Another Bullseye! The Phisix Weaves Into A New Frontier.

``Elections are won by men and women chiefly because most people vote against somebody rather than for somebody.”-Franklin Pierce Adams (1881-1960) American Journalist

SO it’s all splashed over the headlines; the Phisix has finally joined its peers (global bourses) to set a fresh milestone high!

Yet, against the conventional wisdom where elections have been thought of as a menace to the markets, we unequivocally asserted that given the today’s credit-driven inflationary environment, political exercises would have minimal consequences to our financial markets.

The Election Drivel

In our January 22 to 28 edition article, Financial Globalization and Not Elections Will Determine the Path of the Phisix we said,

``Unless political developments would have an impact on the capital flow framework as that of Venezuela or Thailand, they are unlikely to MATERIALLY affect the capital flow dynamics on our financial asset markets today. Hence, under such premises, the political election like in the past will most likely be discounted.”

And no matter how media in cahoots with mainstream analysts portrays markets as being event-driven, the fact is that trends, and not events (unless it comes on a complete surprise or shall we say “shocks”) largely determine the market’s activities.

Take for instance the assertion that the markets “cheered” the elections or that “peace dividends” have equally caused the market’s elation.

Figure 1: stockcharts.com: Phisix on a CHEER mode since March!

THE week prior to the election proper, the Phisix had already climbed by 2.6% which essentially confirmed our “election spending” theory.

Here we conjectured that the lagging performance of the Philippine benchmark, which had been be traced to local selling, could have been a direct or indirect result of campaign fund raising via the stock market. Hence, if such activities have indeed weighed on the markets, in spite of discordant behavior of the other Philippine asset classes, i.e. firming Peso and the rallying bonds, aside from the buoyant asset classes of our neighbors of the US markets, the Philippine Stock Exchange (PSE) would recover at the eve of the campaign raising. AND IT DID SO!

If we take a gander at Figure 1, the Phisix is limned on an upside “cheering” mode even PRIOR to the elections. POST-elections simply AMPLIFIED such trend with a breakout gap from February’s high on Tuesday (the Day AFTER), and carved a fresh record at the week’s close.

To quote Sherlock Holmes in the crime novel “The Hound of the Baskervilles” ``The world is full of obvious things which nobody by any chance ever observes."

Furthermore, we argued that in a declining trend of the US dollar, foreign money would likely buttress our markets.

Over the past TWO weeks, where the Phisix climbed by an amazing 5.2%, foreign money flows heavily streamed into Philippine equity assets accounting for Php 5.224 billion or about 11% of the aggregate turnover. Moreover, the scale of influx was seen over the broadmarket, which essentially confirms our outlook that the fate of the US dollar has been a key pillar to global money flows.

As we have said before, media loves sensationalism because it has to sell what the public wants. Such is the reason too why market actions are explained away simplistically, where our “experts” join in to add “authority” on the subject matter even if premised on tenuous grounds. This is because, as mathematician author Nassim Taleb says, ``We favor the visible, the embedded, the personal, the narrated, the tangible. We scorn the abstract.”

Because market actions are oversimplified, what would have been the explanation if the markets fell after elections? “Disappointed by election results”, perhaps?

Now, if one considers the elections as the MAIN driver of our financial markets, would an opposition dominated Senate be favorable to the nation’s present political environment? Could it not translate to even more political tumult and instability rather than harmony? Or could it be indicative of an aggravated gridlock, where legislative activities would grind to halt? (I know; they appear to function more as a body of inquisition rather than of legislation, which provides its members ample room for political “showmanship”….or perhaps a public “spectacle”. Yet the public loves it.)

In other words, looking at the political dimension alone hardly suffices for the present bullish theme…IF politics had been the SOLE DRIVER. However, in reality it isn’t. Markets comprise of multitudinal dimensions and variables, therefore, in absence of any meaningful enlightenment, our “experts” speedily arrive at flaky justifications such as the “peace dividend” bunk.

In the same manner, we can see how politicians undeservingly seize the present developments as propaganda opportunities to snare credit.

Figure 2: Stockcharts.com: World Equity Markets on A Bull run!

Where the international financial markets have shown intensifying correlation due to increasing dynamics of financial markets integration, according to Standard & Poors (emphasis mine), ``Based on monthly returns over the past five years, the S&P 500 and the MSCI-EAFE, which tracks developed markets, registered a correlation of 0.85. (A perfect correlation is 1.0.) Similarly, the MSCI-EM index, which represents emerging markets, sported a 0.78 correlation with the "500." Mid and small-cap U.S. stocks also had correlations of at least 0.77 with developed and emerging markets, as well as larger U.S. blue chips”, a 77% to 78% correlation can hardly be assessed as “insular”, it would be downright misleading to impute the domestic market’s record breaking run to “micro” activities, as shown in figure 2.

The chart shows how the world markets have been performing synchronically through the Dow Jones World Index ($DJW-Main window), iShares MSCI Emerging Markets Index (EEM-above window), JP Morgan Fleming Asia Equity (JPAIX-upper below pane) and the Fidelity Southeast Asian Fund (FSEAX-bottom pane) which all have been in a winning streak!

So while indeed several administrative reforms helped boosted the fundamental outlook for the Philippine asset class, it would be inappropriate to read through this as its main driver, since an ocean of liquidity has bolstered global asset classes of diverse nature and in different geographical zones. One must remember that foreign money flows represents a majority of our trades in the Phisix or even in other asset classes.

China’s Financial Liberalization + Global Excess Reserves =Phisix 10,000?

Figure 3: Economist: Asian Hoarders

And speaking of global liquidity, Figure 3 from the Economist depicts of the foreign exchange reserves rich countries which come mostly from Asia and other emerging markets and has signified improvements on their respective economic and financial outlook. In my view, the massive surpluses are indicative of an inflationary boom.

According to Bloomberg analyst Andy Mukherjee (emphasis mine), ``The bloated and growing Asian foreign-exchange reserves are being increasingly financed by an expansion in the monetary base. Base-money growth in China was 21 percent in 2006, double the annual average of 2004 and 2005. It was about 20 percent in Korea in 2006, six times the average in the preceding two years, according to a World Bank report last month.

``Unmistakably, Asia is contributing -- along with petrodollars and Japanese carry trades -- to a surfeit of global liquidity and a mispricing of risk....Standard & Poor's, which raised the credit rating on eight out of 34 emerging-market sovereigns and lowered its assessment on just one in the 12 months through August 2006, is talking about the need to redefine the ``emerging market'' label, and in certain cases, even eliminate it.”

Yes, these excess savings are likely to provide a floor for risk asset classes, where according to Morgan Stanley’s Stephen Jen (emphasis mine), ``This ‘real’ liquidity arises from a mismatch between world savings and investment rates. World capex has surprisingly been too low to absorb all available savings. Annually, there are some US$800 billion worth of ‘excess savings’ from oil exporters and Asian exporters to chase after assets.”

Another buoyant development likely to boost the global equity asset markets could be the recent liberalization actions undertaken by China to allow its residents to invest overseas via the qualified domestic institutional investors (QDII), which is meant to ``allow for an 'orderly outflow of funds' from the mainland and ease pressure on the yuan to appreciate, Hong Kong Monetary Authority chief executive Joseph Yam said.”

While at the onset the estimated QDII licenses covering 18 commercial banks have an aggregate quota of only around US $14 billion, where 50% or about $7 billion would be allowed to invest overseas, this should translate to a minimal impact over the interim.

However, looking at the bigger picture, this reflects a very important breakthrough as the enormous amount of Chinese savings has far reaching potential impact once totally deregulated, according to JP Morgan (emphasis mine), ``the Chinese savings pool of RMB36 trillion (more than US$4.6 trillion) has proven to be too big for the domestic stock market (market cap only RMB 15 trillion, with RMB 6 trillion floatation). EM/Asia stands to benefit the most as Chinese investors would want to have a natural hedge against renminbi appreciation, and Asian currencies are likely to appreciate over the long run along with renminbi to provide the hedge.”

So there you have US$800 million of excess “public” savings plus a potential US $2.3 trillion from Chinese resident investors that could be invested in today’s rapidly integrating world financial markets whose equity market cap according to the World Federation of Exchanges, is about $50.623 trillion end of 2006. And the noteworthy part of it is that a substantial share of these could be invested within the region (Asia’s market cap of US$11.838 trillion or 23% of the world).

Just imagine even if a fraction of the said amount would be invested in the Phisix, such would drive the Philippine benchmark to parabolic heights!

Aside from technical developments in the US markets, these efforts by China to liberalize have possibly led to the “capitulation” of one of my bear favorite analyst Richard Russell. CBS Marketwatch analyst, Mark Hulbert quotes the Dow Theorist practitioner Mr. Russell (emphasis mine), ``We saw something that is extremely rare [on April 20 and April 25], in fact I can't remember ever having seen this before. What I'm referring to is that on those two dates all three Dow Jones Averages, and -- closed at simultaneous historic highs. To me, a fellow steeped in Dow Theory for over half a century, this was like a clap of thunder... My take on the situation is that the stock market (and the Dow Theory) told us that an unprecedented world boom lies ahead."

Short Term Risks: Overheated Markets and a US dollar bounce?

Yes, despite the exuberant outlook, risks abound. Aside from the factors of excessive leverages and speculation, structural imbalances, asymmetric carry trades and untested novel financial instruments, short term risks include an overheated global equity markets following its recent sizzling hot streak. In addition, a potential rebound or rollover of the US Dollar (represented by its trade weighted index) from its recent lows could heighten volatility, as shown in figure 4.

Figure 4: BCA Research: US dollar Poised for a Rebound

Notes the widely followed independent research outfit BCA Research (emphasis mine), ``The U.S. dollar has moved into oversold territory, and according to our capitulation index a bounce is likely. Furthermore, speculators are short the currency and sentiment has been declining for the past 18 months - both measures are often good contrarian indicators. However, the bigger question for the dollar is whether there are fundamental reasons for currency strength. Currently, the global macro backdrop still supports a soft dollar. The U.S. remains the weak link in an otherwise solid global economy and further growth redistribution (via an adjustment in the currency) is likely needed. Still, any signs of improvement in the U.S. housing market as the year progresses would result in an unwinding Fed rate cut expectations and provide support for the currency. Bottom line: Betting on the dollar can be justified purely on technical grounds, but improvements in the U.S. housing picture would add momentum.”

Finally, the breakout from its 10 year range by the Phisix signifies our bullmarket is in a PRIMARY TREND, which places my Phisix 10,000 at a very attainable target.

Most of the questions I receive today allude to what issues are likely to move during this bullmarket phase of the cycle.

Over the past two weeks as the Phisix gained by over 5%, where advancing issues dominated the market with 548 against 432 decliners and 505 unchanged issues, local investors appear to be dithering as foreign money went into a shopping spree.

Because in bullmarkets it is a general rule that ALL stocks go up, previous heavyweight laggards as San Miguel and SM Investments substituted the previous heavy cap favorites in PLDT and the Ayala Group in pushing the Philippine benchmark to its recent record highs. This clearly shows that past performance does not equate to future actions, as the favorites underperformed against the former laggards.

Yet, the average investors can hardly grasp that in a bullish cycle, stocks either go into a rotation or move up simultaneously especially at cyclical peaks. The public believes that micro forces drive the local market when evidences tell us that the present cyclical advance is hardly a “micro” thing.

I’d like to repeat a very important message (which I have practiced) from Jesse Livermore, in his investing classic, Reminiscences of a Stock Operator (emphasis mine), ``I never hesitate to tell a man that I am bullish or bearish. But I do not tell people to buy or sell any particular stock. In a bear market all stocks go down and in a bull market they go up...I speak in a general sense. But the average man doesn’t wish to be told that it is a bull or bear market. What he desires is to be told specifically which particular stock to buy or sell. He wants to get something for nothing. He does not wish to work. He does not even wish to have to think. It is too much bother to have to count the money that he picks up from the ground.”

Believe me, it is a basic rule which works.