Sunday, October 28, 2007

On Political Controversies: A Little Economic Analysis Can Go Along Way

``All data indicate that the more objectively educated people become today, the more likely they are to trust the state as a means of social salvation. You can map this demographically. The higher the level of education, the more the inclination toward socialist thinking. Why is this? Hayek might say that it has something to do with the hubris of intellectuals who believe that they can concoct a better social order in their minds than the one that freedom can create. Mises might draw attention to the resentment on the part of intellectuals, that they are not as valued by society as entrepreneurs or sports stars. Rothbard might point out that intellectuals are drawn to the state as a way of legitimizing their ideas and securing their financial well-being.”-Lew Rockwell, President and founder of the Ludwig von Mises Institute, the First and the Next 25 years

If the Glorietta 2 blast turns out to be an accident instead of a ghastly terrorist activity, then our observation, which had earlier demystified the political complicity largely sold by politicians and media and bought by the politically obsessed public, appears to have been validated.

Like in the financial markets, this simply shows how the fickle public easily embraces oversimplified explanations to issues bereft of logical arguments. And naturally, when an issue is stripped of the political equation, the public’s attention simply gravitates to the next controversy. Easy come easy goes.

It never ceases to amaze how we never seem to realize of mainstream media’s implicit principal role of SELLING SENSATION, with politicos and their affiliates serving as their feedstock--where the heavily promulgated notion of a “collectivist” political economic renaissance can be seductively acquired from the simplistic exercise of “virtues based governance” or from the leadership “game of musical chairs” or from a bigger “welfare based system”. Since the said solutions appear to be so easy to achieve, isn’t it a wonder why such “appealing” formulas has been paradoxically so elusive…since time immemorial? Yet, for most analysis, selectively choosing on facts to prove assertions on such premises rather than objective appraisal manifests of how we never seem to learn from history or even from developing trends.

For us, any present gains derived from such dynamics are likely to be short-term in nature and illusory. Without the attendant material reforms in the country’s deeply entrenched system of a political “semi-feudal” patronage framework to a culture of entrepreneurship, we are unlikely to see our version of “Shangri-La” or an end to such controversy focused political leadership cycles. Today’s affluent modern nations have existed mostly not due to a single particular leader, but through its economically empowered people. We recall China’s opening campaign transit towards a market economy from a communist regime with Deng XiaoPeng catchphrase, “To get rich is glorious.”

Besides, since it is mainstream media’s business to sell controversies, hence there will always be controversies to be found. Moreover, as information gets diffused via the non traditional channels aided by advances of technology, controversies are likely to permeate to wider range of issues and to flourish even more. Again like in the financial markets, today’s environment can drown you with an ocean of information, yet, what matters aren’t the superficialities of the sensational, but of the substance. Author Steven Landsburg says it best, excerpted from his book More Sex is Safer Sex, The Unconventional Wisdom of Economics (highlight mine)…

``The problem with the news is that it tends to be reported by journalist majors. That’s probably better than letting them design bridges, but it does call for a certain skepticism on the part of the reader.

``Even when the facts are right, the interpretation can be very wrong—especially on hot button issues like racial profiling or outsourcing, where prejudices run deep. If you want to know what’s really happening, a little economic analysis can go along way.”

Phisix and Global Markets: A Momentum Play In the Face of Adversity

``The moment we want to believe something, we suddenly see all the arguments for it, and become blind to the arguments against it."-George Bernard Shaw

We had earlier contended that the market would react with temporal influence from the recent unfortunate Glorietta 2 incident. Unluckily we have not been accorded the opportunity to witness its solitary effect, since a big drop in the US markets preceded a bloodbath in global markets, particularly reflected in Asia, this week. Succinctly put, the 3.98% drop of the Phisix last Monday was seen from the reflections of the Glorietta 2 blasts and most importantly, a ripple from the US markets. It is the latter that has likely impacted the Phisix more than the sordid Makati incident.

Anyway, global markets recovered strongly from Monday but our Phisix ended the week down by .91%. The Philippine benchmark greatly lagged its highly spirited neighbors, such as Indonesia (up 2.37%), Thailand (+2.14%), Malaysia (+2.06%) and Korea (+2.94%) this week, where we cannot yet rule out the potential impact of the last Friday’s incident, as shown in Figure 1. Although, since the authorities have leaned towards the accident angle, media have correspondingly shifted away from the issue to focus on ex-President Joseph Estrada’s pardon which has similarly dissipated analysts attribution of Glorietta 2 incident to market actions.

Figure 1: Buoyant ASEAN indices

What can be factually observed was that foreign selling had stepped up for the second straight week to the tune of Php 2.561 billion, its highest scale since the week which ended in March 2 of this year. Another, the share of foreign participation has been below 50% of the aggregate Peso trading volume for the third consecutive week or about 45% this week. Notably, all these suggest that local investors have taken the drivers seat.

Now since local investors are likely to be politically infatuated than their foreign contemporaries based on the PSE’s previous experiences, then it would be sensible to argue that if the Glorietta blasts had a negative impact then such could have negatively affected the trading activity patterns of local investors, which doesn’t seem so.

Nevertheless, foreign selling has been seen even prior to last Friday, although they doubled from last week. So while these data suggests that the recent activities could have little connection from last Friday’s adverse Makati incident, it remains to be seen if present operatives will continue.

Bullish Premise: Buoyant Region, Halloween Indicator and Strong Asian Currencies

Given that the US markets have closed strongly last Friday, together with upbeat sentiments in ASEAN markets, also seen in Figure 1 where Indonesia ($IDDOW-highest pane below Phisix) appears working for another breakout, Malaysia ($MYDOW-lowest pane) recently brokeout, and Thailand ($SETI-middle pane) at resistance levels, we are inclined to view that the present optimistic momentum could likely continue for the Phisix (main window) barring any shocks.

Further with the Peso at Php 44.06 against the US dollar, a SEVEN year high, where if the recent firming short-term Phisix-Peso correlation should hold, this should augur well anew for the Philippine equity assets.Figure 2: Halloween Indicator

Next, if we take the potential direction from the US markets, the inspirational leaders of global equities, seasonal strength could likely be a force that may support momentum, as shown in Figure 2, where the November to April cycle has been historically favorable for investors. This should likewise support the US presidential cycle which could translate to a positive yearend.

Bearish Premise: Rising Risk Aversion, Worsening US Housing Recession, Narrowing Market Breadth

Nonetheless, we cannot write off the risks which persist to becloud the US economy and its financial markets aside from questioning the health of the global credit system as risk aversion has not been the same as prior to the July Credit Crunch.

The highly reputed independent BCA Research, shown in Figure 3, while maintaining a bullish stance remains equally cautious…

Figure 3: BCA Research Risk Aversion Returns

From BCA Research (emphasis mine), ``Renewed concerns emanating from weakness in U.S. housing, further turmoil in the financial sector and credit markets have sparked a broad-based selling of financial assets. Over the past couple of days, implied volatilities have moved higher, carry trades have begun to unwind, stock indexes across the globe have taken a haircut and government bond markets have rallied. While further downside is probable in the near term, a bear market in risky assets is unlikely: The global economic backdrop remains decent despite a weak U.S. economy, and further monetary easing will be provided. Investors should continue to bet on reflation, but also to expect heightened volatility and a further narrowing in breadth of the advance to persist heading forward, particularly in the U.S.”

And speaking of narrowing market breadth, since the US markets have been strongly up due advances in the overseas levered technology sector, analyst Mish Shedlock points out that the chunk of these advances came from only three stocks see figure 4…

``Of the 400 NASDAQ points we're up this year, 206 came from three stocks. Apple (AAPL): 127, Research in Motion (RIMM): 47, Google (GOOG): 31”

Figure 4: Narrowing Market Breadth?

A narrowing market breadth refers to growing divergences in the general market where the advances of an index have been mostly due to select issues. Such deteriorating breadth could be indicative of a maturing bullmarket or could even presage a top.

Nevertheless Mr. Shedlock notes of the high P/E ratios from which the investors have priced in for the recent market leaders: “Google (GOOG): 55.91, Research in Motion (RIMM): 81.39, Apple (AAPL): 52.57”

Reflation Trades And Policy Steroids

Better still, global markets have presently been elevated from expectations of “reflation trades”, where as we had repeatedly pointed out (market on steroids or Dr. Jeckll and Mr. Hyde), each time the financial market undergoes some volatility, chatters of policy actions by central banks have cushioned and stirred up a buying frenzy in the equity markets.

Nonetheless such reflation trades have been quite visible with the record breaking week for the global financial markets as reflected in a record low US dollar, all time high for oil prices and 27-year gold prices! See figure 4.

Figure 4: Evidences of Reflation trades

The Euro heavy US dollar trade (upper pane) weighted index continues to decline on expectations that Fed instituted monetary policies will be effected in support of the asset markets while gold (upper pane below main window) and oil (main window) have risen on the account of fundamental demand supply disequilibrium aside from the deterioration of the US dollar.

In addition, the continued strength of emerging markets appears to have been backstopped by rising commodity prices as the Reuters-CRB Index (lower window).

We think that the markets have been manifestly underestimating the potential threats posed by the continued degeneration of US real estate industry to its economy as well as to the global credit markets, which has not fully recovered.

Recently the Bank of England said that its financial system is vulnerable to another shock which threatens to spillover to its economy, from the Timesonline (highlight mine),

``Britain’s financial system is vulnerable to new shocks in the wake of its most severe challenge for decades, and banks and authorities must learn the lessons of the crisis, the Bank of England says today.

``In its first detailed analysis of the squeeze that has engulfed credit markets since the summer, the Bank says that financial institutions have become more fragile and that the availability of credit may tighten. In turn, it sounds a warning that tighter lending conditions could spell serious fallout for the economy, with sub-prime borrowers and highly-leveraged companies particularly exposed.

Similarly the IMF recently warned of the heightened risks of a Global slowdown, from (highlight mine),

``World economic growth is expected to slow next year, with recent turbulence in financial markets triggered by the fallout from the US subprime mortgage market clouding prospects," the IMF said in the October 2007 World Economic Outlook.

``Risks to the outlook, however, are firmly on the downside, cantred around the concern that financial market strains could deepen and trigger a more pronounced global slowdown. Thus, the immediate focus of policymakers is to restore more normal financial market conditions and safeguard the expansion," the report adds

While remaining long term bullish on Asian equities we think that there is a real risk where volatility could pop out from nowhere and spoil the fun over the interim. Staying completely out seems to be a poor option, unless one believes that the world will undergo a depression spasm. Instead, selective positioning based on one’s risk profile should be considered. Nonetheless, as the markets remain heavily on policy steroids, we will play by the momentum and manage risk accordingly.

Learning From Warren Buffett’s Recent Actions

``Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well.” - Warren Buffett

Unlike the average speculator, who prefers mainstream media and general forums as primary sources of information, it has become an obsession for us to improve the way we manage our portfolios by learning on how great investors manage theirs.

So instead of paying a hefty price for a Certified Financial Analyst (CFA) title, which does not guarantee one’s success except for a job at an investment house or financial institution, we try to keep track of materials or developments or analysis of our favorite investing icons on how they deploy their capital while comprehending on the way they approach the financial markets by possibly reading them literally or through their actions.

While we cannot totally assimilate on their investing styles, where like thumbprints our investing patterns are unique from each other with respect to returns expectations, risk profiles, time preferences, value formation and tools utilized to make investment decisions; we can adopt from them some of the positive characteristics as part of our portfolio management.

For instance, we have long noticed that the world’s greatest stock investor, the Sage of Omaha, Mr. Warren Buffett who was once a micro “bottom up” investor have been transformed into a macro “top-down” investor when he became cynical of the US economy, the US markets and the US dollar.

As an example the following are some of his known earlier quotes…``If we find a company we like, the level of the market will not really impact our decisions. We will decide company by company. We spend essentially no time thinking about macroeconomic factors” or ``Betting against America has been the stupidest thing since 1776.”

Today, Mr. Buffett is looking at “macroeconomic factors” as well hedging against America by heavily betting against the US dollar. Recently, one of the revealed secret currency holdings of Mr. Buffett had been the Brazilian Real as disclosed in an interview in Fox News.

In short, Mr. Buffett assumes on the changing conditions of the financial markets with an appropriate adjustment in his capital deployment strategies. So aside from patience, discipline, humility and full appreciation of risk return trade offs, Mr. Buffett’s other strong attribute is his ability to be flexible by keeping an open mind.

Yes, while his flagship company, the Berkshire Hathaway, recently sold their holdings in PetroChina shares with a stupendous gain of over 10 times, his move could have been construed as having yielded to pressures from several shareholders protesting PetroChina’s indirect political exposure to Sudan, through its parent company China National Petroleum Corp, where the African government is accused by the US of supporting the latest incidences of genocide. It is said that Berkshire has retained a very small exposure (about 3.15%) to the company from which would not require much of public disclosure.

Following last year’s $4 billion acquisition of 80% of Israel’s Iscar Metalworking Company and UK based retailer TESCO, Mr. Buffett has been on a spree to acquire about 20 South Korean Companies such as Posco (a steelmaker whose largest export market is in China and Japan), Kia Motors, Shinyoung Securities Co, Dae Han Flour Company and others.

Aside, Mr. Buffett’s acquisition during the last 6 months included 3 railway companies in the US, Burlington Northern Santa Fe, Norfolk Southern Corp and Union Pacific Corp, health care providers as United Health Group and WellPoint Inc., Pharmaceuticals as SanofiAventis and Johnson and Johnson, Financials as Bank of America and Dow Jones and Industrials as Ingersoll Rand (according to

Figure 5: Berkshire Hathaway’s Portfolio Distribution

Berkshire Hathway’s distribution has been weighted towards the financials, since his core business is the insurance unit General Re, and consumer goods, which he finds as easy to understand-ergo in a much better position to weigh risk, as seen in Figure 5 courtesy of

If there are any clues that we can get from Mr. Buffett’s recent activities is that aside from directly hedging against the US dollar via the currency market routes, Mr. Buffett has been steadily building his company’s portfolio’s exposure towards emerging markets especially in Asia.

It is likely that this move could be representative of his first wave of investing forays into the Asian markets and could possibly increase his exposure soon, possibly in Japan and Taiwan, although he has recently warned of the steep appreciation of stocks in China. In effect, Mr. Buffett’s increasing presence in Asia buttresses our position that Asian stocks are in a secular advance phase.

Another, his recent exposure towards the railway business could be construed as a parallel play on commodities which has been levered to global growth. In addition, his recent buys in the pharma and healthcare sectors is a position on the retiring Baby Boomer generation and demographic trends.

In all, this is not to imply that we should copy his investing patterns or mimic on the issues which he positions but rather understand the reason why he has taken such actions. If we agree on the premises of his investing themes then we can act to invest accordingly based on the domestic market’s universe of available stocks.

Sunday, October 21, 2007

Glorietta 2 Bombing: A Message In A Box?

``The idealist argument -- that a country that pursues only its physical and economic security will lose its moral foundation -- is not a frivolous argument. At a certain point, the pursuit of security requires the pursuit of power, and the pursuit of power is corrupting. At the same time, pursuing justice without a sufficiently large sword will get you whipped.”-George Friedman, Stratfor

Our deepest condolences and sympathies to those affected by the recent blasts in Glorietta 2.

Coming across the news reports, numerous speculations or accusations had been made as to who or which party has been responsible for such dastardly act. Of course, the easiest part is to fingerpoint, the hardest part is to produce evidence supporting such allegation.

Most of the missions undertaken by terrorists are about political missives or symbolisms which it desires to project or convey to the public or to their constituents. Usually deaths and destructions are merely associate collateral damages or part of the props of which the culprits or perpetrators use to highlight their message.

Take the case of the infamous Sept 11, the said essence of such undertaking was to send a message to some ideological religious factions that the perceived impregnable state of the US was actually “vulnerable” to attack, and simultaneously should have stirred as a rallying point for similar religious ideological upheavals in some parts of the world.

According to Stratfor’s Fred Burton (emphasis mine), ``Among its primary objectives in carrying out the 9/11 attacks was sending a message of empowerment to the Muslim people and sparking a general uprising that would culminate in the rebirth of the Caliphate. While the envisioned uprising did not materialize, it has become increasingly obvious that al Qaeda's message of empowerment and the call to jihad has resonated strongly with some people.

``Another objective of 9/11 was to spark an American retaliation -- a goal in which al Qaeda obviously succeeded. The U.S. invasions of Afghanistan and Iraq have been viewed by many in the Muslim world as aggression against Islam, and for grassroots militants (especially those of Generation Y) this is reason enough to act.”

Put simply, if a mission was specifically designed to transmit a particular message then the underlying tactical operatives had been thoroughly acquired as to signify its context.

Said differently, the targets was not picked out of the blues or by mere randomness, the Glorietta 2 attack was deliberately determined, planned and executed like any high profile terrorist projects over the past years in order convey a particular message directed to a specific audience.

For instance, it took Al Qaeda’s 9/11 about two years for realization. In the same frame, it is highly probable that the Glorietta 2 project had taken some considerable time period for gestation. The implication that anyone could have pulled out such events randomly for specious political goals runs on the lines of politically biased and logically incongruent arguments. If the latter had been the truism then evidently Metro Manila bombings would have been a regular fare or subjected to daily if not weekly bombings.

To the point that if the objective had been simply to scare off investors, then the potential targets could have been instead the Bangko Sentral ng Pilipinas or the Asian Development Bank, the NAIA, Export Processing zones or even the Philippine Stock Exchange.

Or why not Boracay or known beaches or tourism spots where foreigners frequent as the Bali bombers targeted in 2002…if foreigners had been the target? This apparently isn’t so.

Now using the same line of reasoning we ask why Glorietta 2? Why NOT the other malls or marketplaces?

Given the security complacency arising from the recent nonevents, our two cents tells us that these areas had been equally vulnerable if such had been their premeditated goal.

On the other hand, if the objective was allegedly to create a “martial law” atmosphere, then simultaneous terrorist activities all over the metropolis ala the Rizal Day December 2000 irrespective of the quality of the targets would have been more plausible to paint the appearance of concerted destabilization or to portray the inability of the administration to secure the premises of its sovereignty, most especially within its natural domain, the Malacañang. Hence, the required police or military state.

For a martial law planner, the more the incidences, the better, as the degree of casualties won’t be much of a concern relative to the scale of attacks. But this doesn’t look so, as the large number of casualties appears to be part and parcel of the design.

Yet, a one-off event like Glorietta 2 unlikely justifies the “purported” mission. This is not 1972, where communists groups were at the fringes waiting for the opportunity to pounce on the metropolis for control, from which the administration had sufficiently used an alleged internally generated ambush to secure a mandate for 14-year dictatorship. Meanwhile, the residual rabid Communists regimes of today are fast decaying societies so much so that the progressive counterparts have “opened” their economies and culture to a much globalized world. In short, there exists no conditional resemblance to 1972 to rationalize such actuations.

The allegation of employing political diversion is a probable motive but seemingly not a compelling one, unless one has become so desperate as to distort their values to exact tributes of blood from the populace. And this applies to both political camps. Political diversion or destabilization can always come in different forms or avenues without the necessary bloodletting especially from the vulnerable public, from which we ask anew why Glorietta 2?

Lastly we must not forget that the executioners of the plot are risk takers, in other words, success of their mission depends on the continued secrecy and the effective precision implementation by the participants involved in exchange for a desired goal.

As risk takers they require calculated action. And perhaps these incorporates operational procedures such as detailed planning, surveillance, logistics and resource mobilization, role modeling to actual execution. Any miscues would have given them away to the web of intelligence of the authorities or to the mall securities. A single deviation jeopardizes the entire project or diminishes the efficacy of their mission.

This runs in contrast to the common perception brought about by media reporting-bombers don’t just walk into malls and casually explode themselves to thy kingdom come. These are not suicide bombers. Nor do they walk in liberally unchecked by the security to deliver their package and leave. That would look too easy and would be seeing these happen all too frequently.

Nonetheless, it is unlikely too that such misdeed could represent as vindictive action against the owners of the property. The risks and logistics involved are simply too high in order to attain an “emotional/egotistical” outcome.

Of course, we could be wrong about all of these. But the likelihood is that the architect/s of such despicable act is one/are those that bears some malevolent ideological underpinnings against the local elite from which their message appears to be directed at. As to what benefits was gained or would be gained is simply beyond us for now.

But as the recent event shows, politics like the markets appear to function somewhat similarly in the sense that people can easily attribute causes to events to the point of absurdity or incredulousness.

Glorietta 2: Event Driven Reactions Are Short-Term Oriented!

``Prices are not driven solely by real-world events, news and people. When investors, speculators, industrialists and bankers come together in a real marketplace, a special, new kind of dynamic emerges-greater than, and different from, the sum of the parts. To use the economist terms: In substantial part, prices are determined by endogenous effects peculiar to the inner workings of the markets themselves, rather than solely by the exogenous actions of outside events.”- Benoit Mandelbroit, The (Mis) Behaviour of Markets

The public tends to equate bombing incidences to affect the markets negatively. While in many instances such observations have proven to be accurate, the connections have not been CATEGORICAL.

For instance, the December 30, 2000 or the series of “Rizal Day” bombings, which resulted to 22 fatalities and over 100 injuries, the Phisix reacted with a 3% decline during the following trading session.

On the other hand, the much deadlier February 27th Superferry bombing which according to had been the “worst” terrorist attack in the Philippines that accounted for 116 deaths, was largely ignored by the markets; the Phisix even registered a marginal gain of .8% during the next trading day!

We see the same reaction across the globe.

In October 12th 2002, the bombing of Indonesia’s tourist haven of Bali killed 202 of which 164 were foreigners, saw its main benchmark fell 10.3% in the next session. Madrid’s March 11, 2004 coordinated bombing in its commuter train system which accounted for a death toll of 191 and over 2,500 injuries, also suffered 3.5% loss the day after.

Just last Thursday, a day prior to the unfortunate Glorietta 2 incident, Pakistan’s former Prime Minister Benazir Bhutto’s return from exile was met by suicide bombings which claimed 133 lives. Meanwhile, Pakistan’s Karachi 100, which had been on a sizzling hot winning streak, simply shrugged off the event to even post a measly .2% advance on Friday.

As a possible clue to how the local market would respond, the Philippine Peso had enough time to reflect on last Friday’s day of abomination, since the bombing occurred at around 1:30-40 pm while the domestic currency market closed at 4:30 pm.

The USD-Peso opened higher at 44.15, compared to Thursday’s 44.05 closing. In the wake of the Glorietta 2, the Peso stormed to a high 44.355 but eventually closed at 44.24 or .4% higher than Thursday. In short, while such terrorist actions negatively affected the markets as a knee jerk reaction, such events tend to get DISCOUNTED going forward.

Figure 1: Previous Bombing Incidences and the Phisix

In Figure 1, the previous bombing encounters, marked by the green arrows, shows of the disparate reactions by the Phisix over different time frames, the purpose of which is to prove the LASTING effects of the perceived “event” based determined market reactions.

The 2000 Rizal day bombing saw a one day decline, but surged over the quarter following Ex-President Estrada’s ouster, and massively declined going to the end of the year (down by about 37%).

In contrast, the February 2004 Superferry bombing registered slight one day gains, was mixed over the quarter but was significantly higher at the end of the year (up over 20%).

No, Rizal day’s bombing was not the causative agent for the year end decline of the Phisix. By looking at the big picture, one would understand that the 2000-2002 as the LAST LEG of the Phisix BEAR market cycle which COINCIDED with the decline in US markets and its ancillary economic RECESSION. The Rizal day bombing was an unfortunate incident that was eventually glossed over by the market.

A similar reaction can be viewed from the US. The infamous 9/11 2001 incident occurred when its markets had already been cascading, this we discussed in our September 17 to 21 edition (see Comparing Past Outcomes From FED Actions Is A Gambler’s Fallacy). The shocking event aggravated the prevailing dour sentiment and steepened the market’s decline instead of prompting it.

Incidentally, both markets (US and the Phisix) bottomed in late 2002 to 1st Quarter of 2003 and interestingly, rose almost synchronically until recently.

The same dynamics goes with 2004 Superferry incident; the year end gains had been confluent with the STRENGTH in the global markets. All the negative reactions arising from the bombing incidences of Bali or Madrid or the rest of the world have proven to be BUYING opportunities since all of the equity yardsticks had been significantly higher today relative to the occurrences of such incidences simply because global markets have surged!

True enough, while the odds are strongly tilted in favor of a significantly lower Phisix (give or take 3% down) on Monday’s opening, or of any markets subjected to terrorist’s activities, the dominant sentiment which will determine long term investor returns will be established by much larger and far more complex factors than simply than the aftermath of Glorietta 2.

Unless one is privy to the plans by criminal perpetrators, no one can accurately predict when such events will happen and correspondingly take requisite actions. A rational investor would instead ascertain variables which should determine the longer horizon of the market’s direction rather than ridiculously attempt to “time” the markets over the short run. In short, investors should weigh on the risk-return tradeoffs in determining their decisions rather than be held hostage to emotional vagaries.


1. “Events” based market reactions are largely knee jerk reactions and dissipate over the longer period.

2. The markets have NOT been EVER been SINGLE variable determined over the broad picture. While one factor (as events) could outstrip the others into influencing the short term activities in the markets, many long term variables determine directional flows of the each of the markets (currency, commodities, bonds, stocks etc.). Paraphrasing Warren Buffett mentor Ben Graham, over the short term the market is a voting machine, over the long term a weighing machine.

3. Investor’s returns are determined by the appreciation of and corresponding action in terms of long term cycles and trends.

Phisix: A Tug of War Between the US Dollar and US Markets Determines Outcome

``And of course, one of the new rationales to justify the dollar trend of late is this canard: A tumbling dollar is “really very good” for the US economy. Yeah, sure it is! Can you imagine how much better off the average US citizen would be if the dollar fell to something like 40 on the US dollar index? Heck, in a world where Mr. US Consumer imports more goods than he ever did in the past, imagine if his global purchasing power was cut in half. That would be just dandy wouldn’t it! Where do they come up with this nonsense?” - Jack Crooks, Black Swan Capital

While Glorietta 2 will take our markets down for over the short-term, one potential variable with far greater risk influence is the recent turn of events in the US markets.

As the investing public widely knows, July’s market downturn had been an offshoot to the recent seizure in the global credit system that has led to a bout of liquidity driven selling prompted by the commonly touted “subprime” losses.

Following the coordinated efforts by global central banks to restore or normalize the liquidity flows in the global financial system, the markets have shown strong signs of recovery to the point that many global equity indices have succeeded to surpass previous highs. This astounding pace of rebound has somewhat restored confidence into the marketplace.

Yet, regardless of the stream of successes in the equities front, we pointed out how the global credit markets have failed to completely normalize which posed as the proverbial “Damocles sword” over the recent bacchanalia.

The justification from which has lent the global markets a considerable upside momentum had been

1.) the expectations that the vigorous global economy would continue to cushion the US economy from a hard landing as evidenced by the robust performances of industries with substantial exposure to the global economy, and

2.) the “don’t fight the FED” arguments or that investors would continually be shielded from steep losses by the “Bernanke PUT” or the tendency of the US Federal Reserve to keep injecting liquidity into the system to buoy the financial markets and keep the Main Street from falling into a recession.

Such positive spin has concomitantly been reflected in the performance of the US dollar index which has evinced of continued infirmities (drifting in uncharted lows) in the face of potential inflationary actions by the US FED.

US Dollar Woes: Exodus of Foreign Investors in August

Yet, the somber part shows that where US had been heavily dependent on foreign central banks as a backstop to bridge the capital flow gaps from its current account deficits, the recent turmoil has prompted these stopgap actors to visibly reduce their holdings on US dollar assets. The US requires around $70 billion dollars a month or about 25% to 30% of portfolio money to fund commercial papers market during the last two years.

According to the US Treasury International Capital flow for August the US recorded a negative $69.3 billion capital flow where both foreign public institutions and private investors shied away from supporting US denominated assets as shown in figure 2. Leading the pack of the exodus included major Asian trade partners as Japan and China.

Figure 2: Net Security Purchases By Foreigners Turns Negative!

This from the Ambrose Evans-Pritchard of the Telegraph (highlight mine), ``Asian investors dumped $52bn worth of US Treasury bonds alone, led by Japan ($23bn), China ($14.2bn) and Taiwan ($5bn). It is the first time since 1998 that foreigners have, on balance, sold Treasuries….

``Central banks in Singapore, Korea, Taiwan, and Vietnam have all begun to cut purchases of US bonds, or signalled an intent to do so. In effect, they are giving up trying to hold down their currencies because the policy is starting to set off inflation.”

So, from an orderly adjustment comes the heightening risk where the US dollar could unwind violently.

Black Monday’s 20th Anniversary: A Sympathy Decline?

Friday, October 19th was the 20th anniversary of the fateful Black Monday Crash, the worst ever one-day decline experienced by the US markets which resonated around world, where the Dow Jones Industrials tumbled by 22.6% in 1987!

The anniversary appears to have undesirably been met with a “sympathy” decline in the US markets where the Dow Industrials fell steeply by 366.94 points or 2.64%, S & P 500 39.45 points or 2.56%, and the Nasdaq 74.15 points or 74.15%.

The aggregate losses over a weekly scale were remarkably broadbased which can be seen in Figure 3.

Figure 3: S & P: Week on Week performance by Sector

While figure 2 tells us that most of the damages were associated with the industries DIRECTLY linked to the US housing recession and sectors affected by slackening domestic consumption, which has been as expected, we are alarmed by the steep falls in the previously globally levered sectors as the information technology and the energy sectors and the consumer staples with overseas revenue exposures of 56%, 56% and 47% respectively (revenue weightings according to the Sam Stovall of the S & P).

Week on week the financials continue to bleed heavily down 7.62%, followed by consumer discretionary, Utilities, Materials and Industrials with losses of over 3%.

Could it be that foreign selling in the US securities has PRESENTLY spilled over to equities as part of the diversification out of US dollars?

Figure 4: Foreign buying of US Equities still positive but dropping steeply!

Foreign support for US equities has mostly emanated from Europe and the Rest of the World, where Asia had been a marginal net buyer since the start of the year.

However, the sharp drops in the degree of buying in August comes mainly from Europe and the ROW and has steeply dragged down the overall 12-month sum and the 3 month annual rate as shown in Figure 4 courtesy of Dr. Ed Yardeni’s

In others words, given that the US dollar trade weighted index is now trading at its ALL time lows as shown in figure 5, there is that big chance where the outflows which began in August could be a START of a new trend and not merely an aberration.

A Tug of War Between the US Dollar and US Markets

Figure 5: US dollar index at All time Low

Where in contrast to the precipitate drop last July which had been spurred by liquidity woes as corollary to a sudden systemic credit drought, the recent losses suffered by the US markets had been imputed to corporation earnings deterioration apparently reflecting the worsening state of the US economy.

The distinction is that THEN Global central banks were quick to respond to the credit seizure with an admixture of policy adjustments to provide for band-aid treatments which apparently succeeded, as measured by the performance of the equity markets.

Today the problem seems different, while the credit woes implied monetary tightening; the aftereffect could now be seen in surfacing in corporate earnings as shown by the S & P chart in Figure 6.

Figure 6: S&P, Phisix, Gold and US 10 year Treasuries

The sharp decline in S & P 500 has been accompanied by a considerable volume buildup as shown by the blue circle in the main window. This could suggest for further downside action.

Recently we have pointed out that the Philippine Phisix (above window) has been increasingly correlated with the movements of the US dollar index than to the US markets since the recovery run last August. However, it should be noted too that the former’s connection with the US markets remains significant as shown by the blue vertical lines where volatilities or inflection points have been almost in lockstep.

This has also been mostly true with gold…until February. But apparently, the latest activities in gold prices have considerably shown a MARKED DIVERGENCE; it was least affected during the July credit squeeze and has grown strongly despite the recent weakening in the US equity markets (green circle).

Nonetheless, the collapse of 10 year Treasury yields (red circle in the lowest pane) in the light of probable foreign selling depicts overarching concerns over the vitality of the US economy.

As we have repeatedly said, despite the record high oil and gold prices, Chairman Bernanke and the US Federal Reserve, who realizes of the sensitivity of its financial driven economy to the degree of leverage embedded within its system, aside from protecting the primary conduits of the Fiat Paper Currency standard, will risk to err on the side of inflation, where its monetary policies will adjust depending on the performance of its equity markets in lieu of the accelerating decline in the housing industry.

The US treasury’s plan to convene banks and financial institutions to create “a single master liquidity enhancement conduit, or M-LEC” is simply one of these measures to shelter banks from further losses.

To put bluntly, if the US equity markets continue to drop and hit our 10% strike price (Dow Industrials 12,780 or S&P 1,410), we should expect the FED to cut by another 50 basis points, where the sharper the drop, the bigger or the more frequent those cuts will be.

Otherwise if the US market recovers and continues its upside move then it could defer its action until the market reveals signs of distress.

With Friday’s move, we can expect the market to test the downside.

Across the Pacific, at the current clip we expect the Phisix and Asia to trail the US markets until those gamut of rate cuts would shear the “umbilical cord” that joins the US and the Asia.

In other words, volatilities prompted NOT by Glorietta 2 but by the actions in the US dollar and the US markets are likely to sway the Phisix over the interim.

But, we expect buoyant gold and oil prices to support or cushion emerging markets as well as the “strongest link” embodied in the Asian region.

In effect, we should expect to see the deepening of such divergences as the foreign central banks and private institutions reallocate more of their funds away from US dollar assets, where the incentives to own and support these appear to have greatly waned by:

1. Rising Asian and OPEC inflation rates which could lead to the depegging of currency links (Gulf countries) or should translate to further domestic currency appreciation requiring less to recycle surplus funds into US dollar denominated assets.

2. Losses could prompt Central Banks to cut positions as the declining US dollar reinforces the loss in the price values of their portfolios.

3. The prospects of an economic wide spillover from the accelerating deterioration in the US housing industry should translate to declining returns or yields.

4. A rapidly slowing US economic outlook would prompt for expectations on policy actions that would narrow the currency yield spreads and reduce the advantages of holding US dollar assets.

5. Through Sovereign Wealth Funds (SWF), global central banks have now been shifting to non-US dollar assets to increase returns via purchases in mostly global equities.

Even the IMF recently says that the US dollar remains overvalued.

The US dollar may bounce due to being technically oversold. But if the August trends reveals of a sustained outflow from its foreign principals then the US dollar will likely head lower and should mark an all important inflection point. And asset allocations would ultimately adjust to such developments.

Sunday, October 14, 2007

Global Markets: High From Wall Street And FED Steroids?

``The capitalistic social order, therefore, is an economic democracy in the strictest sense of the word. In the last analysis, all decisions are dependent on the will of the people as consumers. Thus, whenever there is a conflict between the consumers views and those of the business managers, market pressures assure that the views of the consumers win out eventually.”-Ludwig von Mises, On the Manipulation of Money and Credit

Global markets remain on fire last week with many bourses posting new highs.

In Asia alone, while the gains of the Philippine Phisix had been modest (+1.28% w-o-w for the FOURTH successive week), impressive gains were seen in China’s Shanghai Index (+6.32%, w-o-w), Indonesia’s JKSE (+5.5%), Bangladesh’s Dhaka Index (+4.88%), Thailand’s SET (+4.07%), India’s BSE 30 (+3.63$) and Hong Kong’s Hang Seng (+3.62%). Only Taiwan’s Taiex (-1.26%) and China’s Shenzhen Index (-.98%) were down for the week.

Figure 1: ASEAN Bourses On A Streak!

Figure 1 shows of an apparent “choreographed dance” by ASEAN bourses, with Indonesia’s Dow Jones Indonesia in the lead following a strong breakout (pane below main window) to account for a remarkable year to date gain of 46.12% (as of the Oct. 12th)!

Our Phisix (main window) hovers slightly above its previous resistance (now support) following the latest move to etch a FRESH historic high, which accounted for a year to date advance of 28.22%.

Meanwhile, Thailand’s SETI (middle pane) and Malaysia’s Dow Jones Malaysia (lowest pane) appears be at edge of the same “breakout” routine, with year to date gains of 30.48% and 25.45%, respectively.

Technically speaking, with the Phisix clearly WAY above its 50-day and 200-day moving averages (dma), represented by the superimposed blue and red line, this signifies indications of OVERBOUGHT conditions. Moving averages are the average prices of a security over a defined period, a barometer utilized by trendwatchers to gauge on the health of a trend.

But again since markets don’t move MECHANICALLY, plain momentum and raw emotions can simply prod the Phisix to do an Indonesia and overextend the current trend.

And since markets are behaving in near unison, it does not seem pragmatic to look at the action in the Phisix as a singular metric in determining the ebbs and flows of the present short term trend.

Aside, similar to last week which came COINCIDENTAL to the breakdown of the US dollar trade weighted index, foreign money has turned meaningfully positive but saw a decreased exposure relative to the local counterparts.

What this implies is that aside from the conventional “portfolio” money “IN” flows, we have been witnessing a trend of enhanced participation by local investors.

And amidst the concurrent breakdown in the US dollar is the mirror images-record closes of the Baltic Dry Bulk index (above 10,000- a fresh all time record), Oil via the West Texas Intermediate Crude benchmark (fresh all time record) and gold, which appear to have supported emerging market equities, aside from the “global outperformance” theme which has equally steered US stocks to record highs.

Could it be that the current market activities simply reflects on the recent spike in US monetary aggregates as shown in Figure 2?

Figure 2: St. Louis Federal Reserve: Surging M2 and MZM

According to the St. Louis Federal Reserve, through August, M2 (seen in the left) or a measure of money supply or liquidity as defined by ``money supply that includes M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds” surged by 8.6% per annum, while MZM or Money Zero Maturity (seen in the right) also another measure of liquidity as defined by, ``MZM represents all money in M2 less the time deposits, plus all money market funds…MZM has become one of the preferred measures of money supply because it better represents money readily available within the economy for spending and consumption. This measurement derives its name from its mixture of all the liquid and zero maturity money found within the three "M's.” soared by 24.3% per annum!

Are we thus seeing the effects of the combined reliquifications by Wall Street via money market funds or mutual funds that strictly invest in short-term but low risk liquid instruments as US government agencies and treasuries, and the US Federal Reserve?


``Predicting a circumstance can sometimes help prevent its occurrence—if it’s controllable. And most dramatic changes in life, markets and science often occur from circumstances that couldn’t be predicted. And even if they could be predicted, they might not be controllable (earthquakes, torrential downpours). But that doesn’t stop the circumstances’ actors, 24-hour cable pundits or policy makers from explaining pretty much everything away. This is natural, part of our biology. We seek causation. We seek confirming evidence.”-Joshe Wolfe Forbes Nanotech

Figure 3: Economagic: Strong Currencies back ASEAN Equities

Again the strength of the Peso has mirrored the Phisix, with both drifting at breakout territories. The same story can be seen applied to our ASEAN neighbors, as shown in Figure 3.

In contrast to the mainstream thinking that the Peso’s rise has been endemically propelled, Malaysia’s recently unpegged Ringgit and the politically hampered Thai Baht has shown similar relative strength that appears to have equally bolstered their bourses.

In the latest blog post last Wednesday, following a record run by the Peso, we were delighted to see a more germane reportage from which we quote anew the Philippine Daily Inquirer (emphasis mine),

``Traders said offshore investors were more bullish than local traders and were quoting the peso at 44.15-44.20 to the greenback in over-the-counter deals, outside the currency exchange Philippine Dealing System.

``The peso would have strengthened further if not for continued dollar-buying by the central bank, Bangko Sentral ng Pilipinas (BSP), on the spot market. However, dealers said the BSP purchases were not as heavy as in previous days as its dealers saw that the market was nearing a correction.

``The BSP purchases were estimated at $100-$200 million. Tuesday’s total volume was $640 million.

``The peso’s extended rally was also supported by a strong regional currency market, which in turn was caused by weak sentiment on the US dollar and by the region’s much-improved economic fundamentals.

Bullish Foreigners, Regional Driven, and State of Today’s Money System

Three notable observations:

One. Foreign investors have shown more BULLISHNESS in the currency market than local investors of late.

This similarly reflects on the internal activities of the Phisix since the advent of October, as noted above.

Two. The Peso’s moves are reflected REGIONALLY and NOT AN INSULATED phenomenon.

This is where it can be shown that the arguments of the baneful effects of a strong Peso signify ONE dimensional thinking.

Since the region’s currencies have been on an equally firming trend but on a distinct degree, the competitiveness of our industries depends on country’s scale of productivity and efficiency and not simply brought about by pricing power or through currency mechanisms.

Blaming the Peso for our woes is tantamount to barking at the wrong tree. Instead, experts should look at the economic or opportunity costs of politicization of the industries, overregulation and skewed policies, as well as, choking bureaucracy and the endemic culture of dependence (mostly to politicians) and risk taking aversion.

The growing obsolescence of the “Mercantilist” paradigms, aside from contributing more to global imbalances, and knee jerk reactions such as suggestion for capital flow restrictions or currency manipulation will improve LESS of the Philippine’s economic conditions. These signify temporary stop-gap measures which don’t deal with structural deficiencies of the economy. The present economic models should take advantage of the deepening trends of technology enabled regionalization as well as niche marketing/specialization in this much integrated world.

Three. The strength of the Peso and of the region reflects the state of the today’s Fiat Currency standard.

Essentially, it is NOT the Peso which is rising but of a phenomenon of a depreciating US dollar, the world’s de facto foreign currency reserve. The fall of the US dollar against a majority of world currencies simply reflects on the ACCRUED EFFECTS of misdirected policies in the US. Since the US dollar functions as the anchor of today’s monetary structure, naturally its conditions RIPPLE throughout the financial and economic realm worldwide.

So under present conditions, either our central bank or the BSP allows of an unfettered market determined rise of our currency, which should give rise to a consumption boom and/or trigger a massive reverse capital flight or repatriation of domestic capital stashed overseas (think Filipino migrants buying domestic real estate or investing in call centers or investing into the Phisix), or applies a “managed” float via open market interventions or printing pesos to buy US dollars, which adds to domestic liquidity.

The news report manifests of the second option. Nonetheless, in both instances, conditions allow investors the “incentive” to further rev up on the Phisix over the long term.

Political or Economic Democracy?

Let us divert for a while and dabble on the political context of this issue; as we have repeatedly argued, such inflationary actions (such as currency intervention) add to social inequality. While it stands to benefit select industries as ours, the promulgated intent, as advocated by some mainstream experts, of attaining an egalitarian society or social equality using inflationary activities like the above is almost equivalent to the idiom “left hand doesn’t know what the right hand is doing”. The end effect has always been through diminishing business competitiveness, surge in taxes and rising consumer prices.

One has to understand that the major beneficiaries of government inflationary activities are the banking and finance industries, the main conduits of the Fractional Banking Reserve system, and most importantly the political bureaucracy and their associate providers or “special interest groups” (e.g. the alleged doleouts to select local government units and members of the congress by the present Philippine incumbent administration) where they are accorded the privilege of buying freshly printed money with today’s prices while leaving out the public to buy at tomorrow’s much higher prices-mostly in the name of social equity but behind the scenes is all about the perpetuation of power.

Most politicians, regardless of their affiliations, are inclined to idealistic vote generating rhetoric but are disinclined to do corresponding unpopular actions of sound money and policies when in power. And so goes with the majority of media, where controversies and short-term nostrum sells.

Yet most of the leaderships within the bureaucracy are predisposed towards reaction “knee jerk” based solutions. Recent reactions of global Central banks exemplify this. While the recent credit crisis appears to have seemingly abated, the day of reckoning has simply been postponed but should worsen in scale. This will likewise be reflected in the financial markets.

On the other hand, prevalent in the street, in the café or again in media, it appears that everybody else knows how to spend on other people’s money in one form of social program or another, without looking at its unintended consequences. Just watch political discussion programs or editorials, everybody seems to be an expert in forecasting. The irony, is when you put them into the markets to apply their “expertise”, none of them can call it consistently right, if they even can make a majority of accurate calls. So how can a political social improver, who is unable to predict the markets rightly, make a right judgmental call on the adequate balances of a living and dynamic economy with even more variables to reckon with? In the case of the US Federal Reserves, former Chair Greenspan escaped without much blemish, but will it apply to Chairman Bernanke as well?

For others, the role of our political economy has been to redistribute wealth from productive individuals or entities to those devoid of the virtues of savings, hard work, and industry or to political parasites. As they say there are two ways to generate wealth by hard work and savings or by plunder. Unfortunately some suggestions cater to the latter though indirectly.

As we always aver, when economic opportunities are determined by politicians and the bureaucracy instead of the markets, our political economy is then reduced to a game of musical chairs, where the vicious cycle of personality based politics signifies only a symptom of a deeper structural malaise; the lack of respect for a market driven economy. We opt to choose our leaders via political democracy but elect to have our economic choice determined, not by ourselves, but by political leaders, whose operating incentives are far different than ours.

Some Asian nations have shown, like the Hong Kong and Singapore, how the lack political democracy can be compensated by a market based economy or economic democracy or the respect for entrepreneurs. However, some see it the other way around, obliquely the success of political control, you call this selective perception. Unfortunately for us, we see what we want to see and choose not to learn.

Correlation Does Not Imply Causation

Now back to the financial markets, the perspective that the strength of Peso is required to bolster the Phisix has been tangential as shown in Figure 4.

Figure 4: Phisix-US Dollar Peso: Correlation Does Not Imply Causation

While the Phisix (black candle) and the Peso (red line) have shown stronger correlation of late, one must realize that the Phisix had been on an uptrend since June of 2003 (thanks to Greenspan’s 1%! Fed Rate), as shown by the upside green arrow, even when the Peso continued to flounder. The Peso only reversed in October of 2005, shown by the downward pointing blue arrow, almost ONE full year when we made our forecast and TWO YEARS AFTER the Phisix gradated into the advance cycle.

And in perspective of the past advance cycle in 1986-1997, the Phisix had not been accompanied by an attendant rise of the Peso. Yet, past conditions are unique to the present, unworthy of simplified association.

In short, as we always argue, CORRELATION DOES NOT IMPLY CAUSATION. Although, they may have interlocking relationship somewhere, it COULD NOT BE ESTABLISHED as a textbook case of “cause-and-effect” over the bigger picture. Such attribution requires more evidences of sustained tight correlation over time.

Yet, this similar frame of oversimplified narratives (using different variables) on the Peso’s conditions can be found elsewhere in the mainstream analysis or media reporting, something we will deal with sometime in the future.