``Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one” -Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds
Finally after 6 weeks consecutive weeks and a dazzling 21.64% of gains, the Philippine benchmark, the Phisix, finally succumbed to a hefty 7.72% “profit taking” streak over the week.
Yeah, cower in fear because the big bad bear is back in picture! But is it?
Figure 1: Global Profit Taking
Anyone looking for a simplified answer should get this…we aren’t alone. See Figure 1
While the domestic losses may have the biggest in Asia, perhaps exacerbated by the uncertainties over the political front or just plain momentum-sentiment based panic, the carnage in the region had been nearly equally as steep. For instance, Vietnam, Thailand, Indonesia, Hong Kong and India suffered losses anywhere in the range of 5%-7%. That has been the rule.
The chart shows how the Dow Jones World, Asia Ex-Japan and Emerging Markets simultaneously turning down.
And again, China has again been the exception with both indices (Shanghai and Shenzhen) gaining nearly an astounding 5%.
But it isn’t China alone this time, the recently concluded longstanding Tamil insurgency problem in Sri Lanka appears to have brought about a stockmarket honeymoon.
The Colombo Index has spiked by nearly 9% this week, and is the first of among Asian markets to have reached the pre-crisis levels and is just off by about 20% from the 2007 high see Figure 2.
Figure 2: Bloomberg: Sri Lanka’s Colombo: Honeymoon
And I am predisposed to think that Asian bourses will follow suit.
Additionally, I’d like to point out that the Sri Lankan Colombo index has defied the tide because of an extraordinary development.
Going further, the scale of the recent losses has extended throughout most of Europe and to the Americas. Nevertheless, it has been a mixed showing for the Middle East and African region.
G-8 Communiqué As Catalyst?
So what has spurred this so-called global profit taking?
Technically speaking, under normal circumstances, no trend goes in a straight line.
Empirically, we have been witnessing excess volatility from a massive liquidity driven environment.
Fundamentally, I am predisposed to view this event, the G-8 meeting in Italy last weekend where leaders spoke about plans (actually blarneys) to unwind rescue program-as having been the main catalyst.
This from the Wall Street Journal (bold highlights mine), ``World financial leaders are starting to examine how they will unwind their emergency spending packages and bank rescues as signs emerge that the economic crisis may have hit bottom.
``Finance ministers from the Group of Eight leading countries on Saturday asked the International Monetary Fund to research strategies to slim budget deficits and reduce government presence in the financial sector, but in a way that wouldn't reignite the crisis.”
Three observations from these meaty statements:
One, governments have engaged in massive scale of emergency programs without the benefit of studying the possible unintended effects of such programs.
Two, along with this is the NO contingent or NO exit plans.
Gadzooks! Governments have been operating on mere BLIND FAITH on the feasibility of mainstream economic models!
And lastly, asking the IMF to “research strategies to slim budget deficits” is downright and strikingly preposterous! It resonates of the addiction by governments on boondoggles (spending binges) without considering the financing or all other aspects for that matter.
Commonsense says that you either need to cut spending or raise revenues! How complex or difficult could that be? And you don’t need the IMF for that. Qué Horror! Maybe the G8 leaders need to bankroll me for a lot cheaper price.
Markets, acting apparently on cue, shuddered from the thought of such exit plans! This goes to show how increasingly dependent our financial markets have become to money printing dynamics.
The Ivory Tower Syndrome?
Yet for some, commonsensical thinking or basic economic reasoning isn’t the preferred view.
Ironically commonsensical thinking has been perceived as tantamount to the Ivory Tower Syndrome.
The comments of Professor James K. Galbraith of the Lyndon B. Johnson School of Public Affairs at the University of Texas relates to its definition, ``I don’t detect any change at all. [Academic economists are] like an ostrich with its head in the sand.”
Experts afflicted with the Ivory Tower Syndrome simply means losing touch with reality.
It’s because these experts mostly live in a theoretical world filled with quant or econometric models, with virtually no hands-on exposure at risking their own money. Nonetheless they survive under the stipend of institutions and by NOT getting their hands dirty. In other words, perspectives of Ivory Tower analysts are most likely to be unrealizable, if not delusional and unworthy to be heeded.
As the global financial markets endured from a meltdown during the last quarter of 2008, we pointed out that some significant signs, such as the emergence of barter trade (which signified as an impasse on trade finance more than an economic problem) and an appearance of a bottoming market in China, defied the “realistic” consensus view that the world would fall apart.
At the heat of the panic we even declared a buy! [see October 12, 2008 The Bullish Case: It’s Blood On The Streets!].
Then, except for a few experts as Warren Buffett, Jeremy Grantham and John Hussman whose outlook we explicitly covered, other prominent value investors joined the contrarian bandwagon as Steve Leuthold, Anthony Bolton, Vanguard’s John Bogle and Rob Arnott we mentioned in The Rise of Value Investors Amidst A Prevailing Fear and Loss Environment. All of these elite savants, along with my humble perspective, challenged the interpretation of reality by the consensus as the imminence of deflationary depression!!!
Further, we even found evidences of a bottom in commodities last November 2, 2008, see More Compelling Evidence For An Inflection Point in Commodities!.
Moreover, as signs of improvements got reinforced, we repeatedly pounded on the table that stock markets and commodity markets will eventually be driven by government printing presses around the world, which has collectively been operating on 24/7 basis.
And instead of getting tied with economic gobbledygook, we focused on the inflation dynamics which in our view should give us a better glimpse of the market’s direction [see November 30, 2008, Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?]
This means that, in contrast again to the consensus, whom has opted to fixate on mainly the economic template, our fundamental area of concern has been to scrutinize on the actions of global political leaders and central bankers with its possible ramifications or impact on the markets and the economy.
Simply stated, we DIDN’T DEAL with esoteric mathematical models or flamboyant statistical artifacts seemingly aimed to mostly impress gullible audiences as employed by most mainstream analysts with their highly flawed models, we simply dealt with plain vanilla economic reasoning.
As Gerard Jackson in Economic commentators still clueless about the recession so aptly put, ``Unfortunately there are no mathematical relationships in economics. This means that economics is qualitative and not quantitive, despite the obvious importance of statistics.”
The point of this rant is not to accept or deny the pejorative imputation of Ivory Tower analyst, since that would be subjective. People can just say anything about anybody, true or untrue. It’s all a matter of consistency or inconsistency between the allegation and the performance.
Importantly, the perception of reality has always been a preconception out of individual biases. Alternatively, this means ``People believe what they need to believe, when they need to believe it”, a favorite quote of mine excerpted from Bill Bonner of the Daily Reckoning fame. Otherwise, this is also known as the confirmation bias-or the proclivity to look for or interpret data which confirms to inherent beliefs.
Ipse Dixit: Fundamental Driven Markets
In the present circumstances what seems to be the predilection of the mainstream?
Since the markets have shown signs of “life”, many have extrapolated current price levels as an attribution to “fundamental” driven market-economy dynamics.
In other words, the George Soros’ reflexivity theory seems to be getting even more entrenched- many now insist that fundamentals matter more than liquidity. Why? Because prices say so!!!
Funny, but 9 months ago or even at the start of the year, we haven’t heard arguments of such genre. Now market actions appear to calcify on the biases of many market observers.
Let us put it this way, since we believe that this episode has been tightly driven by the interlinkages of global liquidity channels, then it is likely that stock market and commodity market performance will be reflective of the state of inflation absorption as well as the degree of monetary inflation across the global economic and financial system.
In other words, inflation is always relative. As Henry Hazlitt in What You Should Know About Inflation [p.130] wrote, ``Inflation never affects everybody simultaneously and equally. It begins at a specific point, with a specific group. When the government puts more money into circulation, it may do so by paying defense contractors, or by increasing subsidies to farmers or social security benefits to special groups. The incomes of those who receive this money go up first. Those who begin spending the money first buy at the old level of prices. But their additional buying begins to force up prices. Those whose money incomes have not been raised are forced to pay higher prices than before; the purchasing power of their incomes has been reduced. Eventually, through the play of economic forces, their own money-incomes may be increased. But if these incomes are increased either less or later than the average prices of what they buy, they will never fully make up the loss they suffered from the inflation.”
Applied to the current setting, I would deduce that that the stock market and commodity markets have been the secondary recipients of global government spending, central bank lending, direct grants and US Federal Reserve purchases of US sovereigns and mortgage bonds. This has prompted some corners to baptize a moniker for this phenomenon as the bailout bubble, as earlier discussed in Monetary Forces Gaining The Upper Hand Equals The "Bailout Bubble"?.
Whereas circulation credit or bank lending from emerging markets or in Asia or in parts of the US (such as federally insured mortgages) or elsewhere could account for as primary or also secondary channels. The Wall Street Journal gives as this clue, ``Because businesses can't put trillions of new dollars to work in such a short time, the money is finding its way into financial markets.” (bold emphasis mine)
Since markets always operate on the basis of expectations, then a synchronic decline in global markets suggest of four possible causes, outside the technical and sentiment based considerations:
One, markets could probably be discounting a peak in government sponsored programs. Given the addiction of governments as shown by the G-8 news, this isn’t the likely route. Governments have been relishing both the spending spree and the apparent initial favorable effects on the markets.
Two, markets could also be factoring in a culmination in bank lending thru policy induced tightening or a by an aggregate private institutional policy curbs.
This isn’t likely so too. Since the US Federal Reserve has been providing leadership and guidance to global central bankers’ action, then its policy rates could serve as bellwether to the interest rate policy direction of other major central banks see figure 3.
Figure 3: St. Louis Fed: Fed Fund Rates futures
We note that while the Fed rates futures have indeed seen a marginal increase to the upper band of the official Fed Rates, it hasn’t succeeded in breaking out yet.
Three, a combination of both.
Fourth, false negative or also a trial balloon. Here the market may have misread the government actions or communications on the threats to unwind or reverse emergency programs, where the official G-8 communiqué may have been unintentional or intentional, possibly targeted at testing markets response.
While I am not certain on the true state of the markets now, the G-8 pronouncements most probably embodies the fourth variable.
Governments given their ideological underpinnings and the present conditions are unlikely to further discomfit the markets. So any further weaknesses by the stock markets are likely to prompt for “dovish” or market friendly communications from the officialdom.
This brings us back to the revitalized arguments of the ‘fundamentalist’, if markets have been moving based on fundamental factors and not from liquidity transmission channels, then why is it then that global markets continue to act almost uniformly? Why are correlations high among regional markets (except for China and Sri Lanka) or even relative to global markets?
The reaction seen in the global markets hasn’t been seen only on Phisix component issues but also in the internal market actions as seen in the market breadth and in the sectoral performance, of the Philippine Stock Exchange (PSE) see figure 4.
Figure 4: PSE: Sectoral Performance, Fundamentals, Where?
The Banking index (black candle), Service (Gray), Commercial Industrial (pink), Holdings (red), property (blue), All index (maroon) and mining (green) have all been down.
The most recent carnage has almost been in the scale of the climax of the October-November 2008 rout, where advance-decline balance has almost been 1:4 ratio!
Further deterioration of market internals at the same rate as last week would translate to the same tsunami that would sink all ships afloat!
So fundamentals, where?
Focus On Issues That Matter
People are unarguably entitled to their perception of reality. If anybody wants to believe in the “reality” of Santa Claus or Peter Pan and tinkerbell or Superman or a living Elvis, no one will stop them.
Although we are open to exchanges of ideas in the same way markets operate on the exchanges of goods or services based on voluntarism and the availability and expected informational changes, my preference for cerebral stimuli are based on merits and show proofs or evidences and not on Ipse-dixitism or an unsupported assertion.
That’s because to operate on hunches or base intuition is likely to be a very risky endeavor where cognitive biases can function as fatal traps. And this applies not only to the investment sphere but to real life non-investment decision making.
A misdiagnosis that leads to a wrong cure risks worsening of the conditions of a patient possibly by complications. In investments, the same misdiagnosis could translate to heavy losses.
And that’s why we try to avoid dealing with gossip or trivia based market actions. Sensationalism, which connects to the majority, only reinforces cognitive biases. And what usually are deemed as popular issues or causes are frequently flawed or even illusory. For instance, politicians sell free stuffs-health, education, jobs, including bailouts and etc. especially during election seasons. In a world of scarcity, there is no such thing as free lunch. Another, some people equate stocks to horse racing, hence, they get what they deserve.
And by the omission of the sensational, it doesn’t matter if our viewpoints aren’t popular. What matters for us is survivability and feasibility.
Conclusion
Despite the harrowing performance of the Phisix or of global stock markets, which may have been prompted for by market’s realization that the good party days may be cut short perhaps based on the conveyed communication by the G-8 meeting or possibly due to overextended or overheated winning streak, it is highly likely that these setbacks could be temporary.
Governments sensing the latest streak of triumphs aren’t likely to upset the present gains, in spite of pressures applied by certain quarters. The present environment has been ideal for the governments as they benefit from both their spendthrift ways and an ephemeral favorable market condition which illuminates on the vainglories of the fictitious centrally based solutions to national economic problems. Maybe Murphy’s Law applies here: If it ain’t broken, don’t fix it.
If today’s markets have been responding to the expectations of culminating inflationary actions then governments will most likely change tones and revert to dovish themes while simultaneously re-inflating the system. That’s our bet.
Besides mainstream experts adhering to the predominant ideology would constantly use technical jingoism of “output gaps” and “idle resources” to rationalize or justify further money printing activities through-quantitative easing, deficit spending, Zero bound policies, negative real interest rates and etc.
So I’d go against the technical outlook which is in present emitting signals in conflict with the probable effects from government policies. Stock markets could go lower or consolidate but won’t probably retest the old lows.
Finally, what appeals to people is what they like or want to hear, read or see premised on their underlying biases.
Biases are inherent to human nature, as it had been hardwired to us by our ancestors. It has been programmed into our genes. Although, the best way to manage bias is by keeping an open mind.
After all, in the markets, it isn’t about being “right” in terms of convictions, it is essentially about being profitable by adopting the “right” flexible mindset and discipline.
So from our end, if the Ivory Tower syndrome equates to survivability, feasibility and performance, then it’s no shame to be labeled as one.
Unfortunately, the idiom, which means to lose touch with reality, would lose its relevance.
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