``Do what you will, this world's a fiction and is made up of contradiction.” William Blake
We recently stumbled across a Pollyannaish article whereby a domestic broker boldly declared that the Phisix as still in a bullmarket and forecasted the Philippine benchmark to reach new record levels or gain some 25% from the current levels at the end of the year (I hope they are right, but bearmarkets descends on a ladder of hope).
The article cited a string of positive “micro” developments to justify its projections which was mostly buttressed by the assumption that US-Philippine linkages have shrunk in significance to meaningfully impact the domestic economy.
While we partially sympathize with such views, we think that such sanguinity is uncalled for simply because, for us, such outlook greatly underestimates the risks involved under today’s operating environment aside from overestimating the resiliency of the
The fact is, given today’s highly correlated financial markets as shown in Figure 1, a bullish view on the Phisix basically requires either of the two outcomes—a mild or benign US recession which recovers swiftly OR that the Philippines and to some degree other ex-US financial markets or nomenclature asset classes “decouples”.
Figure 1: stockcharts.com: Still A Bullmarket?
As you can see, global equity markets reacted in near unison (vertical blue line) last October to the recent tremors which begun last July (look at the peaks and troughs of each benchmarks).
The Phisix (center window) peaked earlier compared to the synchronous decline of the Dow Jones World Index (topmost window), emerging markets (pane below the Phisix) and
Besides, on a technical standpoint, none of the above markets looks like operating under bullish conditions. In fact, with over half of global markets touching the 20% loss threshold --which is a technical definition for a bearmarket--last January 21st, this means that the Phisix and the many global markets have transitioned to an interim bearmarket as discussed in our January 21 to 25 edition [see Phisix: On A Bear Market Template, Bear Market Rules Apply].
As you readers maybe familiar with, we have been a proponent of “past performance does not guarantee future outcome”. We argued about the bullish case of “decoupling” signals in our January 21 to 25 edition [see Emerging Markets and the Philippines: The Last Shoe to Drop?] where in the past selloffs, emerging market assets were dumped across the board, but today the degree of categorical selling has diminished. In fact, there had even been signs of divergences-recent selloffs were ONLY seen in the equity markets-not the bonds or the Peso (Ok, Philippine bonds declined this week-mostly on the account of inflation concerns; emerging bonds fell too so as with the Peso).
Philippine Exports Immune From US Recession?
Figure 2: Deustche Bank: Top 5 Export partners 2004
Ok, let’s us play the devil’s advocate and assume the bearish scenario.
We read many discussions asserting the premise of Philippine economic resiliency based on the diminished linkages between the
On the surface, indeed our exposure to the
The recent growth of intraregion trades had been a function of “vertical integration of production chains, whose final demand”, according to ADB “is outside the region” see Figure 3.
Figure 3: ADB: Regional Supply Chain Platform
What this means is that instead of direct shipments, regional trading dynamics have morphed or shifted into an interdependent network of supply chains where intraregion exports has mainly functioned as inputs to the production processes meant for reexports to major economies or outside the region.
Today’s trading dynamics operates like a regional outsourcing. As an example we’ll take the composition of a Dell laptop as described by Gavekal Research in Our Brave New World. ``The keyboard was made in
As you would have probably been aware of,
However as ADB’s notes (Uncoupling Asia Myth and Realities), ``more that 70% of intra-Asian trade consists of intermediate goods used in production, and half of this intraregional trade in intermediate goods is driven by final demand outside
What this means is that Asia is still heavily reliant to the consumers of US, Europe and
Because of the informal adoption of Bretton Woods 2, or a monetary regime of competitive managed devaluations by most Asian economies in the past, this signifies as subsidies to the production aspects of the region’s economy at the expense of the consumption side. Hence we have seen in the recent past, the soaring economic growth of emerging Asia, the migration of industries from the
On the obverse side, this monetary paradigm represents subsidies to the consumers at the expense of the production side for the consumption based Western economies. Hence, the explosion of debt driven asset markets (real estate and stocks) supported by financial innovations (derivatives, structured finance, originate and distribute models) and the massive current account deficits.
Since currency adjustments are just beginning to impact Asian consumers, global depressionists say this would not be enough to stimulate Asian consumers to pick up or fill the slack from the retrenching Western consumers.
And worse, because of the huge global current account imbalances, past improvements in the current account balances of deficit countries as in the
Figure 4: Black Swan Capital: Money Back to the Center?
The narrowing of
Money back to the center means that under a debt driven deflation scenario or contracting global liquidity, which global depression advocates predict, money dynamics will evolve from centrifugal (flowing outward from the center) to centripetal (flowing towards the center) or money will seek refuge in the US dollar, the de facto reserve currency of the world.
So by virtue of induction in the context of exports, a severe recession in the
Will Remittances Save the Day?
Or how about remittances, many have argued that the
Figure 5: DBS Bank: Falling overseas deployment (left pane), Falling Remittances (Peso)
Media accompanied by their coterie experts always pontificate that the Peso’s rise had been “caused” by the surging remittances. As we have pointed out in the past What Media Didn’t Tell About the Peso, and Philippine Peso And Remittances: The Unsecured Knot the correlation of the Peso and remittance growth has been more of a recent experience, in other words, causal relationship is tenuous.
Remittance growth has been exploding since 1990s yet the Peso soared only in 2005. As we have noted, analysis using remittance driven Peso dynamics suggests either a “tipping point” or “critical mass” has been reached enough to tilt the balance in favor of the peso to reverse in 2005 from its 45+ years of depreciation or there had been a tremendous “lag” time for remittances to be reflected in the Peso. For us, it is partially about remittances, and mostly about regional currency regime, the US dollar standard and regional capital flows.
Here is the comment from DBS bank on their first quarter outlook (highlight mine),
``This is the math: in the year-to-3Q07, US dollar-denominated remittances were up almost 15% compared to a year ago. In peso terms, however, this gain translated to just 4.4% YoY - only moderately faster than the 3.2% YoY pace of inflation at home. As is evident from the chart, the damage was most acute in 3Q07, when peso appreciation accelerated as remittances growth slowed. No wonder then that consumer spending, which has come to be so dependent on the income that overseas Filipinos send home, slowed noticeably in 3Q07, to 5.6% YoY from a three-year high of 6.0% in 2Q07.
``Looking ahead, consumer spending in 2008 looks set to, at best, only match the 5.7% rise we expect for this year, assuming that monetary policy will be supportive. Remittance growth is likely to slow, on a combination of a stronger peso and slower deployment of overseas workers. The government, in wanting to improve the quality of the workers it sends overseas, has been placing more stringent conditions on deployment, including the lifting of minimum wages. Foreign countries can also be partisan in their labour policies, such as the
In the right chart of Figure 5, DBS Bank notes of how the Peso has appreciated more than the pace of growth for remittances. Here we raise some questions; why has the Peso continued to rise in the face of declining growth rate of remittances? How valid is the conventional “cause-and-effects” view of the rising Peso?
Another important variable is the question of remittance contribution to personal consumption. The highly popular explanation is that remittances have been a major contributor to personal consumption and thus has served as a major fuel for our domestic economic growth. But like the analysis above, they seem to be more of logical deduction than of analysis based on statistical estimates or figures.
In short, until we see some figures, we remain unconvinced of the so-called “multiplier effect” of remittance spending, which I believe is highly overrated (a justification used by experts to call for more Central Bank intervention). Since I wrote the National Statistical Coordination Board, to request for this info last October we have not received a reply (we wrote them again this week).
As proof again look at the analysis above, it says that because of the declining growth of remittances (using 3rd quarter stats), personal consumption should slow. Yet recent consumption data during the 4th quarter shows of a substantial rise as our domestic GDP soared to decade year highs. According to NSCB.gov, ``consumer spending grew by 6.3 percent from 5.8 percent a year ago.” So essentially, the impact of a strengthening Peso to overall consumption (aside from the purchasing power) has been less than what is accepted wisdom.
Now, DBS suggests that the slowing overseas deployment (leftmost chart) could serve as a probable indicator or precursor to the slowing of remittance trends. Notably this comes in the light of the economic conditions PRIOR to the global credit crisis which may evolve into a meaningful global economic slowdown. This means that wildly optimistic analysis based on recent “strong” trends will get likely get slammed if declining overseas deployment trends conspires with a
Conclusion: Discretion Is The Better Part of Valor
So in the context of exports and remittances, global depressionists have valid arguments which should not be discounted. But the global financial markets and the economy is not just all about exports or remittances, there are other factors at play such as government policies, technological breakthroughs, globalization (finance, trade and labor)/protectionism, geopolitics, demographic trends, monetary dynamics and others.
Let us put into the place an objective perspective, in the context of the Philippine economy, if the highly popular remittances signify 10% of GDP then there is the other unpopular 90% of which is of more significance. Using common sense, I wonder when the popular 10% has surpassed the unpopular 90% in real life importance.
Also, if exports and imports contribute 40% each to the GDP then there is the other 60% to reckon with. Unlike mainstream experts who believe that they are uniquely armed and equipped with sophisticated analysis using modern statistical data which presumably captures the entire spectrum of variable working parts of the economy….we don’t. We don’t pretend to know everything. We even don't know much of anything that's why we question. Hence, we respect randomness or the influences of unknown variables.
Bottom line: Avoid looking for reasons to rationalize one’s biases (confirmation bias). Avoid also from falling into “conflict-of-interest” traps (agency problem). In matter of portfolio risks deployment, as a saying goes, discretion is the better part of valor.