Sunday, March 25, 2007

Watching the Tape: We’re Keynesians for the Moment

``The exit strategy is painfully simple: Ultimately, it is up to Ben Bernanke – and whether he has both the wisdom and the courage to break the daisy chain of the “Greenspan put.” If he doesn’t, I am convinced that this liquidity-driven era of excesses and imbalances will ultimately go down in history as the outgrowth of a huge failure for modern-day central banking. In the meantime, prepare for the downside – spillover risks are bound to intensify as yet another post-bubble shakeout unfolds.”-Stephen Roach, The Great Unravelling

Lord John Maynard Keynes once said, Markets can remain illogical far longer than you and I can remain solvent. The statement seems indisputably accurate, and when applied in a different context, it simply means we shouldn’t “fight the tape”.

Yep, markets today have rebounded strongly from its recent shakeout lows last late February, and if one were to use the China’s Shanghai Index as barometer to future directional flows, then figure 1 tell us that what was said to have been the epicenter of the latest bout of volatility had been merely a blip.

Figure 1: Shanghai Composite Index: What Volatility?

The losses during last end-February had been completely erased and with this week’s 5% gain as the Shanghai Index trades at new record HIGHS!

And it is not just a picture of China; we see various markets in all parts of the world, appearing to have been injected with renewed adrenalin.

Figure 2: Carry Trade Still At Work?

In figure 2, courtesy of, we note that the US benchmark, the Dow Jones Industrial Averages (candlestick) bouncing ferociously off its lows coincidental to the decline in the Japanese Yen.

The inflection points (red arrow) of the Japanese Yen seems to ran inversely parallel to the turning points of the Dow Jones (blue arrows) and the JP Morgan Emerging Debt Fund (lower panel-blue arrows).

What this probably implies is that the carry trade is “back in business” and that the declining yen could have provided for the necessary fodder or ammunitions to restore the risk taking activities as reflected by the bounce in emerging market stocks and bonds, as well as in the other asset markets.

While it is to my opinion that the present behavior of markets have been simply cyclical, undergoing a natural corrective phase, then signs are that the US markets following the break from its 50-day, may further advance. However, one noteworthy development is that the breakout came amidst tepid volume (shown above) which leads us to question on the strength or sustainability of the breakout.

The Phisix also has been at the trails of its counterparts rallying 3.52% over the week, with the Peso nearing its record milestone high to close at Php 48.16 per USD over the week. Since we noted that the Phisix and the Peso has shown some relative strength, I will have to change my neutral view on the Phisix, once the Peso breaks its recent high at Php 48.03 to a US Dollar, to a buy.

Of course, IF the Yen have been a crucial factor in determining liquidity conditions allowing for today’s worldwide rally, one must be reminded that the downtrodden Japanese currency in spite of its recent flagging conditions has been drifting near its all time lows relative to the US dollar and the Euro as discussed last March 5 to 9 edition (see US Markets: Risks of Ponzi and Speculative Finance). Hitting support levels usually generate violent reactions which may once again lead to heightened volatility.

The question is IF the Yen has indeed BEEN a pivotal factor in determining liquidity flows.

Figure 3: Rhodes Report: Yen Volatility has led to Financial Market upheavals

In Figure 3, Richard Rhodes of the Rhodes Report depicts of past financial market upheavals as a result of the Japanese Yen’s volatility. Again, a critically oversold Yen may lead to severe market swings which may affect global asset prices.

Of course, others may argue that the recent rebound by the global markets have been due to statement changes by the US Federal Reserve, indicative of a potential shift in FED policy.

Figure 4: Federal Bank of Saint Louis: Market prices in a RATE CUT?

The indicated changes in the recent FED outlook implies of a slightly weakening economy [from “somewhat firmer” to “mixed”], but still concerned over inflation represented by the price indices [“Recent readings on core inflation have been somewhat elevated” and “the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected”]. However, the most striking development in the word parsing game over the FED’s statement was the explicit EXCLUSION OF THE “ADDITIONAL FIRMING” clause.

The market seemed quick to interpret this as carte blanche omission of further rate hikes and instead tilted the outlook toward a RATE cut, as shown in Figure 4. ``Interest-rate futures show a 28 percent chance the Fed will lower its target overnight lending rate between banks a quarter- percentage point to 5 percent on June 28” from a Bloomberg report.

In my view, the shift in the statement represents as INSURANCE, where if the US markets would feel the pinch from the ripple effects of the unwinding subprime mortgage implosion towards a greater segment of economy, the FED has made available its “BERNANKE PUT” option or readiness to deploy its contingent “liquidity of last resorts” measures. So those contending that US FED will not intervene have now been given a preview of what comes next. On the other hand, it also marks the concern of the FED over the degree of landing.

In the event that the US economy decelerates more-than-what is-expected the Bernanke Put would likely be set in motion. Whether such actions will successfully reduce the impact of the deterioration has yet to be known although, I am in the camp of PIMCO’s Paul McCulley and Merrill Lynch’s David Rosenberg (March 5 to March 9 edition, see US Markets: Risks of Ponzi and Speculative Finance), who suggests that any forthcoming slowdown in the FED will be LESS determined by the price of credit, again to quote Paul McCulley ``It is also the case that once a speculative bubble bursts, reduced availability of credit will dominate the price of credit, even if markets and policy makers cut the price. The supply side of Ponzi credit is what matters, not the interest elasticity of demand.”

Yet, the bizarre part is how prices can persist to rise in view of an economic deceleration and declining trends in corporate profits. These shows of how distorted market pricing has been and how addicted the global financial economy have been to “low interest rates” and to the “massive creation and intermediation of credit, derivatives and digital money”.

Another timely reminder comes from, William Hester of the Hussman Funds, who warns that present expectations have been derived from conditions different from the past, ``In any case, investors should keep in mind that the stock market's reaction to Fed cuts has historically been dependent on other conditions such as valuations, economic expectations and the slope of the yield curve. The belief that rate cuts strongly benefit the stock market is based on conditions that don't match the present very well. It's possible that a Fed cut might help the stock market later this year. But given current conditions, history doesn't support much risk-taking based on that hope.”

Well, it’s hard to be overly optimistic knowing the possible risks of Damocles’ Sword hanging over the US and global markets via the Carry Trade or the degree of the impact by an imploding US real estate industry. However, Lord Keynes is right in terms of market’s irrationality, which means we shouldn’t fight the tape. Yet we can ACT on using the tape for our benefit.

History Is Not a Closed Book: Signals from Noises, Seeing Opportunities in Problems

``All political thinking for years past has been vitiated in the same way. People can foresee the future only when it coincides with their own wishes, and the most grossly obvious facts can be ignored when they are unwelcome."-George Orwell

FINANCIAL markets thrive on dissenting opinions. An exchange occurs when a buyer, who buys on the general premise that the price of the financial security will rise in the future; in contrast to a seller, who sells on usually the belief that price of the same financial product will fall, agrees to consummate a deal on an agreed price. And because markets are mostly about psychology and human action, subjective convictions are parlayed into actual risk-taking activities. Curtly said, differences in outlook make trades possible.

Since we write about the financial markets, being that “what we see depends on where we stand”, our opinions are usually subjected to validity test by MEASURE of PERFORMANCES. Markets continually give us a HUMBLING experience where we are often reminded of our vulnerabilities to countless errors from actual SUFFERING or losses. Hence, we try to avoid losses or the angst of suffering by LEARNING from our past mistakes. And in doing so, we countenance the possibility of such shortcomings by keeping an open mind or by accepting views in contradiction to our biases. Therefore, an imperative quality of a successful investor’s mindset is one’s ability to DISTINGUISH the requisite SIGNALS from the confounding NOISES. Some information matters while others don’t.

So in trying to winnow signals from noises, we go back to our assertion that Japan’s aging population will be forced to alter the construct of their “homogenous” society, the latest news from Japan Times shows us some telltale signs ``The Japan Business Federation (Nippon Keidanren) has proposed that skilled foreign workers be allowed to get temporary full-time working positions at Japanese companies in areas where Japanese workers are scarce....The federation said those foreign workers should be accepted from countries that have signed economic partnership agreements with Japan and should be limited to those with skills in areas where Japanese workers are scarce.”

Of course, this is aside from the recent FTA agreement concluded by Japan and the Philippines to test the waters of accepting nurses and caregivers to compliment their declining labor force. In short, demographic trends are gradually shaping the political and economic framework of Japan. What used to be will NOT be.

We see a similar case but from a different angle in India, whose economy seems to resemble our own, allow me to quote at length another favorite columnist of mine, MSNBC Jim Jubak. Please bear in mind that this article is imbued with political, economic and investing dimensions (emphasis mine),

``Somewhere between 30% and 40% of the country's crops rot in the fields or spoil in transit because of the country's creaky infrastructure. There simply isn't any way to get the food to market in time. What does make it through the supply chain is subject to huge markups at each stage of the process, because getting food from warehouse to distribution center to retail store to consumer is so time consuming and cumbersome. Consumers pay twice as much for wheat, for example, than do wholesale buyers. That adds another layer of inflation to food prices at a time when food inflation doesn't need any help in running wild: Wholesale wheat prices jumped 54% between April and November 2006.

``Agriculture isn't the only sector of the economy paying the price. On overcrowded highways, speeds average less than 20 mph. Major cities in some Indian states cut power to factories one day a week. Ships have to be unloaded manually and cargo manually loaded onto trucks. Getting cars the 900 miles from the factory to the port at Mumbai takes one automaker 10 days.

``India spends just 4% of its gross domestic product on infrastructure in comparison to the 9% spent in China. That disparity has existed for more than a decade. As a result, while China has 25,000 miles of expressways, India has just 3,700 miles.

``Facing what amounts to a rebellion by the rural poor over soaring food costs that is likely to cost the ruling Congress Party power in New Delhi, the government budget released in March promises to tackle the infrastructure part of the problem by raising spending on roads, bridges, airports, etc., by 40%. But the government isn't stopping there: It is promoting public-private partnerships on infrastructure projects that are projected to invest $300 billion to $500 billion over the next five years.”

Our take: The political survivorship of its ruling class DEPENDS on delivering affordable basic services to its constituents, where infrastructure bottlenecks in the face of rising demand has resulted to pressures of rising consumer prices which has affected its rural poor.

Hence, the political elite seeks to undertake projects which would facilitate MARKET FORCES by increasing ACCESSIBILITY, promoting COMPETITION and permitting FOREIGN CAPITAL to finance these in order to accomplish such goals. So what you have here is NOT your moral “virtuous” order at work but of allowing market forces to solve its economic and political problems.

On the investing dimension, it goes to show that the infrastructure boom is in GLOBAL LATITUDE which should continue to provide underlying support to the global commodity cycle.

Essentially you have been presented with TWO outstanding complementary themes, INFRASTRUCTURE and COMMODITIES. Notwithstanding, the rapid growth in key emerging markets with SIGNIFICANT POPULATION offers various LATERAL opportunities in many aspects of a rapidly changing world where a ``TRIPLE CONVERGENCE – of NEW players, on a new PLAYING Field, developing NEW processes and habits for HORIZONTAL collaboration”, to quote Thomas Friedman in his marvelous book the WORLD is FLAT, could likely be the important forces that would shape politics and economics in the 21st century.

India and Japan’s present evolutionary experience can best be observed by the following prescient quote lifted from John Maudlin’s equally magnificent book “Just One Thing” on James Dale Davidson and Lord William Rees-Mogg in the Sovereign Individual in 1997...

``In short, the future is likely to confound the expectations of those who absorbed the civic myths of 20th century industrial society. Among them are the illusions of social-democracy that once thrilled and motivated the most gifted minds. They presuppose that societies evolve in whatever way governments wished them to-preferably in response to opinion polls of scrupulously counted votes. This was never true as it seemed 50 years ago. Now it is an anachronism, as much artifact of industrialism as a rusting smokestack. The civic myths reflect not only a mindset that sees society’s problems as susceptible to engineering solutions; they also reflect a false confidence that resources and individuals will remain as vulnerable to political compulsion in the future as they have been in the 20th century. We doubt it. Market forces, not political majorities, will compel societies to reconfigure themselves in ways that public opinion will neither comprehend nor welcome.

Finally we argued that the main reason why the Philippine economy has been sluggish is due to its dysfunctional markets, prompted by various forces. Although we have dealt with this in the past, our aim is to show how inadequate our financial sector has been in providing the necessary savings and investment channels for our domestic capital investments and the corresponding support for the consumer sector.

Figure 5: Barry Ritholz/Wall Street Journal: Banking on Consumers

As shown in Figure courtesy of another favorite analyst Barry Ritholtz, the Philippine banking sector represents only 55% of our GDP considering that the banking sector has been the traditional, if not the dominant source of financing for our enterprises in contrast to developed countries or to some of our neighbors.

Although the chart INTENDS to show of a probable shift from an export-driven paradigm to a consumer driven growth engine by heavyweight emerging markets as India and China, the insufficiency of their financial infrastructure and the narrow breadth and depth of its banking system makes such transition to be graduated. Even so, the massive ongoing wealth transfer from the West to Asia makes such direction almost inevitable.

In the investing spectrum, if you share the conviction that emerging market economies will advance to a level near the developed worlds then investing in the FINANCIAL INFRASTRUCTURE and its BANKING system, which may enhance the breadth and depth of its markets in support of its economic goals are the way to go, aside from the earlier themes I mentioned.

Cloaked beneath every problem are opportunities, seeing it is a matter of choice.

Monday, March 19, 2007

Additions to History Is not a Closed Book

In reply to a comment from a reader, I'd like to make additional clarifications.

Age of Derivatives.

According to BIS, derivatives turnover has reached $431 trillion in October to December alone. According to Financial Week, the notional amount of outstanding OTC (over the counter) was $370 trillion for the first half of 2006 alone. OTC means these are private contracts and are unregulated by authorities.

In addition derivatives is a financial instrument “derived” from some other underlying securities.

Our global economy is only about $45 trillion, while estimated global capital stock is $143 trillion which means derivatives are about 7 times global economy or three times global capital stock.

Since derivative contracts should "derive" from collaterals of other securities this means that the world is 3 times as much leveraged than existing global capital stock.

As Lord Rees Mogg says “Now we have a fashion for high leverage – in derivatives, in private equity and in hedge funds. The global financial system has spread its sails. The momentum is awe-inspiring. There is less transparency than there used to be – investors do not understand derivatives; hedge funds are less transparent than old fashioned investment businesses; private equity is less transparent than public companies.”

While derivative products are meant to reduce risk by diffusion, they do not imply a risk free environment, to quote Kevin Warch, member of the board of Governors of the FED in his speech on Market Liquidity Definitions and implications, ``Even the most sophisticated financial products are not immune to the physical Law of Conservation of Matter – the risk must rest somewhere.”

Well, Warren Buffett, from his personal experience, thinks that Derivatives are a menace and even labels them as Financial Weapons of Mass Destruction.

Keynesians and inflationary policies.

When we say no country wants a strong currency, it means that in order to preserve or gain from the market’s export share, countries’ tend produce or “manipulate” far more money relative to that which is required for economic growth.

For example, if EU’s GDP growth is at 2.5% and money growth is 9.8%, effectively you are seeing a greater supply of money relative to demand. And when supply is larger than demand effectively you reduce the value of the goods or services which is in surplus, such is Economics 101.

The problem here is that all countries are engaged in mass money production and such is the reason why Gold, which is neutral currency, has progressed relative to ALL major currencies and such is the reason why you also see rising consumer prices all over the world.

Best explained by Paul Van Eeden ``When we understand that monetary inflation means an increase in money supply and that an increase in money in money supply causes a devaluation of all the money outstanding we can make sense of the world even as economists, journalists and politicians attempt to obscure the truth.”

You can read more of about this through his link.

Even John Maynard Keynes, in his The Economic Consequences of the Peace (1919) piece acknowledges the dangers of monetary inflation or “no country wants a strong currency” phenomenon, ``There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

Yet practicing Keynesians (or government interventionists) believe that savings is not an applicable function today simply because they think they are fungible (transferable to assets) and governments will always be the buyers or liquidity providers of last resorts.

As evidence we cite Wharton’s famous Jeremy Siegel, ``Could they precipitate a crisis? Not with the Fed on top of it. The Fed can diffuse any crisis. If everyone gets on one side of the market and things are out of control, the Fed is the ultimate source of liquidity. I think that they can prevent that from spinning out of control.”

Oh, am not Keynesian, as I mentioned, I lean on the Austrian School of Economics persuasion, where real savings matter.

Moreover into currencies, while one may think that the world is trying to “stabilize fluctuations”, what appears to be is not what is. Do you know that Warren Buffett, Bill Gates and George Soros have all bet against “stability” such that they understand the risks of a potential US Dollar Crisis? All the imbalances chatters seem to stem from one source, today’s US Dollar Standard system or Fiat/Paper money system.

Japan and Selective Arguments

The reason I made a comparison on Japan is that self-righteous arguments present only one side of the coin, as earlier explained as cognitive biases. For a balanced view, I injected a broader dimension which considered the suicide rates, credit rating and more importantly demographic trends. The intent is to show a BIGGER picture.

Yes, while I agree that Japan is a homogenous society, investors look to the FUTURE to position for returns. And we understand that economies will NOT thrive under a population that is NOT growing, NOT increasing its TAX base and ECONOMIC base to quote analyst John Maudlin. Therefore, demographic trends will mean a CHANGE in the societal structure of the Japanese in order to maintain their economic weal. What used to be will not be.

As I earlier argued CHANGE is the defining structure of today’s economic landscape from which investors should pay heed to. You may read more about demographic trends in UN’s Replacement Migration.

With regards to India, I’ve said my case.

On Rapid Population Growth

The problem of rapid population growth is not the growth per se. It is the inability of investments to keep up with the pace of its growth, which leads to productivity loss.

In today’s world, aggregate investments are low compared to the past, according to the IMF. And we simply see an upswell of financial markets relative to global GDP which means people are deploying capital derived from thin air to outright speculations rather of direct “productive” investments, hence the global imbalances.

In addition, the context of rapid population growth straining resources has been a longstanding Malthusian argument. To quote Elliot Gue, of the Energy Letters, ``Nevertheless, Malthus’ prediction has proven spectacularly incorrect in the two centuries since his Essay on Population was published. While the global population has continued to grow at the geometric, accelerated pace that Malthus projected, food production also rapidly accelerated after 1750 to more than keep up with that growth. The UK’s population exceeded 17.5 million by 1850 and topped 60 million by the latter part of the 20th century. More importantly, the total world population is at least six times what it was when Malthus penned Essay on Population. Not only has the population increased but so, too, has the consumption of food per capita.”

In other words, today’s commodity cycle has not been solely driven by the dynamics of growing population but of the dynamics of RISING purchasing power from a BROADER base of population. Again Elliott Gue says it best (emphasis mine),

``The United Nations predicts that by 2050 the global population will rise from the current six billion to exceed nine billion, with 5.2 billion living in Asia. Clearly, a growing population spells more demand for all sorts of food. But population growth in Asia plays only a tiny role in the boom in demand for food already apparent in the region. A far more important factor is rapidly rising Asian incomes and the emergence of a middle class. As nations develop and consumers become wealthier, food consumption patterns change. Not only do consumers eat more food, they tend to eat more meat and greater quantities of packaged and processed foods. Income is not the only determinant in these shifts--local tastes, religious practices and regional supplies certainly have an effect--but it is the primary factor behind differences in food consumption between countries and shifts in diets over time.”

I hope this helps.

Sunday, March 18, 2007

Filipinos’ “Flawed” Culture? History Is Not A Closed Book

``It’s one thing to talk about ethics, but quite another to adhere to them. An ethical person consistently acts in accordance with his code of moral values. By contrast, a hypocritical person preaches a high standard of morality, but acts otherwise.” –Robert Ringer, A Wisdom-Filled Self-Eulogy, Part II

Price is a function of exchange subjectively valued by multivariate economic actors. And exchange is a function of markets, whose output (aggregate of production distribution, services, remittances, investments et. al) determines what is known in economics as your statistical GDP or GNI.

While academic textbook defines economics as a study of how forces of supply and demand allocate scarce resources, calculations to determine such resource allocations can ONLY BE done through the concept of pricing. The failure of the political paradigm known as “communism” was primarily an UNRESOLVED problem of economic calculation under centralized planned authorities or the inability to do away with pricing or with money. Who needs money in a Utopian society, anyway?

Financial markets or capital markets, serve as a mechanism of exchange for financial products; hence they operate under the same principle. Needless to say, today’s global economic environment have been dominated by so-called “paper shufflers” where financial assets overwhelm the real value of aggregate exchange of goods and services by about 3 to 1. As evidence we cite, McKinsey Quarterly’s estimate of the total global capital stock is $143 trillion whereas global output as about $44 trillion in 2005. In short, finance dominates today’s global economy.

Since value is determined by individual minds, then markets are basically psychologically driven. Having said so, in the realm of financial markets the psychological or emotional attributes of GREED, FEAR and HOPE serve as universal variables in determining value. So, whether you are long term investor, trader or a scalper, and REGARDLESS of color of the skin, culture, religious beliefs, political convictions and etc, such attributes accompanies the way decisions are made.

So whether we buy San Miguel Corp shares in the stock exchange or we buy a bottle of San Miguel Beer in a Bar, grocery or in the neighborhood Sari-sari store (as I did last night), (The difference being that of the platform of where the exchange is conducted.), essentially you are looking at the same operating principle; MARKETS AT WORK. My simple message is that MARKETS are the economy.

In the lay context, what is all so often labeled as “economic deprivation” translates effectively to AN INADEQUATE EXCHANGE MECHANISM that result to negative ramifications of poverty, inequality or low quality of living or simply said, DYSFUNCTIONAL markets (caused by distortion or underdevelopment).

For instance, how does our agricultural worker, representing the largest workforce in the Philippine labor pie, improve on their share of income when they continue to rely on the traditional channel (market), or in particular the “traders” (who gets a big chunk of their profits), for the exchange of their produce? In other countries, including our peers, they get not only full value of their produce (by bypassing middlemen) but have the ability to HEDGE their products from variable risks factors such as weather, seasonality and etc.

Therefore, the key question is HOW to resolve on what INHIBITS our markets from functioning at the optimum for the benefit of, what politicians and their factotums by nature call as the “common good”. Yet, media and celebrity pundits frequently tackle on tangential issues to becloud the perception of the public while politicians eagerly jump on controversies to use such opportunity to impose more “controls”. Again this reminds me of one popular quote by Dr. Samuel Johnson, one of England’s greatest literary figures, ``Patriotism is the last refuge of a scoundrel."

Since psychology drives capital deployment decision making, whether motivated on grounds of political (e.g. public institutions) or economic goals, we are inherently subject to heuristics (mental short cuts) or inherent biases. After all, we are merely humans, where our ancestors have basically shaped the functionality of our minds and biases operating under survivorship conditions then. As an example, fear leads to our natural defensive reaction (against predators) such as running!

We easily succumb to oversimplifying events based on our present knowledge giving us the “illusion of knowledge”. And because we think that we know the problem, hence we usually give out our “one-size-fit-all” remedies/panaceas out of the “illusion of control” on our perceived woes.

As examples, the recent circulating email describes of our “Flawed culture” (or “national inferiority complex”), which is no other than a recycled, resurrected makeover of the James Fallows’ Atlantic Monthly’s 1987 controversial piece “Damaged Culture”, or of common polemics on overpopulation, lack of education, cultural diversity, fragmented society, pervasive “corruption”, lack of “safety nets”, patronage politics, inadequate social spending, “unsophisticated” voters and others, all of which contribute to the lack of productivity or have been cited by different quarters as responsible to the present state of our depressed society.

While all of them may have SOME influence to the country’s downtrodden state, the weightings or relevance applied are different and will continue to shift as the landscape evolves.

Because these are ALSO elements to our living and breathing network of exchanges or markets, they are predominantly multi-dimensional variable based and NOT singular factor determined operating under the evolution of dynamic environments. When we say dynamic we mean changing micro and macro dynamics, such as new regulatory environments, shifting consumer/voter preferences, demographic and migratory trends, wealth changes, climate changes, capital flows, technologically and scientifically driven advances, inflationary driven psychology, et. al..

In other words, some problems contribute more than the others while some factors may nonetheless be rendered insignificant over the passage of time.

On the other hand, external factors have likewise been shown to have grown more in influence to the structural changes in our environment. For instance, how does one reckon with the so called “lack of national identity” dilemma operating in the FACE OF EXPLODING MIGRATORY TRENDS (UN says-about 191 million migrants in 2005 and growing) under the auspices of deepening trends of globalization?

No, the migratory trends today, which used to be driven mainly by seeking for “greener pasture” have now seen other sources of impetus; global demographic requirements, “ethnic reconsolidation” to quote the Economist, taxation, politics and et. al., have not been directed merely on labor skills (although they constitute the significant majority) but to growing trends even among the investor class. Hence, could we be at the cusp of the emergence of global citizenship?

Daniel Altman who writes for the International Herald Tribune and YaleGlobal (emphasis mine) says it best, ``...citizenship is becoming less and less about patriotism. In obtaining a second or even third nationality, earning a living is often a higher priority than confirming a sense of identity and belonging. Seeking a better deal from society can also be a prime motivation.”

The issue here is that market and economic environments are highly complex in nature and continually operate under fluid circumstances, where nothing is definitive except for change.

We also read of proposed simplistic solutions to our miseries, as being “Attitude” in nature, specifically, Ethics, Integrity, Responsibility, Respect to the laws & rules, Respect to the rights of other citizens, Work loving, Strive for saving & investment, Will-accompanied by super action, Punctuality and Community service, citing nations which have openly espoused such virtues as “progressive”. While I do not contest the INTENT of the message, as it is indeed IDEAL, the truth is HOW I WISH it were APPLICABLE or REAL.

For instance, while I would agree that Respect for Property rights and Personal Responsibility are key ingredients to functioning markets, the need for savings for instance would be an arguable topic. The others look like political gimcrackery.

Of course, through the Austrian persuasion I have learned that real savings are indispensable because they represent real wealth. However, practicing Keynesians would argue, “Huh? Who needs savings in the age of derivatives? With the combination of “money created from thin air” and the dawn of “digital money”, why save or produce when we can simply speculate? Have not savings today been represented by rising asset values?”

As we earlier mentioned today’s world is more of finance, ergo a Keynesian world. No country wants a STRONG currency and thus every country works to destroy or debase the value of their currency. These are manifestations of the inflationary proclivities. Nonetheless, beyond the knowledge of the public, inflationary policies serve to benefit special interest groups associated with the powers that be (for preservation). Yet, is it not a wonder why the widening worldwide inequality gap has been a consequence of collective INFLATIONARY POLICIES adopted by Keynesian protégés ensconced in central banks and in government bureaucracies?

One should also remember that today’s leaders maybe tomorrow’s mediocre performers or that Empires operate on their own CYCLES too. Have we not been colonized by Spain for over 300 years when they were yet at the helm of the world? Whereas the 19th century belonged to the England, the United States took over the mantle in the 20th century following the World War I.

One can have a short glimpse of the time intervals of shifting empires since Man’s civilization began, as illustrated by, as shown in the link below:

Do you think that history ends today?

To wit, such assertion of a simplified Utopian solution have been grounded on cognitive biases such as “framing” [ heuristic in which people tend to reach conclusions based on the 'framework' within which a situation was presented], “representativeness” [James Montier of Dresdner Kleinwort--the judging of events by how they appear than they likely are] and “fallacy of composition” [ infers that something is true of the whole from the fact that it is true of some (or even every) part of the whole].

For instance Japan having been mentioned as one of such virtuous examples/practitioners. If they have been so puritanical, why have Yakuza’s (Japanese Mafias) thrived in such environment?

Or consider the suicide rates; among developed countries Japan has the most incidence of suicide statistics according to WHO, 36.5 for males and 14.5 for females for every 100,000. Compared to the Philippines, 2.5 and 1.7, or India 12.2 and 9.1, respectively. Should this imply that they are richer but we are happier (reword: appreciate life)? So which among these qualities should be highly valued? Or which should determine a nation’s success, a higher per capita GDP or lower suicide rates? (Now I pose to you a counter-FRAMING question.)

You might want to know that Japan’s credit rating is at the level of Botswana, an African nation, considering its about 160% public debt to GDP. Or of its declining or shrinking population from which if present trends persists, NO Japanese will be left standing by the next century (!), to paraphrase an official.

Who then pays for all of the debts incurred by them UNLESS they radically change, in terms of culture, i.e. to accept immigrants as part of society, empower female to close the gender gap and to increase fertility rates, and in politics, i.e. allow further ingress of immigrants? [Faced with Hobson’s choice, the inevitable reform path makes me bullish on Japan].

Morality, argues Steven Levitt and Stephen Dubner, ``represents the way that people would like the world to work-whereas economics how it actually does work.”

If history were likewise determined by such idealistic virtues, then John Lennon’s world of “Imagine” would possibly be realized on a pragmatist level and we would all be living in harmony with reduced conflicts. Yet as shown above history belies such utopian setting.

Yet the problem with moral solutions lies in its DEFINABILITY. The broad coverage makes them seem like motherhood statements mouthed by political demagogues. Another, moral solutions usually serve as cloak for more regulations or Spending Other People’s money (SPOM), which in most part have been the ROOT cause of the market asymmetries here or elsewhere.

In addition, we can argue about Switzerland’s success (specialization) or of Canada and Australia (market and commodity driven economies) or of Vietnam (China modeled-liberalization), but moralizers make the same predictive fallacies as that with typical market analysts; projecting past performances into the future.

For example, to argue that India is poor and imply to remain so (Oh yeah?), simply because they do not follow the said virtues, is predicated on the analogy that mechanical rotary telephones will never change.

Figure 1: Goldman Sachs: BRICs on the Run

The emerging markets phenomenon known as the Brazil, Russia, India and China or BRICs as labeled by Goldman Sachs shows if the present clip of growth rates were to persist, your unvirtuous paragon will SURPASS the virtuous ones as shown in Figure 1. Says the Goldman Sachs study in 2005 (emphasis mine),

``They suggest that if things go right, the BRICs could become a very important source of new global spending in the not too distant future. The chart below shows that India’s economy, for instance, could be larger than Japan’s by 2032, and China’s larger than the US by 2041 (and larger than everyone else as early as 2016). The BRICs economies taken together could be larger than the G6 by 2039.” The assumption here is for present conditions to maintain its pace which is a big IF going forward.

Yes, the meaningful transition in support of these evolving trends are becoming more apparent, this latest account on the convergence of global pay for managers, according to Financial Times (emphasis mine), ``Forecasts of wage increases in more than 50 countries, published by consultants Hay Group, reveal that real pay is predicted to race ahead in Asia and eastern Europe this year compared with the "developed old economies". Faster wage growth reflects "the wealth creation being generated by rapid economic acceleration in China, India, the former eastern bloc and the Baltic states," says Hay.”

Again, if such trend persists, the income levels for managers in today’s developing “POOR unvirtuous” countries (Philippines, India, Vietnam Egypt or others) and the developed world could reach near PARITY sometime in the distant future!

Nor is it limited to wages, Forbes list of billionaires shows of a growing trend of successful entrepreneurs from your unvirtuous countries, quoting William Pesek of Bloomberg (emphasis mine), ``Yet Forbes's latest tally says even more about what's happening within Asia. India wrestled the top spot in Asia from Japan, which held the title for two decades. India has 36 billionaires with a total of $191 billion; Japan has 24, with a total net worth of $64 billion....Following the money offers insights on the changing of the guard in world's most-vibrant economic region. Japan once dominated Asia, yet developing powers like India and China are moving to center stage. Expect more of the same in the years ahead.

Before bringing this to a close, I’d like to show you another “human” cycle phenomenon which should affect the global markets, economies and or politics alike over the next few years or so.

Figure 2: Puru Saxena/ Barry Bannister, Stifel Nicolaus: Commodity Cycle

It’s called the commodity cycle. And the upturns of commodity cycles have been in the past associated with wars, simply because supply shortages create intense competition which eventually spillovers to the political arena, as shown in Figure 2.

As Dr. Marc Faber explains (emphasis mine), ``But it’s not only the commodity-importing nations that become more belligerent when shortages drive prices higher. The commodity producers themselves find they are in a sweet spot and become more aggressive in their relationship with their clients — the resource-importing nations. So, whereas we have seen that in the 1980s the balance of power in the world began to shift towards the industrialised nations as commodity prices fell, today it would appear that the balance of power has already shifted back to the resource producers — especially the oil producers. This shift of power to the resource producers is particularly pronounced when new countries and regions become involved in the “trade network”, as Kondratieff observed, because the demand from the traditional sources is, as a result of the entry of new countries into the global economy, gradually displaced by the incremental demand of nontraditional and new sources.

Today’s upturn in the commodity cycle once again reveals of patterns of bellicosity as seen in the geopolitical developments of the Middle East (Iran, Iraq et. al.) and the rising tide of “nationalism” in Russia, Venezuela, Bolivia and others which are potential sources of future conflicts.

As historian Niall Ferguson warns in his War of the World: History’s Age of Hatred (emphasis mine), ``We shall avoid another century of conflict only if we understand the forces that caused the last one-dark forces that conjure up ethnic and imperial rivalry out of economic crisis, and in doing so negate our common humanity. They are the forces that stir within us still.”

In finale, since economies are the aggregates of functioning networks of exchanges or of markets, psychological underpinnings dictates on its cycles, most commonly characterized by greed, fear and hope.

Division of Labor enhances the exchange mechanism and allows for more social cooperation which leads to the so-called ATTITUDE “moral” solution. The successes or failures of economies have been ascertained by multi-dimensional variables which influence on the degree of the operativity of the markets.

In essence, the FUNCTIONALITY OF MARKETS ESSENTIALLY DETERMINES THE WEALTH TRANSMISSION. The so-called success formula has ONE coincident denominator, a market based economy.

Critiques or analysis of perceived inadequacies accompanied by “moral” solutions based on “selective” information reveal of MENTAL DISHONESTY and or the lack of understanding of the dynamics of market based cycles and evolutionary shifts in the global economic landscape to pass “undeserving” judgments.

The risk is such that we fall into the cognitive traps obviously laid by vested “political” interest or their functionaries to promote regressive policies camouflaged in the name of “common good”. Worst of all, is to repeat the same mistakes of our forebears.

Remember, today’s commodity cycle tell us that shortages and rising prices have tendencies for hawkish attitudes that may lead to undue “belligerency” or aggressiveness. It would be better for us to promote social cooperation via increased trade and work on to improve on our markets than to undergo violent upheavals brought about by the order of closed societies “nationalism” or “myopic” populism.

With regards to the Philippines being a “Damaged or Flawed” culture, history is not a closed book. Believing so, only imprisons one to corridors of the past.

A Correlation Is A Correlation Until It Isn’t

``We view financial risk much like popcorn popping in a microwave. Until the first kernel pops, one tends to believe nothing's happening...the initial pop seems like a random event until the second occurs. A third. A fourth. Then the popping goes wild."-Richard Bernstein Merrill Lynch chief investment strategist quoted in Time magazine.

There has not been much change in the markets this week since shakedown began at the end of February. For the moment, we still see a semblance of the same variables that appear to be influential forces at work.

Our Phisix was down 1.21% over the week, as global markets appear to be on a downward trek. Our inspirational leaders the US markets have likewise been down, the Dow Jones Industrials lower 1.35%, S&P 500 1.13% and the Nasdaq .62%.

In the meantime, we saw the Japanese Yen significantly higher up 1.19% while the Swiss Franc likewise higher 2.17%. The significance of these currencies as we have mentioned previously is that they have been presumed to have acted as FUNDING currencies for the so-called CARRY TRADE arbitrage, where the yield spreads against the other currency pairs, have been used as leverage to invest into other asset classes. Such has been said to have provided for the gains in the global cross-asset markets via increased liquidity, which has supported risk taking activities.

The recent turn of events has demonstrably been coincidental with the movements of such currencies giving credence to the belief that the CARRY TRADE could have been a significant factor in the recent upsurge in volatility. Declines in equity and credit markets have been simultaneously seen with the ferocious rally in the Funding currencies.

Yet, this phenomenon called the CARRY TRADE has gone against the traditional economic wisdom called “uncovered interest parity” where to quote the Economist (emphasis mine),

``Countries that offer high interest rates should be compensating investors for the risk that their currency will depreciate. In other words, the forward rate should be a good guess of the likely future spot rate.

``In the real world, uncovered interest parity has not applied over the past 25 years or so. A recent academic study has shown that high-rate currencies have tended to appreciate and low-rate currencies to depreciate, the reverse of theory. Carry-trade strategies would have brought substantial profits, not far short of stockmarket returns, although dealing costs would have limited the size of the bets traders could make.”

In other words, some traditional economic theories as cited above do not seem to apply in today’s rapidly evolving marketplace. Such is the reason why markets may seem so illogical, simply because they act to defy on our beliefs or of past paradigms. Again, the lesson being that past performances does not guarantee future outcomes.

I, for one, while being a skeptic, have observed at this amazing “circumstantial evidence” of correlation, but would not simply write off the possibility or probability of its causal relations with the actions in the financial markets today.

Since the world is undoubtedly extremely leveraged, the carry trade could simply be a part of the growing mechanism to accommodate more leverage.

Nonetheless many analysts, some of whom I highly respect, dismiss on the premises of its correlation based on the lack of direct evidence, in the form of official flows. The Bank of International Settlements (BIS), an international organization of Central Banks, have largely been neutral about this, as evidence have been “mixed” based on global claims as shown in Figure 3.

Figure 3: BIS Tracking the Carry Trade

Claims in Japanese Yen or Swiss Francs have not established any material footprint as with regards to the much touted CARRY TRADE in play. Although the BIS admits that quantifying or measuring the volume of carry trades have been “problematic”, the best evidence they could come up with could be seen via Forex Futures.

According to Patrick McGuire and Christian Upper of BIS, ``Data on open positions in exchange-traded FX futures in potential funding and target currencies provide the strongest evidence for a growth in carry trade activity in recent months. Noncommercial (“speculative”) short positions in yen futures traded in the United States rose between mid-2006 and late February 2007, particularly during periods of yen depreciation (Graph B, righthand panel). By contrast, speculative short positions in the franc yield little evidence of an increase in futures-based carry trades over this period. Data on speculative long positions in FX contracts on the main developed-country target currencies increased considerably in the second half of 2006, but declined somewhat in early 2007 (Graph B, right-hand panel), consistent with the rise and subsequent fall in the carry-to-risk ratio over this period. However, the weekly movements in this ratio appear to explain little of the changes in speculative positions, although the relationship is statistically significant for some currencies”.

As we always say, a correlation is a correlation until it isn’t. While our aim is to distinguish signals from noises, we see correlations as possible clues for signals in determining the future directions, as in the case of the Phisix and the Philippine Peso shown in Figure 4.

Figure 4: Inverse movements of the Phisix and the Peso

The blue arrows above shows of the inflection points of the Peso and coincidentally they have also proven to be counter inflection points for the Phisix, represented by the red arrows. When the Peso declines relative to the US dollar, the Phisix falls vice versa. The correlation seems to have become emergent in 2005.

I have asserted in numerous occasions that portfolio flows at the margins have determined the price variability of the Peso, in contrast to the conventional wisdom that remittances have been its key driver or of other factors suggested by our experts.

If my observations remain valid or cogent, we will see the same patterns unravel as the Phisix corrects or consolidates on the GROUNDS of foreign portfolio outflows on the “reappearance” of global risk aversion.

I believe that markets always convey some latent messages via its price action, so I listen to them and heed their messages instead of trying to “rationalize” or deliver a simplified explanation on their behavior in contrast to our experts or my contemporaries.

My observations of the Peso’s correlation have not been limited to the Phisix but also for Philippine sovereign bonds. In short, circumstantial evidences points to the validity of my theory that the Peso asset classes are set at the margins by portfolio flows.

Figure 5: Philippine Sovereign 2 year and 10 year yields

As you can see in Figure 5 courtesy of, the spike in the Peso over the same rising risk aversion event in May of 2006, simultaneously manifested a jump in the USD relative to the Peso, the decline in the Phisix and equally a jump in yields (falling bond prices) for Philippine sovereign debts.

If I am correct that the countertrend phase is still at work, then the likelihood is that all three markets could show of the same degree of correlation over the interim.

Finally, I still think that today’s market activities are natural cyclical transitions playing out unless proven otherwise. Question is if we are going to see fundamental support for this decline, particularly on the risk of a US recession, this raises the risk of greater degree of volatility.

However, unlike in 2006, today’s shakeout has NOT seen a safe haven rush towards the US dollar. Instead the US dollar, as measured by its Trade weighted Index, continues to swoon even as volatility continues to snowball.

While others argue that emerging markets will drop like a stone if the US goes into a recession, in contrary, I think that the emerging “stagflationary” environment in the US will translate towards further decline in the US dollar and be supportive of the precious metals class and of the emerging markets.

The likelihood is that we will see a departure from presently aligned correlations of ALL market classes with those that thrive under such defined environment.

Following former banker and Citicorp Chairman Walter Wriston’s (1919-2005) principle, ``Money goes where it is wanted and stays where it is well treated”, Asians have treated money well relative to its Anglo-Saxon counterparts and therefore, money flows should be expected to continue.

Sunday, March 11, 2007

Hope is A Good Companion But a Poor Guide!

``Risk can be a friend or foe and as an investor you will succeed or fail depending on how you deal with it. Risk is inherent condition of all investments and should be respected, assessed, managed and prudently controlled.”-Ed Easterling of Crestmont Research, Risk is Not a Door Knob

TO some, my words of caution have been viewed as displeasing or unwelcome, as I had been expected to play the role of a perpetual cheerleader for the markets. There are even those of you who think that my views as that of a messenger of doom, a party spoiler. ``Therefore, whoever thinks he is standing secure should take care not to fall.”-Corinthians 10:12

Yet the reality is that parties don’t last. They never do. And betting on unfounded optimism can result to capital losses or mental anguish or a combination of both. As market savant Andy Kessler quotes his friend, ``The stock market trades to inflict the maximum amount of pain”. Pain especially for those who apply vanity to the markets. As we have said before, people get what they deserve.

You have to understand that my sustenance depends on being MAINLY profitable, which means reading, analyzing and acting right. Even when we maintain certain convictions, we certainly avoid from FIGHTING THE TAPE because previous experiences tell us that doing so leads to emotionally wrenching losses. Instead, we treat the trend as our friend. And even among hardcore chartists, they will tell you that markets are rangebound 80% of time and trends only 20%.

While we may not be always precise, we can consistently be profitable for as long as we principally act to PRESERVE our capital. And in doing so, we bank on the wisdom of Aesop’s principle with the foremost question in mind, is the bird in the hand is worth more than two in the bush?

Yes, our market operates in a juvenile state, such that it has been a ONE WAY street for investors; one can only earn from consolidating or advancing markets. When the cycle turns, all our investors can do is to sit on the sidelines and wait. Having said so, our fate depends on these conditions unless hedging facilities do come on stream. To my knowledge, hedging facilities such as short trades or the development of the option markets are still on the design boards yet [shorting may come soon].

In my case, I have made use of the advancement of technology and globalization trends to position on the overseas markets, particularly on Asian markets, as to diminish my home bias [expand my country risk profile] and reduce my dependence on the developments in the local markets.

In the aftermath of the recent tremors in the global markets, the bulls have been quick to respond with the conviction that the recent drop would be quick one, where like a storm, would be gotten over with soon. I do hope so too. But as Mark and Jonathan Finn of the Vantage group says ``HOPE is a good companion but a poor guide”.

Phisix: Market Indicators Suggests for Further Corrections

``Markets are cyclical – always and forever. As share prices oscillate between lofty valuations and lowly ones, investor perceptions oscillate between greed and fear. When investors are fearful, they demand a large margin of safety from the assets they buy. But when they are fearless, they worry less about safety than an intoxicated teenager.-Eric Fry, Whack-A-Risk Rude Awakening

Figure 1: Corrective Phases of the Phisix

Judging from past experience of if one would use past data to extrapolate on the future, the shortest corrective phase of the Phisix since 2002, was in 3 months, i.e. October 2004 to January 2005, as shown in Figure 1.

The end of the corrective cycle is determined by its breakout from its previous high. The numbers indicated in the chart shows of the months it took for the Phisix to eventually supersede its previous highs.

As you would notice, one of the core pillars of my analysis has been anchored on the understanding of market cycles, where market cycles are principally determined by psychology as previously defined. And the present market cycle implies that the corrective phase is a natural phenomenon.

Since the start of the cyclical reversal in 2003, declines as measured by peak to troughs had an average period of about 2 months, where if applied to the current settings (topped at February 21) would possibly translate to a trough sometime latter April. (That’s IF the cycle plays out as in the past! But what if HOPE or the bulls are right?) The rest of the months which follows the trough represents as the healing phase or a period of consolidation segueing into gradual ascendance.

There is also the seasonality factor. You’ve probably heard of the axiom “Sell in May and Go Away”. While this may not always hold true, it simply implies that the seasonal periods of May [50:50 for May-June in a span of 22 years] heading towards the third quarter COULD be the weakest link for stock performance.

In other words, based on cyclical and seasonal factors alone, the odds for a short-term massive comeback looks obscure, or your two birds in the bush in exchange for the present one comes with significant obstacles.

Yet this does not even consider the degree of the upside gains relative to its possible percentages retracement.

If one were to use the Fibonacci figures, based last July’s trough until the peak of February 21 as possible indicators, the levels of retracement are at 2,890 (38.2%), 2,750 (50%) and 2,550 (61.8%). Pardon me for practicing financial astrology [in accordance to Benoit Mandelbroit’s thoughts on chart reading] here. So far the Phisix has yet to reach any of these natural retracement or fallback levels which may suggests of further room for retracements.

Question is, with the current developments and at present levels is it worth the risk to underwrite?