCA Research: Global Earnings Revised Down

``The path of least resistance for global earnings estimates is down until economic growth prospects turn-up anew.

``Analysts continue to rein-in earnings expectations after an impressive three year run of positive revisions. The de-rating will continue until signs emerge that global economic momentum is set improve. On this note, our proprietary Global Leading Economic indicator is still falling, and further weakness is likely as a cooling U.S. economy weighs on global growth. The offset for global stocks is that fund managers are already very bearish on both U.S. economic growth and earnings prospects over the next 12-months, as gauged by the latest Merrill Lynch fund manager survey. Accordingly, a weaker growth environment appears to have already been partially discounted. Bottom line: expect directional uncertainty in equities until yearend based on Q3 earnings results before prospects improve next year.”

BCA suggests that extensive bearishness could have been factored into the markets, or possibly, dominant negative sentiment could have fueled the recent rebound in the markets despite the lingering uncertainties. In short, investor sentiment swings and technical “chart” factors could have boosted equity prices abetted by liquidity leakages.

Furthermore, it is also important to mention that PIMCO’s Mr. William Gross, the “Warren Buffett” of Bonds, one of the most successful bond fund managers, if not the top-rated, in the investing world, have audaciously declared in his latest outlook that the bond bull market has began and would be the last, in his words, ``that this bond bull market will be the last; that history, as almost all active bond managers have known it since 1981, will come to an end a few years hence.” Mr. Gross attributes the rebound of bond prices to a significant slowdown in the US economy driven by an intense decline in the housing industry to be followed by possible money easing steps by the Fed.

Mr. Gross’ outlook is similar to my view that the bond markets are treading over to the bear territory over the long-term. The foundation to this outlook, according to Mr. Gross (emphasis mine), ``The important idea is that such a forecast speaks to eventual reflation, inflation, and declining bond prices sometime out there in 2009 and far beyond as the U.S. seeks to address its enormous future liabilities concentrated in social security, healthcare, and foreign holdings of U.S. bonds.” He also thinks the Dow Jones could possibly hit 5,000 in the distant future! My, my, my.

In contrast to the US markets which had undergone a bullrun from 1982 to the onset of the millennium, the Philippine market has basically risen from its nadir in 2002. Yes, today’s marketplace has been “globalized” in a sense that the activities have been running in almost parallel motions. But seen over the long run, both markets are coming from starkly divergent reference points and would, in high probability, remain divergent. In short, the cycles underpinning these markets are structurally dissimilar.

In a recent talkshow at Channel 27’s ANC channel, Rep. Joey Salceda of Albay raised as the “biggest risk” to the planned implementation of the grandiose projects enlisted by the PGMA at her SONA as a US slowdown. If I heard him right, he noted that for every 1% decline in US GDP, the Philippine growth clip would taper by an equivalent of 1.5%. That’s pretty significant. If the markets are all about economic growth then we should expect the domestic markets to consolidate or move rangebound as the US goes into a (hard or soft?) landing. I don’t expect our markets to fall off the cliff as a high probability event, even if the US goes into a recession.

If liquidity propulsion would still be the driver of world financial markets, then as the US Federal goes on a cyclical peak for its money policies, the domestic financial markets may in essence part ways from the directional path of the US markets. My bet is for this eventuality.

While I remain confident that the Philippine cycle remains on the upside over the longer period, the financial markets could be frayed by considerable headwinds caused by exogenous factors over the immediate term. One can take advantage of present swings or volatilities in the market to trade or to accumulate on dips. Posted by Picasa

Want a Stock Market tip? PGMA’s SONA was a Mouthful

``Men are more moral than they think and far more immoral than they can imagine.”-- Sigmund Freud

Any keen observer of President GMA’s State of the Nation Address (SONA) last week would have noted that the ambitiously grandiose programs enumerated were practically a dead giveaway in terms of stock investments for a serious investor over the long horizon.

These projects have been designed to mainly benefit several industries which we have dealt with as part of the unfolding global big picture trend (see November 29 to December 3, 2004 Domestic Investment to Help Drive the Phisix?), particularly domestic infrastructure, agriculture, tourism and energy. The SONA simply highlights the economic potentials of the Philippines and its crucial role to the region and the world, vicious politics aside(!).

Private Sector Initiatives

At an estimated humongous cost of P 290 billion, critics of these programs miss out the fact that, had the domestic financial markets been more developed and pervasive, e.g. bond (municipal or LGUs/Corporate) or commodities market, funding for these programs would have been complimented if not driven by private investments. PGMA herself appears to have overemphasized on the supply-side and glossed over the demand side, possibly espousing John Say’s Law of “Supply creates its own demand.” Knowing such opportunity I would have suggested to her to add infrastructure programs that would enhance the deepening of the domestic capital markets notwithstanding.

We should not forget that global liquidity has been a key driver of the world’s financial markets from which has propelled real economic growth, to quote a recent article from Joanna Chung of the Financial Times (emphasis mine), ``The sudden interest illustrates a broader theme in emerging markets over recent years: the constant hunt by bond investors for extra yield and their willingness to seek it in ever more far-flung locations”. One could expect the search for yields to spill over towards direct investments for as long as these projects are economically viable in an investor friendly environment (unencumbered by rent seeking politicians and the suffocating onus of regulatory tomes).

Regional Investment trends

Moreover, bilateral or regional investments can also help bolster these investments. Recall that Asia holds about $2trillion of surplus foreign exchange reserves, as shown in Figure 1.

Figure 1 IMF: Foreign Exchange Reserves and Share of Capital flows

China has, for one, financed the ongoing North Rail project in Central Luzon, and has aggressively been expanding its exposure worldwide to even remote distances, far flung and highly volatile areas, as Paul Mooney wrote for Yaleglobal, ``Chinese are busy developing much-needed African infrastructure: roads and rail lines in Ethiopia, Sudan, and Rwanda; a new hospital in Sudan; a farm and a bridge across the Nile; reclaiming thousands of hectares of farmland in Tanzania.”

Clearly, China’s foreign policy has been engineered to ensure a steady supply chain of raw materials and commodities for its rapidly growing resource-hungry economy by positioning and investing in resource-rich countries. Put differently, China’s national economic interests dictate a policy towards securing resources by investing in countries abundant with resources regardless of the underlying political conditions.

Moreover, with its teeming foreign exchange reserves, China has embarked on acquiring over 100 oil fields and companies globally in the past 5 years, according to Bloomberg’s Asian analyst Andy Mukherjee.

In short, this ongoing trend to secure supplies to feed and sustain its prevailing economic growth dynamics is likely to continue for a foreseeable future and is likely to translate to more direct investments into the Philippines for similar motivations.

One must not forget that compared to Africa or Latin America, China has some shared history and culture and is geographically closer to the Philippines, hence, would perhaps merit more investment considerations, but with one possible drawback: our close political affinity with the United States (a topic for another time).

And this has not been limited to China, even other emerging countries as India has shown indications of expanding investments for similar incentives.

Figure 2 IMF: Asia Surpluses to Possibly Find its way back home

One development I am betting on is that once this “Bretton Woods II”, or the tacit or implicit “unofficial” US dollar peg adopted by many Asian nations in order to make their currencies cheap to drive on an export-driven economic growth, outlives its usefulness there is that big likelihood that the plethora of excess dollar reserves stacked up in Asian Central Banks would be channeled towards investments within the region as shown in Figure 2. Where instead of supporting the debt-driven US consumption growth engine through indirect subsidies via investments in US assets, mostly in treasuries, Japanese and Chinese reserves would flow as investments within Asia. Then, your great boom comes into being....the Phisix would cross over the 10,000 mark! But of course, such gradient would not come painless though.

And emerging signs of increasing regionalization that would pave way for such realization have been evident; for instance, leaders of the ASEAN community aims to draft a charter next year that would take initial steps to integrate economically ASEAN member countries, according to a report from the Associated Press (emphasis mine), ``A charter for the economic integration of the Association of Southeast Asian Nations, or ASEAN, is being drafted and may be ready by the time Singapore hosts regional heads of state next year, Singaporean Foreign Minister George Yeo said late Tuesday...The creation of a unified ASEAN bloc by 2015 would allow for a free flow of goods, services and human resources across the region, but will not include a single currency system, ASEAN officials say.”

Boom in Agriculture

As per the industries cited, since I have been bullish with gold in 2003 as I had been equally optimistic with soft commodities on the premise of supply inelasticity in the face of growing demand, but on a more subdued degree since agri-based companies make up a lean representation or inventory of publicly listed issues.

As an aside, I think that private sector investments will also continue to effuse towards agri-based industries, despite its endemic volatility, as growing demand may outpace present supplies borne out of a similar theme; the investment cycle~ underinvestments during the past two decade or so.

Future trend dynamics for agriculture will be levered on the growing financial empowerment of resource rich-emerging market population that would uplift consumption trends, unraveling trends of migration to cities or “urbanization”, the continued industrialization of emerging market economies, growing shortages of arable land due to desertification (expanding deserts) and a potential worldwide water crisis, competing demand for energy usage (raw materials inputs) and technological innovation that may spur yield productivity.

Tourism’s Rosy Prospects; Medical Tourism’s Solution to Migrating Professionals

Of course Asia’s vigorous economic growth performance has been a key factor in today’s tourism traffic dynamics. Increasing wealth, burgeoning middle class and growing access to credit has driven growth in the tourism industry.

Figure 3 Tourism & Travel Institute: 2004 Positive Growth Rate across all regions led by Asia

For instance, in 2004 around 30 million Chinese (again) took foreign vacations and is likely to reach 100 million in the coming years. According to the World Travel and Tourism Council (emphasis mine),

In terms of demand, growth will double in a decade, ``In World, in 2006, Travel & Tourism is expected to post US$6,477.2 bn of economic activity (Total Demand), growing to US$12,118.6 bn by 2016.”

In terms of growth, `` activity is expected to grow by 4.2% per annum in real terms between 2007 and 2016.”

In terms of capital investment, growth will be expected to also double in 10 years, ``Travel & Tourism is a catalyst for construction and manufacturing. In 2006, the public and private sectors combined are expected to spend US$1,010.7 bn on new Travel & Tourism capital investment worldwide - 9.3% of total investment - rising to US$2,059.8 bn, or 9.6% of the total, in 2016.”

Notwithstanding, the growth prospects of the highly underrated and unappreciated but very lucrative medical tourism industry which according to, ``Medical tourism is growing rapidly, far outstripping the 4 to 6 per cent growth in general travel bookings predicted for 2006, with the number of medical tourist visits to many countries swelling by 20 to 30 per cent a year. The industry in Malaysia, Thailand, Singapore and India, currently worth around half a billion dollars a year in Asia, is projected to generate more than US$4.4 billion by 2012.”

So instead of hollering against medical professionals for leaving overseas over greener pastures and requiring big brother to inhibit or regulate these flows, the proliferation of this medical outsourcing trend should effectively stanch the tide of manpower outflows if given the appropriate incentives to thrive, expand and compete against, note, our very own neighbors. Medical professionals and investors should instead combine to utilize the financial and capital markets to take advantage of this embryonic “hot” growth trend and invest to compete, enrich and retain our workforce. It is savings and entrepreneurship that drives economic prosperity through free markets and not regulations.

In all, the programs cited by the President in her SONA, taken from an apolitical standpoint or perspective, appear to be achievable and come in the light of the present global macro trend dynamics. Under the auspices of a consistent and stable investor friendly regime and politically unfettered market oriented policies, it would seem that the private sector investments could compliment funding or even drive these investment programs. Growing trends of regionalization and economic integration could also be a platform for such investments. In addition, development of the nation’s juvenile capital market infrastructure would essentially buttress these programs.

You want a Stock Market tip? PGMA’s SONA just gave you that list! Posted by Picasa

Tuesday, July 25, 2006

Reuters: Big Oil renews Asian crude hunt as reserves dwindle

Some say there have been no short supply of oil, and that present prices of oil reflects “speculative or terror” premium.

Well, it looks like major oil companies have been sifting through even from the least prolific fields as signs of desperation to add up on their depleting reserves.

An excerpt from Reuters...

"It may have a long way to go before rivalling hotspots such as West Africa or Libya, but growing resource nationalism in the rest of the world -- from the Middle East to Russia to Latin America -- is giving Asia an edge, especially as Big Oil struggles to replace its dwindling reserves.

"Because there are opportunity constraints, companies are willing to look at areas that had not previously interested them," said Mark McCafferty, head of South East Asia research at energy consultants Wood Mackenzie.

"People are looking at the Philippines, for example, despite the fact there have been no recent successes. Companies are now willing to take a look to see if there is any potential."

Shell, which in 2004 opted not to develop a small oil reserves associated with the Philippines' biggest natural gas field, this year committed itself to exploring the country's East Palawan basin.

"Exploration activity in the Asia-Pacific region has increased significantly," a Shell spokesperson said.

Read more by clicking on this link

Monday, July 24, 2006

Phisix-US Correlation, Heightened Liquidity Risks Calls for Defensive Positioning

``The ladder of success is best climbed by stepping on the rungs of opportunity."- Ayn Rand

If there is any one factor that holds sway to the global financial markets of late, it is the speculations about the US Fed’s next moves. Last week, as Chairman Bernanke appeared on the US Congress for his Monetary Policy report, and the equity markets suddenly exploded to the upside on the view that Bernanke hinted for a pause. Global equity markets followed suit, US and global bonds rallied while the US dollar declined.

Figure 2 Phisix (candlestick) and S & P 500 (line)

As shown in Figure 2, over the past three months, or since May, the Philippine Composite Index has largely shadowed the movements of the S & P 500 index of the US. Unlike my original expectations that the Phisix, which had previously ran the same course with that of Gold, would ply the same route or pattern, it now appears that investors have pinned the activities of the domestic market in line with the outlook in the US, which in my view, is not entirely promising.

The US Federal Reserve raised its overnight interbank lending rates for the 17th time last June to normalize its money policies, load up on its monetary ammo against possible emergence of deflation, defend the US dollar (my view) and moderate the growth clip of its economy. Since the global financial system has been addicted to profuse liquidity injections which led to inflationary pressures worldwide, the prospects of a pause signifies of its continuity, hence the resonant jubilation at first instance.

Yet, the paradox here is that it comes in the face of an economic downturn, which makes the initial euphoria in the US markets unwarranted. Analyst Paul van Eeden warned (emphasis mine), ``On Wednesday the stock market in the US rallied because Ben Bernanke indicated that he might not push for higher interest rates. Two weeks ago the market rallied because of weak retail sales numbers. This market is dangerous: investors are desperately searching for good news.

``When weak retail sales figures and the Fed Chairman's comments that he sees the economy slowing are interpreted as good news for stocks, then you know it is time to get out of the market.”

As you know, I have been in the camp of those who think that the US Fed would embark on a gamut of rates cuts once signs of a downturn snowball. I mentioned that political expediency (election season, pressures from the public), inveterate fear of deflation, aside from ideological leanings by the Fed Chief, past actions undertaken by the Fed (see Figure 3) and the huge leverage in its system which translates to more money “created out of thin air” required to settle the chronically exploding liabilities as possible reasons why the Fed would likely accommodate more inflation risks and focus on sustaining asset-driven growth (see June 26 to June 30 Fed Dilemma: Too Much Pressure To Continue Hikes).

Figure 3: Ritholtz Research & Analytics: Liquidity Driven Banking Policy

Although over the long term, I think that accrued policy mistakes (out of the fixation towards short-term remedies) and rising default risks are likely to drive interest rates higher.

Another cause of concern is the continuing weaknesses conspicuous in the Arabian markets. The liquidity driven Arabian markets stumbled in December of last year and could have foreshadowed the inflection point of world equity markets last May (see Figure 4).

Figure 4: SC Arab Index

Since the onset of the millennium, stocks have grown manifold and had been supported by abundant petro revenues, ``After growing at the average rate of 25.7 percent in 2005 to $597 billion, this year's nominal GDP for the six Gulf states could exceed $700 billion.” notes Henry Azzam founder and CEO of Amwal Investments.

After peaking last December, the SC Arab index has given back over 40% of its gains. It could be that the parabolic rise caused its market benchmarks to stumble under its own weight or that while liquidity continues to be strong; the explosive rise of its stocks was simply unsustainable or lacked the amount of liquidity growth to sustain its pace. It could also mean that Arab stocks have been responding to the liquidity withdrawal measures adopted by global central banks as shown in Figure 5.

Figure 5: Gavekal: Falling Velocity and Global Markets

According to the very perceptive team of Gavekal Research, ``Unsurprisingly, given the latest volatility on equity markets, the overall appetite for risk has fallen dramatically...Since velocity (the private sector’s propensity to multiply the liquidity provided by central banks) has been the primary source for liquidity and the most important driving force behind the rally of the riskier asset classes, this is a very important development. Indeed, with both M and V in negative territory, markets will now face serious headwinds.”

My concern is if Arab stocks buttressed by robust oil revenues continue founder, it could herald renewed softening in global equity markets as suggested by Gavekal over the interim. Until perhaps the Fed goes into an actual stop and global central banks plays follow the leader, then will we probably see a resurgence of global equities.

For the moment, the Phisix’s close correlation with the US markets represents inauspicious development. Until we see a lucid divergence (see June 12 to 16 Awaiting Asia’s Markets to Diverge from the US) of the Phisix or of the region’s activities relative to the US markets, then it would be recommended that one plays defensive and selectively trade or accumulate on opportunities.

Research Process, Value of Time and Probabilities are Key to Outperformance

``Imitation in markets often gets a bad name, but it's important to recognize how vital imitation is in our day-to-day lives. We imitate each other all the time, primarily because other people often have better information than we do. It becomes a problem in markets when everyone starts to imitate one another, and they forget about what they're doing in the first place. It leads to excesses.”- Michael Mauboussin

Rather focusing on tangential issues, I’d like to impart to you some pointers on how to improve your portfolio returns from Michael Mauboussin, chief investment strategist at Legg Mason, an $850 billion highly acclaimed global asset management company in the US and author of the new book More Than You Know. In an interview with David Meier of, Mr. Mauboussin cites three critical factors to concentrate on (emphasis mine)...

``The first thing, I would say, is to focus on process versus outcome. So process means understanding the research process, trying to understand specifically if expectations in the prevailing stock are too high or too low, and recognizing that even if you have a good process, periodically things will not turn out as you had hoped. [However,] a good, quality process will lead to good long-term results.

``The second thing I would say is recognize the role of time. In the very short term, it is almost impossible to discern between luck and skill, because there is just simply too much noise in the system. But over the long haul, certainly a good process will prevail. So [recognize] that it is important to be patient, and often, as you said before, to do absolutely nothing. This is not a business where more activity leads to better results. I think, in general, people perceive that. And certainly in America, there is an idea that doing more work is better. That simply does not hold for the stock market.

``The third thing is to recognize that markets are fundamentally probabilistic, and because they are probabilistic, it requires a certain psychological approach and psychological mindset. By the way, in Robert Rubin's wonderful book, In an Uncertain World, he talks a lot about the probabilistic mindset. He says many people believe they are [taking such an approach,] but very few people have the disposition or time or training to do it properly. So when you have a probabilistic mindset, you are constantly thinking about different alternatives. You are constantly taking information and updating your probabilities and outcome assessments and recognizing, again, that there are many psychological biases that can come into your doing that properly.

Of course you don’t normally obtain such judicious advice from the investing business, such as conventional brokers or some domestic financial institutions alike, as they are hardwired to think and impress upon their clients that returns from the markets entail frequent churning activities. As I’ve said before, it’s mainly because of their revenue models; in contrast to the investing profession, like Mr. Mauboussin of Legg Mason, which focuses on generating “Alphas” or above benchmark returns.

And neither would you hear from investing business community the probabilistic approach towards investing. Probability of outcome is the primer for risk management and essentially differentiates gambling from calculated risk taking ventures. By determining the odds, or the ratio of favorable outcomes to unfavorable outcomes, one could act to reduce or limit risk exposure and optimize on returns.

In my case, the investing-research process, as you probably all figured out, has been largely an amalgam of the Big Picture (particularly capital flows dynamics and monetary and cross market analysis), behavioral finance/economics (understanding the thought process to limit heuristics and mental shortcuts or biases) and a combo of sentiment and the technical picture with occasional dabbles on valuations. In short, I try to be as methodical and systematic as what Mr. Mauboussin suggests and recommend that you do as well.

Domestic Political Developments Unlikely to Drive Markets

I read from some ad hoc commentaries that the direction of the domestic financial markets for the coming week would find bearing from the Philippine president’s State Of the Nation’s Address (SONA). I find this attribution to be ludicrous. Unless of course, draconian policy changes would be endorsed to either choke or liberalize business conditions, the most one can expect from these events would simply be vainglorious political rhetoric and counter demagoguery from the political opposition.

If the previous market’s reaction to past political conditions were to be a gauge (e.g. aborted coup, heated elections, garci scandal, etc...) then the market could be expected to discount this as a nonevent. And as for these forecasters groping for any variables to associate to the market’s behavior, Robert Prechter of the Elliot Wave Theory describes them best, ``Those who regard the news as the cause of market trends would probably have better luck gambling at race tracks than relying on their ability to guess correctly the significance of outstanding news items.”

I would view developments in Lebanon as having more potential significance than local politics. The present military engagement has the open-ended possibility to escalate and diffuse as to drag the entire region into conflagration. With the world’s oil supplies, about three-fifths of the world’s proven oil reserves (see Figure 1), heavily dependent on the region, an expanded theater of war would bring the world to its knees with a supply shock. Think oil at $100 per barrel at least! That is the reason why we have to keep our eyes on the unfolding geopolitics rather than be transfixed on vapid and toxic domestic “personality based” politics.

Figure 1 Commanding Share of Middle East Oil Posted by Picasa

Thursday, July 20, 2006

CBS Marketwatch Mark Hulbert: Explanations R US

The gullible investing public have been regularly inured to believe, especially by mainstream media and their coterie of analysts, that non-economic events (wars, natural calamities & etc.) have significant impacts in the activities in the financial markets. But do such events really move markets?

CBS Marketwatch Mark Hulbert in his latest article “Explanations R Us” cites a study (emphasis mine)...

``A comprehensive analysis of the impact on the market of non-economic events, which despite being nearly 20 years old remains one of the standard academic works on the subject, appeared in the Journal of Portfolio Management in 1989. It was written by economics professors David Cutler, Lawrence Summers, and James Poterba (Cutler and Summers are at Harvard; Poterba is at MIT).

``The professors designed their study to find evidence that non-economic news regularly has a big impact on stocks. They focused on all entries in the "Chronology of Important World Events" from the World Almanac for the period beginning with Pearl Harbor and ending with the 1987 Crash, and then eliminated from their list any events that the New York Times did not carry as a lead story and that the Times' Business Section did not report as having affected investors.

``The result was a list of 49 distinct events, such as Pearl Harbor, the Korean War, Kennedy's assassination, and so forth. The professors then measured the average absolute return of the S&P 500 index on these days.

``The professors came up with little evidence that non-economics events had a big effect on the stock market. On average, across all 49 events on their list, the S&P 500 moved just 1.46%, less than one percentage point more than the 0.56% that prevailed on all other days. Because of this small difference, the professors concluded that there is "a surprisingly small effect of non-economic news" on the stock market.

The lesson here is not to simply to adhere to superficial clues or heuristics or mental short cuts. Sensationalism can divert you to wrong causes and lead your portfolio astray. The financial markets are more abstract, complex and multi-dimensional than commonly thought.

Monday, July 17, 2006

Dow Jones 10,700: Marking the Line in the Sand?

I've always thought that politics...geopolitics, i mean, does play a key role in shaping the direction of the markets. As I've noted in the past, once the critical benchmarks in the US equities come tumbling down, the sluicegates of liquidity maybe opened anew to forestall any incidence of a Central Banker's dreaded nightmare...'deflation'. This could be a possible legacy from Greenspan to Bernanke, otherwise known as the "Bernanke Put". Political expediencies may once again govern money policies.

I had been looking at 10,400 level, about 10% from the recent highs, as a possible threshold level, but maybe have found a clue from's Chip Anderson. According to Mr. Anderson...

"Three big down days have sent the Dow back down to the 10,700 support level. What's that you say? 10,700 is just a number? Just a number like any other? Oh really? Check out this chart:

"10,700 is a number that should make your ears perk up. If the current Mid-East problems push the Dow well below 10,700, it will mark a significant change in the market's technical picture."

Would a break of 10,700 level then be quintessential marking "the line in the sand"??? Posted by Picasa

Sunday, July 16, 2006

Mixed Market Signals, Unfolding Business Cycles

``Ignoring market risk will mean that, from time to time, performance will be lumpy...The fund is unlikely to outperform benchmarks consistently. Rather, the goal is to outperform on average, most of the time, and over the long run.''- Martin Whitman, manager since 1990 of the $8.3 billion Third Avenue Value Fund.

While I might have been right about rising gold prices, the correlation between non-US equity benchmarks, particularly of the emerging market ones, and rising gold prices appears to have broken down.

This week, aside from gold and oil, safehaven bets in the US dollar (as measured by its trade weighted index) and US treasuries have rebounded (as measured by Morgan Stanley US Government Securities) as shown in Figure 2.

Figure 2: Rallying US dollar Index and Morgan Stanley Government Securities

In the currency markets, the rise in the US dollar index has resulted to a broadbased decline in Asia’s currencies. The Philippine Peso fell .08% to Php 52.39 against a US dollar from the previous Php 52.35.

The Bond markets have indicated for a slowdown in economic growth and inflation expectations with a hefty decline in US treasury benchmarks across the board. With Fed funds rate at 5.25%, Treasury yields for Notes (2, 5, 10 and 30 years) including the 3-month T-bill have all widened inversions except for the 6-months T-bills which closed basically flat. Aside from signifying a possible slowdown on a tight money backdrop, another Fed hike in August with bond yields at present levels, or a continuing rally in bond prices even at the event of a pause in August, is likely to widen the yield inversion curve growing the risks of a US led recession.

Asian bonds have mostly rallied, including the Philippines. This has likewise been indicative of a possible slowdown of the world economic growth.

Figure 3: kitcometals: Record HIGH for Nickel

While the bond markets suggest of a slowdown in either economic growth or inflation expectations, in the commodities front we are witnessing a strong resurgence following oil’s new highs. Nickel carved out a fresh record high up 15% for the week (see figure 3), followed by a strong finish by copper (+4.7%) silver (+1.1%) and gold (+5.23%). The commodity indices of the CRB-Jeffries closed 2.68% higher to bring year to date gains to about 7.6% while the energy heavy Goldman Sachs Commodity Index surged 3.78% to a NEW record high (see Figure 4)!

Figure 4: Rallying CRB and Record High Goldman Sachs

Contrasting stories, we have here. Unlike in the May selloffs where except for the US dollar all assets had been sold off, today there are emerging dissonances. The bond markets whisper of subdued inflation, and a prospective economic growth slowdown, while the commodity markets remain beneficiaries of the residual inflationary policies. You have a yield curve inversion to reflect a tightened money environment but M2, Bank Credit and Commercial papers continue to expand. You also have rising dollar to corroborate the tightening by central banks however, a rampaging gold offsets this. I have argued to the contrary of the consensus opinion that gold’s fate (see June 19 to 23 edition, Has Gold Found its Bottom? Philippine Mining Index to Lead Phisix Anew?) has not been entirely inversely related to the US dollar. In times of uncertainty, gold and the US dollar may coexist. Not to mention that higher oil prices would translate to more US dollar requirements for oil consuming nations, thereby temporarily propping up the value of the world’s currency reserve.

What does this mixed signal imply? Have the leakages in the financial system found its way to commodities? Are the bond markets wrong? Such that commodities will continue to climb even amidst a muddle through environment and eventually bond yields follows? Or are the commodities markets bound for a belated selloff?

So far one clear indication is that the equity benchmarks have been the unambiguous losers. Global benchmarks have taken a direct hit. Wall Street benchmarks have been significantly down (Dow Jones -3.17%, S & P 500 -2.31%, and Nasdaq -4.35%) and so with most of the world’s major or emerging market benchmarks.

Figure 5: Absolute Partners: Average Returns by stage of the Business cycle

Maybe it depends on the stage of the cycles. According to Niels C. Jensen of the Absolute Partners, based on a study called ``Facts and Fantasies about Commodity Futures1”, by Gary Gorton and K. Geert Rouwenhorst back in 2004 (emphasis mine),

``We make the following observations:

1. As we already pointed out, over an entire economic cycle, stocks and commodities behave quite similarly, at least as far as the total return pattern is concerned.

2. Stocks (and bonds) do much better than commodities in late recessions and early expansions. Late recessions are, in fact, the worst environment for commodities where the average return has been negative.

3. The best environment for commodities is late expansions where the average return both in absolute and relative terms is very attractive.

4. In early recessions, where stock and bond returns really suffer, commodity returns are still quite attractive, at least in relative terms.

``All this leads to the $1 million question: Where in the cycle is the global economy today? Knowing the answer to that may explain the difference between poor and good performance in your portfolio over the next 12-18 months.”

Does the weaknesses in the stockmarkets’ worldwide compounded by the tepid rally in bonds imply that we are now entering into the early stages of a recession? We will see.

One thing I would like to repeat is that the Bernanke Put, i.e. Fed’s willingness to bail out the markets with a flood of liquidity, a possible legacy from Greenspan, remains an open option as argued in my June 5 to June 9 edition, (US Recession Watch: A Fed CUT in June or August?).

Once Wall Street’s benchmarks hit substantial or pivotal lows, you can be assured that not only will the Fed pause but Mr. Bernanke & Co. will embark on an abrupt series of rate cutting spree in fear of “destructive” deflation. The appointment of Henry Paulson formerly top honcho of Goldman Sachs as the Secretary of the US Treasury underscores this interest to protect members of the Financial community. Talk about maintaining special interest groups.

Figure 6: Phisix in a Predicament

Finally, relative to the Phisix, it was a curious episode for the Philippine benchmark to rally significantly last Thursday despite the steep losses in Wall Street, which made me think that the gold-phisix correlation could be at work. However, the failure of the mines to perk up gave me less confidence for this outlook. Friday’s 2.27% drop basically reflected the loss of the week (down 2.12%) and validated my doubts. Although, it is too early to call off the relationship: One day or week does not a trend make.

On the fundamental side, Japan’s first interest rate hike in 6 years was accompanied by placating statements of “no intention” of raising rates at consecutive meetings which implies of an orderly pace of tightening. This should reduce the probabilities of a precipitate margin based liquidations of financial assets worldwide.

Second, while my outlook remains for a dovish Fed stance in the face of a deteriorating equity market and softening economy, a continued rally in the commodity markets would most possibly filter into emerging market bourses eventually. If the business cycles study above by Mr. Gary Gorton and K. Geert Rouwenhorst replays itself then possibly commodities are still the place to be in and so with emerging market bourses.

Based on the technical perspective, the outlook remains mixed. Over the short-term especially on Monday, the Phisix may replicate the activities in Wall Street anew and do some backing and filling jobs as it had broken support see Figure 6. The gaps which it had opened would be most likely closed while at the same time trade within the 50-day moving averages (red line) and 200-day moving averages (blue line) over the interim.

I expect some tradeable opportunities in the market despite some interim pressures, simply buy and support and sell on resistances. Keep some long positions on mines and oil for insurance purposes. Posted by Picasa

Lebanon’s Proxy War may lead to $85 to $100 oil?

Last week, I mentioned that crude oil treaded at a critical juncture looking for either a correction or a breakout. With the market’s declarative stand, Oil finally resolved the impasse with a breakout to a FRESH record nominal High. Its sibling gold was equally buoyed as shown in Figure 1.

Figure 1 Record Oil, Gold Follows

While one may argue that seasonality could have also been a factor in oil’s latest upsurge in view of the summer driving season in the US, the breakout coincides with the escalating violence in Lebanon which could have further tipped the fragile scale of balance in the world oil markets.

The public appears to have seriously underestimated the ongoing military developments in the Lebanon, which could run the risks of further escalation. The warring protagonists, Israel and the Hezbollah, seems to acting as representatives for other parties involved in advancing their positions in the Middle East, particularly, the United States and Iran and possibly Syria. In short we could be witnessing an unraveling of a proxy war.

According to the astute guys at Stratfor,

``Hezbollah has two patrons: Syria and Iran. The Syrians have used Hezbollah to pursue their political and business interests in Lebanon. Iran has used Hezbollah for business and ideological reasons. Business interests were the overlapping element. In the interest of business, it became important to Hezbollah, Syria and Iran that an accommodation be reached with Israel. Israel wanted to withdraw from Lebanon in order to end the constant low-level combat and losses...”

``Hezbollah strategically was aligned with Iran. Tactically, it had to align itself with Syria, since the Syrians dominated Lebanon. That meant that when Syria wanted tension with Israel, Hezbollah provided it, and when Syria wanted things to quiet down, Hezbollah cooled it.”

Hezbollah’s possible motivations for the kidnapping and killing of Israelis soldiers which provoked the vindictive strike in Lebanon could be for Iran, 1) to expand its negotiating levers or bargaining chips on its present standoff against the United States on its nuclear program and 2) in lieu of the Al Qaeda, by realigning a global network against US interests, to possibly ‘reclaim its leadership in the Islamic radical resurgence’.

For Syria, a possibility to reassert control or possibly reabsorbing Lebanon and/or to expand its commercial exploits.

For the US, according to the Stratfor, ``an invasion of Hezbollah-held territory aligns Israel with the United States. U.S. intelligence has been extremely concerned about the growing activity of Hezbollah, and U.S. relations with Iran are not good. Lebanon is the center of gravity of Hezbollah, and the destruction of Hezbollah capabilities in Lebanon, particularly the command structure, would cripple Hezbollah operations globally in the near future. The United States would very much like to see that happen, but cannot do it itself. Moreover, an Israeli action would enrage the Islamic world, but it would also drive home the limits of Iranian power. Once again, Iran would have dropped Lebanon in the grease, and not been hurt itself. The lesson of Hezbollah would not be lost on the Iraqi Shia -- or so the Bush administration would hope...Therefore, this is one Israeli action that benefits the United States, and thus helps the immediate situation as well as long-term geopolitical alignments.”

Further, today’s warfare could be a prelude to a US/Israel led military strike on Iran utilizing the present hostilities as cover.

In short, the risks run high that the theaters of war may escalate to include major oil producers as Iran. This heightened anxiety is giving way to a premise for higher oil prices as the drumbeat of war persists. Israel is said to be calling up its reserves, while Syria and Egypt are said to be having on going talks on this matter according Stratfor. $100 per barrel soon?

Based on technical or chart data, using the most recent trough-to-peak move, Crude oil may attempt to go for $85 (!!!) before undergoing a retracement. Posted by Picasa

Politics, Flawed Policies and the Road to Hell

``But there are many others who are not bashful about using government power to do "good." They truly believe they can make the economy fair through a redistributive tax and spending system; make the people moral by regulating personal behavior and choices; and remake the world in our image using armies. They argue that the use of force to achieve good is legitimate and proper for government - always speaking of the noble goals while ignoring the inevitable failures and evils caused by coercion. Not only do they justify government force, they believe they have a moral obligation to do so.”-Congressman Ron Paul of Texas

Oil prices soared to fresh record nominal levels yet domestic media, as we have it, continues to downplay on its significance, relegating such developments to secondary headlines and opting to give prominence to domestic politics. Media, after all, is about entertainment; it is paid to get your attention rather than to inform.

Because of the penchant for drama, personified by top-grossing tele-drama series, the public’s appetite for partisan politics have been constantly whetted upon by the incessant stream of internecine information. While glossing over the ramifications of rising crude prices, in the coming days, you can expect consumer prices in general to rise alongside, and the typical response by some political groups would be to advance on protest rallies using this as cover. As if the toppling of the incumbent government would be able to resolve the imbalances in the heavily politically dictated global oil economics. It never ends.

And because the voting public’s interests are mostly fickle and short-term oriented, the classic response of any democratic governments or its underlying institutions would also be that of immediate-term gratification or appeasement, mostly in adopting policies tilted towards the “appearances” of having significant bearings on “social” dimensions.

Think minimum wage. Most economists are cognizant to the fact that pricing labor costs above what the market can afford to pay have been generally baneful or deleterious to the business climate and contribute more to the unemployment figures rather than solving them, yet because of short-term political demands, such as the Catholic Bishop’s Conference of the Philippines’ (CBCP) adaptation of the ‘Marxist’ view of “priority of labor over capital”, these policies have been commonly accommodated for by policy makers.

Flawed short term policies applied over and over again engenders arrant wedges of inequalities. In short, the glaring conflict of interests between short term political gains for the stark purpose of power preservation and meaningful long-term reforms has been a stirring vacuum in most instances as history have shown are unlikely to be filled. Political players, like anywhere else or for that matter in any form of government, are likely to be subordinate and beholden to the short-term interest of their subjects or interest groups that sustain their existence.

Just ponder, how can long-term structural economic disequilibrium be resolved when political expediencies dictate the appeasement, through the “band-aid” approach, of the public’s divergent immediate term interests?

Today, most governments, be it developed economies and/or developing third world states or taxonomically “emerging market economies” have instead relied on economic growth to resolve such deeply-rooted imbalances borne out of collective policy failures in almost all aspects of governance. They are all in the hope that the present asymmetries will be offset by continuing economic growth. Yet, evidences show that such imbalances get to be accentuated, not diminished.

As testament, money and credit growth, instruments by which collective governments have control over nationally (for US- internationally), has grown tremendously over the years far surpassing the growth in real economic activities. Naturally, such tidal wave of liquidity has percolated into the private sector too. Present inflationary manifestations have been an inevitable product of these. In other words, the offshoot to these state induced interventionists inefficiencies and incompetence are the macro imbalances present in the financial and economic system in the world today. What is unsustainable simply won’t last. But as to when this imbalances would unravel is something I can’t predict. As an example, think of the entitlement programs set to implode in the coming years even among industrialized nations (US, Europe, Japan, due to the colliding impacts from a myriad cocktail of rigid labor and immigration policies, asymmetric capital flows, evolving demographic trends and scientific and technological breakthroughs (converging trends of nanotechnology and biotechnology-which may expand the average lifespan of the population). Nonetheless, such strains would eventually be evinced or transmitted to the financial markets and the global economies.

Despite the cognizance of such variability, most politicians and bureaucrats have largely turned a blind eye on these. Why? Because it requires painful UNPOPULAR structural adjustments, such as hefty cuts in welfare benefits or massive increases in taxation or extended working age requirements or a combination of, something of which they hope would simply go away.

While the gullible public would naturally be enchanted by ‘motherhood’ rhetoric premised on a corporeal “utopia”, who would elect a political actor who would subscribe to worldly pain, e.g. work-saving-investing ethics, as to attain such lofty goals?

My point is simple; voters like the average market investors are after short-term gains and would mainly espouse panaceas in whatever form in pursuit of these. Being personally responsible and observing a regimented way to uplift one’s life is smirked and disdained upon, simply because governments are there and perceived upon as an ‘easier’ channel to provide the short-circuited goals by manner of coercive unproductive redistribution. For an individual, why work or save when government “should” provide? For companies, why be efficient, if they can use laws and regulations to subvert competition, keep costs down and enhance profit margins? Yet, the supreme irony is that despite belaboring governments to live up to expectations (whatever that may mean to you or me), we hate (elude) paying taxes and abhor the perpetual corruption arising from the tentacles of bureaucracy. Still, to quote Murphy’s Law, ``Anything that can go wrong will”. Woebegone, the perpetual vicious cycles of personality based politics!

Nonetheless, statist advocates still believe that Big Brother in government knows what’s best for us. However, even the “noblest” of laws generally meant for our supposed wellbeing have turned out to be a miserable, dismal and disastrous failure. Take for example in the US, the national prohibition of alcohol beverages or the Volstead act of 1919. In an attempt to make alcohol consumption as illegal, the law, according to former US Congressman Bob Baubman (emphasis mine), ``was touted by its backers as the solution to reduce crime and corruption, solve social problems, lower the tax burden created by prisons and poorhouses, and improve health and hygiene in America.”

The net result? According to Congressman Bauman (emphasis mine), ``This ambitiously wrongheaded experiment clearly failed miserably on all counts. Alcohol became more dangerous to consume; organized crime was born; the court and prison systems were overloaded; and corruption of police and public officials was rampant.” In addition, many other repercussions emerged, such as the loss of tax revenues, unbridled smuggling and racketeering, and excess violence according to The feckless “moralistic” (ha ha ha!) law which even then US President Harding hardly observed (as a proponent of the law as Senator, he kept bootleg liquor at the White House!) was finally repealed in 1933.

In the Philippine context, as in every government diktat, quoting Honesto General of the Inquirer (emphasis mine), ``The culture that it is okay for a government corporation to lose money--it's only taxpayers' money, anyway--prevails to this day. There are now over 300 government corporations losing a total of almost P50 billion a year.

As a saying goes, ``The road to hell is paved with good intentions.”