Phisix: “Fear Is A Foe Of The Faddist, But The Friend Of The Fundamentalist”

``Experience shows that, if one foresees from far away the designs to be undertaken, one can act with speed when the moment comes to execute them.” -Cardinal Richelieu, 1585-1542

Present developments continue to pose as a nightmare for local stockmarket bulls as the key Philippine benchmark effectively traversed beyond its July lows. The Phisix is down by over 24% from its zenith in October, so by definition, a 20% loss demarcates a crossover into the bear’s territory.

Like in politics, biases shape opinions. For instance, Bulls will insist that a 50% drop is a typical correction while Bears will argue that a 5% drop is sufficient evidence of an unfolding bear market. So in an effort to balance our bias, we will go by the technical definitions of the prevailing market conditions.

The Phisix fell by 4% over the week, and is down by over 7% in two consecutive weeks for an accrued year-to-date loss of a harrowing 19.74%. Ouch!

While it is a temptation to say that the domestic political maelstrom could have had a hand in these marked turnaround in sentiment, evidence suggests that it has been prompted MORE by developments abroad (see Figure 1).

Figure 1 stockcharts.com: Phisix Impacted by Global Activities

Alongside the decline in the Phisix, the Emerging Market index (EEM) is likewise down 20.94% (using the same peak-“present” trough measurement), the Fidelity Southeast Asia Index (FSEA) 31.1% and the Dow Jones Asia ex-Japan 23.8%. Thus, the activities of the Phisix appear to be a mirror image of its contemporaries in both the emerging markets rubric or relative to its neighbors.

The chart similarly shows that the Phisix (main window) closed past its July lows (as shown by the circle) and seems headed for the three year trend line support of somewhere around the 2,600 level. So if one considers the strength of a trend under technical rules (Alexander Elders-Trading for a Living-incidentally the first ‘stock market’ book my mentor asked me to read of which I am a practitioner today),

-The longer the timeframe, the more important the trendline.
-The longer the trendline, the more valid it is.
-The more contacts between prices and the trendline the more valid the line.

…this means that the 3 year secular bull market trendline remains soundly intact-Yes under this premise we are still in a structural long term bullmarket operating under an interim bear market-and is likely a better determinant of the destiny of the Phisix, as well as the maturity of its underlying trend and the validity of its present path.

So it would be important to watch how the long term trendline reacts under today’s circumstances than agonize over present day losses. As Scottish Philosopher Thomas Carlyle once wrote, ``Our main business is not to see what lies dimly at a distance, but to do what lies clearly at hand.”

And if one looks at the trend features in the charts of the other indices, we note of the same patterns; long term upside trends appear to be unblemished (yet).

Market Forecasting And The Required Winning Qualities

Of course we have met a lot of skepticism over our prognosis of a Phisix 10,000 (some even seem to think that I maybe hallucinating) in the same way when we called for a Phisix turnaround in 2002 or of the Peso’s reversal in 2004.

But as a long term trend and market cycle observer of different asset classes, we can emphasize with confidence that a secular bull market does not generally end with only 100-200% gains. You can go to chartsrus.com and look over the long term performances (over 15 years of insight rich perspectives of market cyclicality) of many world equity benchmarks and see of what I am talking about.

Just consider; we spoke about the revival of the mining industry (even published at safehaven.com) way back in 2003 when gold and oil’s was in an incipient renascence stage (oil above $40s and gold just over $300). The mining index was then drifting at historical lows of 1,000 level, where we predicted it to go over 9,000. Yes then we were even ridiculed as some sort of a wacko!

Today oil is over 10 times from its bottom and is on record highs even under inflation adjusted prices and gold is 4 times from its nominal bottom (Both of which will even go higher over the long term because of two words-government intervention).

Nevertheless, the Philippine mining index TOUCHED 9,067.26 last November 9^th (realizing our target) or eight times from its bottom when we made our prediction! Today, hovering at the 7,000 levels, the vitality of the commodity cycle will eventually reflect on state of the mining index which should push this easily to over 10,000 over the long term.

The point is to understand how market cycles evolve or operate as a significant way to reduce risks. In the same manner as comprehending how different cycles such as business, economic, commodity or credit cycles interplay to shape market cycles or vice versa (theory of reflexivity).

Remember we are not here for vanity which is an outright guarantee for prospective losses. We are here to profit from taking risks which also means accepting mistakes relative to gains.

And importantly, we attempt to imbue the winning qualities as defined by the legendary Peter Lynch, ``The list of qualities [an investor should have] includes patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit mistakes, and the ability to ignore general panic.”

Equity Outflows Are Global As Risk Aversion Rises

Going back to the present market conditions, it is noteworthy that the common denominator for the recent selling pressures in the abovementioned benchmarks is the net foreign selling.

The degree of foreign selling has even begun to impact currency performances of some Asian countries as the Philippine Peso (-1.7%) to Php 41.54 on $69.5 million of net selling, South Korean Won (-4.2%) to 997.32 and Indonesia Rupiah (-1.6%) to 9,226 to a US dollar (Bloomberg) which could have translated into outflows. Remember net foreign selling does not automatically equate to net foreign outflows. It is when the proceeds of net selling are repatriated abroad where it impacts the currency.

Yet, outflows could reflect the present state of rising risk aversion aside from forced liquidations by institutions caught up in the credit gridlock.

Furthermore, the assumption that the US dollar in a tailspin is gaining adherents for investments in its equity market at the expense of alternative markets is unclear. The theory is that relative values are getting cheaper especially in the browbeaten Financial Industry evidenced by the recent activities or acquisitions of Sovereign Wealth Funds (SWF).

Figure 2: Emergingmarketportfolio.com: Equity Outflows is a Global Phenomenon

According to Michael Sesit of Bloomberg, ``In the past two years, sovereign wealth funds and Chinese financial institutions invested at least $77.2 billion in Western banks and money managers. About $66.6 billion of that was placed in the last three quarters of 2007, accelerated by banks' needs for capital infusions after being battered by the subprime- mortgage crisis and related credit crunch.

``The bigger deals include Government of Singapore Investment Corp.'s $9.7 billion investment in Switzerland's UBS AG, and Singapore-based Temasek Holdings Pte.'s 18 percent stake in Britain's Standard Chartered Plc for $9.2 billion. The Abu Dhabi Investment Authority paid $7.5 billion for a 4.9 percent holding in Citigroup Inc., while Temasek invested $4.4 billion in Merrill Lynch & Co. with an option to buy an additional $600 million of stock. China Investment Corp. bought $5 billion of Morgan Stanley.”

Much of the activities of sovereign wealth funds have moderated following the recent stinging reversals in the market. This suggests that following the initial forays by the SWFs in the deeply afflicted financial world, which seems to be nursing significant losses; these entities appear to have mostly stayed on the sidelines since-except in the mining industry.

Besides, there is scant evidence of rotation within the equity markets, according to amgdata.com as of March 12 (highlight mine),

``Including ETF activity, Equity funds report net cash outflows totaling -$1.430 billion in the week ended 3/12/08 with Domestic funds reporting net inflows of $1.949 billion and Non-domestic funds reporting net outflows of -$3.380 billion;

``Excluding ETF activity, Equity funds report net cash outflows totaling -$2.662 billion with Domestic funds reporting net outflows of -$1.776 billion and Non-domestic funds reporting net outflows totaling -$886 million;

``Exchange Traded (Equity) funds report net inflows of $1.231 billion with the largest flows:

$2.195 Bil to the Sel Sectr SPDRs Finl fund;

$2.01 Bil to the iShares Russell 2000 Index fund;

-$1.567 Bil from the iShares MSCI Emerg Mkt Index fund;

$592 Mil to the PowerShr QQQ fund;

``Excluding ETF activity International funds report net outflows of -$718 million as net outflows are reported in all Emerging and Developed regions except Japan ($9 Mil; 0.53% Assets);

``Excluding ETF activity Taxable Bond funds report net inflows totaling $484 million with the largest inflows going to International & Global Debt Funds ($681 Mil; 0.85% Assets);

``Money Market funds report net cash inflows totaling $9.832 billion as assets in the sector now exceed $3.4 trillion;

``Municipal Bond funds report net cash inflows of $677 million.”

So consistent with Figure 2, from emergingmarketportfolio.com, Global equity markets have generally been seeing a withdrawal of funds with the bulk of the outflows from G3 countries (US, Europe and Japan).

Whereas funds flows appear to concentrate on the Taxable Bond funds, Money Market funds, and Municipal Bonds.

Hence, there is little evidence that the debilitated US dollar has been attracting sufficient investments at the expense of the emerging market class as the Phisix. On the contrary, we see the weak state of the US dollar fostered by the unfolding changes in the monetary conditions as potential attractions to the Phisix as discussed in Monetary Conditions Remain Supportive of Emerging Market Assets.

No Bubble In the PSE, Sectoral Performances Evolves To A Dividend Play

Yet in examining the damage arising from the recent selloffs in the Philippine Stock Exchange, the irony is that instead of a pattern of “weak” linkages with the macro environment, we are seeing somewhat of a mixed message from the market activities shown in Figure 3, except for the dividend yield.

Figure 3: PSE: Sectoral Year-to-Date Performances

In developed countries the real estate and the financial industries have been the most bludgeoned sectors. This again is mostly due to the bubble built around depressed interest rates which allowed the public to speculate on real estate “flipping” funded by securitization of mortgages. Thus, when the bubble burst both sectors are today in anguish.

On the other hand, industries which catered to the US consumers, such as exporters have likewise been most impacted in other countries.

Nevertheless as explained in Global Depression: A Theory Similar To A Horror Movie?, the Philippines have entirely missed out the real estate boom as evidenced by the inconsequential growth of real estate loans relative to total loans.

Boom-busts cycles are usually triggered by negative or low real rates which cultivate on spectacular credit growth which is exacerbated by speculative tendencies by the general public. In short, credit growth spurs speculation and investor irrationality.

Martin Wolf of the Financial Times expounds lucidly (emphasis mine), ``All these crises are different. But many have shared common features. They begin with capital inflows from foreigners seduced by tales of an economic El Dorado. This generates low real interest rates and a widening current account deficit. Domestic borrowing and spending surge, particularly investment in property. Asset prices soar, borrowing increases and the capital inflow grows. Finally, the bubble bursts, capital floods out and the banking system, burdened with mountains of bad debt, implodes.”

To add, in the aftermath of the Asian Crisis, the Philippines seem to have just segued into an advancing phase in the real estate industry. This suggests that the market clearing stage from the previous excesses has allowed for such recovery. Thus, no significant margins or leverages have been built into the system yet.

Third, it would seem that the region, flushed with huge foreign exchange reserves, is steeped upon policies geared towards an infrastructure development.

Fourth, current developments abroad coupled with the recency bias or the rear view mirror syndrome following the 1997 Asian Crisis is likely to compel local lenders to be conservative with their loan portfolios. The lessons of the past and the ongoing around the world today will likely lead to stricter lending standards. A gradual expansion is likely to be sounder.

Fifth, the firming Peso is likely to repatriate domestic capital stashed overseas aside from attracting foreign investments based on growth potentials.

Finally, the BSP recently decided to hold on to the present level of interest rates despite surging the consumer price index, see my blog Philippine Inflation Rate Surge on Soaring Commodities!.

Basically this deepens the negative real interest yield environment as the rate of consumer price increases are starting to close the gap with even longer term treasury yields.

Negative real rates are not the same as nominal low interest rates regime. Negative real rates deals with the function of money as a store of value, thus the opportunity costs of holding cash.

Once the purchasing power of a currency erodes, people will be prompted to look for alternative “store of values” in the form of hard assets as property (Hong Kong, China, GCCs) or stocks (Zimbabwe), or cars (Venezuela) as previously discussed.

Negative real rates punish savers and encourage the public to go into debt to venture into speculative activities. The ensuing malinvestments are the reason why bubbles exist on the first place. This is precisely what had happened to the US.

So when a monetary policy is directed towards “growth” via suppressed real interest rates this induces for a low or negative real yield environment. Thus, you should expect some assets to go up because people will simply look for an alternative “store of value” as replacement to an eroding purchasing power of a currency.

Essentially, given the above, the Philippines or the Phisix or its domestic financial markets has not been induced into a bubble or near bubble scenario…in fact far from it.

Thus, claims that the Phisix is in a protracted bearish scenario is unjustified unless the world turns into protectionism-which should lead to global depression.

Nevertheless, the property sector has taken the most drubbing down 31% year to date. In contrast, the play on the Philippine economy’s service sector led by the telecoms has been the least impacted (-15% as of Friday). So you have two domestic oriented sectors both showing disparate activities as gauged by the index performance.

In addition the performance of the financial sector (-19.4%) exhibits general market decline when compared to the Phisix (-19.74%), which could be interpreted as having marginal or little exposure to toxic papers and has thus shown minimal impact relative to its global counterparts.

Whereas the mining sector which has remained in stupor has seen an explosion on the prices of its underlying product (we will deal with potential divergences in the future).

Instead, the sectoral performances appear reflect positions according to the industry dividend yields. Since domestic investors have been responsible for shoring up today’s market, they appear to gravitate towards industries with high dividend yields.

Based on January PSE data, the service sector index has a yield of 4.62% (telecoms has 5%) thus, the least loss (-15%). This is followed by financials with a yield of 2.7% (loss 19%), industrials 2.45% (-15%), Mining 2.06% (-15%), Holding 1.5% (-25%) and Property 1.18% (-31%). The Phisix has a yield of 2.5% and the All index 2.73%.

As a caveat, present dividend yields are not sufficient indicators for future dividend yields. Past performance does not guarantee future outcomes.

Measuring Market Sentiment: Issues Traded and Daily Trades

Finally we deal with sentiment.

Figure 4: PSE: Daily Issues Traded

Market internals tell us where sentiment lies. Figure 4 shows that even while number of issues traded daily seem dwindling, it remains above the 2003 levels (upper red horizontal line) which possibly suggest that investors remain bullish but the extent of bullishness has been on a decline.

As we would also note, as the Phisix climbed the bullish ladder from 2003 until mid 2007, the number of issues traded has also painstakingly followed. The investing public’s predisposition is to tap the broader universe of the market once risk appetite is accommodative. Thus, today’s risk aversion has reduced the number of trades but remains elevated relative to the past.

We will raise alarm bells if there is a sudden drop of issues traded, since a paucity of daily traded issues could also reflect a strike by fundamental based buyers (for us, these are the category of buyers that matters most).

Figure 5: PSE: Daily Trades: Measuring Speculative froth

Daily trades are our best measure of speculative lather, as shown in Figure 4.

Daily trades incorporate day traders or scalpers, punters, mid term traders and fundamental buyers. The red vertical line seems to be the median point of daily trades during the 2003 until early 2006 or the germinal phase of our bullmarket.

Imagine the Phisix has more than doubled from less than 1,000 to 2,200 within the said period yet daily trades averaged ONLY by around 3,000-4,000 per day with occasional bouts of trading spurts.

Noticeably, daily trades picked up ONLY at the close of 2005 which coincided with the second round attempt of the Philippine peso to move higher.

This made us construe that the firming peso has drawn local investors into the market where they actively punted (due to higher returns expectations) at the expense of the US dollar holdings…until late 2007.

Could we be seeing the same but on an inverse scale…declining trade but higher US dollar?

Today the daily trades have plummeted to near the 2003-2006 levels which limns of greatly reduced speculations within the Phisix.

This leads us to deduce that once the 3,000 level per day is met, the Phisix could mark a BOTTOMING OUT since fundamental based buyers are likely to dominate the Phisix investing space!

By then, local scalpers and punters would have turned into long investors, possibly shun the market, and remain bottled up until the market recovers.

Bottom line: the Phisix remains on an interim bear market but is certainly not under the spell of a protracted bear curse unless huge political lapses will be committed here or abroad. The Phisix under present conditions is simply evolving out of its long term cycle.

To aptly quote Warren Buffett, ``none of these blockbuster events made the slightest dent in Ben Graham's investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices. Imagine the cost to us, then, if we had let a fear of unknowns cause us to defer or alter the deployment of capital ... Fear is a foe of the faddist, but the friend of the fundamentalist." (highlight mine)