Situational Attribution Is All About Policy Induced Inflation

``Believe nothing just because a so-called wise person said it. Believe nothing just because a belief is generally held. Believe nothing just because it's said in ancient books. Believe nothing just because it's said to be of divine origin. Believe nothing just because someone else believes it."- Buddha, Unconscious Beliefs

If fundamental attribution bias is the “undervaluing or failing to acknowledge the potentiality of situational attributions”, then that means people overlook or substantially underprices situational developments.

For instance, some have suggested that stock market prices today as having been “overvalued”.

Well in my view, prices are relative:

1. in terms of direction: low prices can go lower and high prices can go higher,

2. valuations are always subjective and

3. prices can be seen as higher/lower in a relative sense when compared to the specifics. In the psychological context this is known as the contrast principle/effect or judgments based on relative comparisons or simply higher compared to what or whom?

Importantly, the issue of prices or valuations would greatly depend on the situational attribution or developments.

Situational Directions

So what has been the “situational” course of events?

It’s apparently not imputable to traditional or conventional specific metrics, because evidences haven’t been pointing to such direction, see Figure 2.

Figure 2: Stockcharts.com: Correlation: Phisix, Euro, Emerging Markets and Oil

The Euro which comprises 57.6% of the US dollar Index according to the ICE Futures, seems to be leading the way for Emerging Market Stocks (EEM), including the Philippine Phisix (PSEC) and commodities as represented by oil (WTIC).

The highs of the Euro (vertical blue lines) have been coincident with turning points of the specified markets above, but with a lag.

In short, over the interim the rising euro, or the inversely the falling US dollar index seems tantamount to higher financial asset prices.

As we have repeatedly argued, the global inflation dynamics are apparently being transmitted into equity, commodities and property markets (ex-developed economies) via the currency channel, as described in many past issues including the latest [see last week’s Warren Buffett’s Greenback Effect Weighs On Global Financial Markets].

Therefore, if markets haven’t been driven by conventional specific metrics, then why should we utilize conventional metrics as a gauge to determine our trade positions? That would be like using sonar to track airplane movements.

Inflation Dynamics In The Phisix And The World

The beauty of any theory would lie within its applicability or by the function of factual evidences… (see figure 3)

Figure 3: PSE Sectoral Indices: Rising Tide Lifts All Boat

The sectoral indices of the Philippine Stock Exchange (PSE) depicting synchronicity in motion.

Current market activities have strongly been demonstrative of the tidal ebbs and flows (or our Livermore-Machlup model see Are Stock Market Prices Driven By Earnings or Inflation? ) of the Philippine marketplace as we have long forecasted.

Our outstanding premise has been the lesser the efficient the markets the more prone to inflation driven dynamics.

Although domestic stock prices have risen in general, price levels have been nuanced, where some sectors have been outperforming the others [see Sectoral Performance In US, China And The Philippines].

The present pecking order of outperformance: Mining (green), Holding (red), the All Index (maroon), commercial (pink), property (blue), bank (black) and services (grey).

As you can see, the “rising tide lifts all boats” phenomena compounded by the relative price level actions have all been reinforcing the symptoms of an inflationary (liquidity) driven boom.

Such situational course of events hasn’t confined locally but to the world though.

As we pointed out in the latest Global Stock Market Performance Update: Despite China's Decline, Emerging Markets Dominate, 68 (83%) of the 82 issues monitored by Bespoke Invest (based on August 20^th) registered positive gains against 14 (17%) which accounted for losses.

Despite China’s Shanghai benchmark, which fumbled for the fourth consecutive week of losses (this week 3.38%) for an aggregate 4 week loss of 17.2%, China has been up 57% on year to date basis.

The Philippine Phisix as of Friday’s close seems to be closing the gap fast.

Nonetheless, the best performances have been among key emerging markets (many of which are situated from Asia), some having been beneficiaries of low systemic leverage and an unimpaired banking system, which has responded favorably to lower interest rates, while some have been reaping from rising commodity prices.

Although we expected some degree of differences relative to the US to emerge, this hasn’t been so yet.

The evolving activities in the US seem to reflect on more of the actions seen in most of the world.

According to Bespoke Invest, ``93% of stocks in the S&P 500 were trading above their 50-day moving averages. That number has come in slightly with today's declines, but it's still above 90%.” (emphasis added)

In short, macro thinkers, who fixate over the actions of the US, but negate the activities across the geographically diverse asset markets have been missing out on these developments.

The Validation Of Our Livermore-Machlup Model

More proof of more liquidity driven boom in the domestic market? (see Figure 4)

Figure 4: PSE: Daily Traded Issues (left) and Number of Daily Trades (right)

When the marketplace becomes reanimated, the speculative appetite expands.

This implies that transactions would cover issues that are less liquid (low market float), which can be found mostly among second or third tier securities.

As you can see in the left window, the daily traded issues have been broadening. This means that the advances in the Phisix are being seen in general terms, validating Jesse Livermore’s assertion.

Moreover, improving daily trades suggests of more people participating or engaging in churning activities.

Again another manifestation of a bullish breadth (right window).

It doesn’t stop here.

Figure 5: Advance Decline Spread: Broadening Gains

Another indicator would be the advance decline spread.

In the height of the selloff in 2008 (red ellipse), the advance decline spread has been obviously tilted towards huge broad based selloffs.

Today we see the opposite, since March of 2009, the internal activities in the Philippine Stock Exchange has largely been in favor of the advancing issues (light green ellipse).

To consider, local investors have usurped the role as the dominant pillar of the current state of the Phisix, a role which we presume should contribute to a sturdier trend and likewise could be deduced as having become less sensitive to the external developments, in contrast to the 2003-2007 cycle.

Added together, all these essentially have been validating our Livermore-Machlup inflation driven tidal dynamics thesis, where the collective inflationary policies by global governments will presumably take a major role in determining asset pricing conditions.

So stubbornly insisting on the idea of conventional metrics as a gauge of the market’s parameters will only lead to wide off the mark appraisals and severe underperformance.

The Economic Disconnect And Domestic Mainstream Policies

So does a 54% year to date surge in the Phisix translate to a V-shape recovery in the Philippine economy?

The Economist gives as an answer, (bold highlights mine)

``Although the return to robust quarter-on-quarter growth of 2.4%—the highest in over two years, following a first-quarter contraction of 2.1%—fits the international pattern, the economy has not contracted at all in year-on-year terms during the current global crisis. Growth of 0.6% in the first quarter appears to have marked the low point in the current cycle. Still, the recovery is far from entrenched. At just 1.5% year on year, real GDP growth in the three months to June was far below the 2004-08 quarterly average of 5.5%.

``In output terms, the service sector was the main driver of economic growth in the second quarter. Services output rose by 3.1% year on year, up from 2% in the previous quarter. Government services rose by 7.7% in real terms, reflecting stimulus spending. Trade rose by 3% on the back of strong growth in retail activity. In contrast, agricultural growth slowed sharply due to weak production of rice and some other crops. And industry contracted for the second straight quarter, falling 0.3%. Although the government's fiscal measures boosted construction, which rose by 16.9%, and mining and quarrying also recorded a big gain, growth in these areas was more than offset by the decline in manufacturing. This underlines the weakness of demand for Philippine exports, which has hit manufacturers hard.”

So seen from mainstream’s “money is neutral” perspective, then today’s Phisix, if it were to reflect on the performance of the economy, has vastly been overbought.

But seen from a perspective where the economy has been detached from the stock market and where the latter have been propelled by circulation credit expansion from a combination of government spending, low interest rate regime and a raft of other Bangko Sentral ng Pilipinas (BSP) policy instruments [as expanded peso and US dollar based repurchasing (repo) agreement, Credit Security Fund (CSF) that guarantees funding access to small cooperatives from which provides financing to small business and the easing of accounting regulations such as reclassifying “financial assets from categories measured at fair value to those measured at amortized cost” and where banks were allowed “not to deduct unrealized mark-to-market losses in computing for the 100 percent asset cover for FCDUs, effective until 30 September 2009).” (Gov. Amando Tetangco Amcham Speech August 11)], all of which could snowball into a massive source of structural misallocation of resources in the local economy, prices will be determined by the scale of leverage that will be imbued by the domestic financial system.

Yet like all policymakers globally (except for Israel which has dumbfounded the marketplace by being the first central bank to raise interest rates), Philippine BSP Governor Amando Tetangco takes on the mainstream tack, (bold emphasis mine)

``This 200 basis-point cumulative reduction in the policy rate will help stimulate economic growth or help moderate the slowdown by bringing down the cost of borrowing and reduce the financial burdens on firms and households. This will help us avoid or at least mitigate the negative feedback loop from weakening economic conditions to the functioning of the financial sector. Lower policy rates would also have the effect of shoring up business and consumer confidence.”

Business Cycle, The Philippine Version

Artificially reduced rates will only send false signals of the true amount of real savings available for lending. This would unnecessarily increase the acceptable level of risk taking activities by shifting the time preferences for both the lender and the borrowers. This in turn induces investments in the durable capital goods and or investments in the longer term process of production at the same time where consumption demand will be expanding which thus would leads to serious economic distortions and competition for resources, or in short, malinvestments.

To quote Professor John Cochran and Noah Yetter in Capital in Disequilibrium: An Austrian Approach to Recession and Recovery, ``But with a credit expansion relative reduction in the interest rate, producers are attempting to lengthen the production structure while consumers are attempting to shorten it. Longterm investment is booming at the same time as demand is growing for final consumption. Available resources are not sufficient to sustain both processes— individual business plans made in response to the interest rate change and the new pattern of consumer spending set up the problem of the ‘dueling production structures’. Thus the expansion in the money supply brings about unsustainable growth, characterized by a pattern of over consumption and over investment accompanied by malinvestment, investment inconsistent with consumers’ time preferences.” (bold highlight added)

Moreover, such policies allows the public to take on more debt than warranted which leads to systemic overleverage similar to the Asian Crisis, US housing and dot.com bubbles, as Prof, Thorsten Polleit explains in Bad News for Our Money ``It allows borrowers to issue even more debt, refund maturing debt at artificially suppressed interest rates, and reduce their real debt burden at the expense of money holders. The downward manipulation of the interest rate drives a wedge between the (real) market interest rate and the societal time-preference rate, and therefore wreaks havoc with the economy's intertemporal production structure. It leads to economic impoverishment, as it would stimulate consumption at the expense of savings and encourage malinvestment of scarce resources. What is more, suppressing the interest rate does not provide a solution to the overindebtedness problem, which is a result of government-controlled fiat money produced by banks extending credit in excess of real savings.”

Moreover, such policies only borrow economic activities from the future.

Floyd Norris of the New York Times recently noted how US homes prices reflected on the degree of inflation, initially rising (boom) but falling back (bust) to the same inflation adjusted price levels where the cycle all began [see US Home Bubble Cycle: Upside Directly Proportional To Downside]. Of course, all these came at the expense of the society. Hence Mr. Tetangco’s anxiety over the negative feedback loop can only be deferred until sometime in the future when enough imbalances will force itself on the marketplace.

Figure 6: Washington Post: Banks 'Too Big to Fail' Have Grown Even Bigger

Of course, monetary inflation has moral consequences; it redistributes wealth in a way where the initial recipients would be major beneficiaries from such policies.

Similar to the US where taxpayers and small businesses and small banks today have been sacrificed for “too large to fail” institutions which has even expanded more today (see figure 6), in the Philippines, investors with liberal access to the domestic banking institutions are likely to be the capitalists benefiting from the economic rent or politically bestowed economic privileges (licenses, cartels, monopolies).

So the wealth redistribution from present economic policies is likely to benefit the political elite at the expense of rest of the society.

In addition, with the fast approaching political Presidential election season, we should expect the present expansionary monetary landscape to be sustained. Here is a clue, again from Governor Tetangco, “Lower policy rates would also have the effect of shoring up business and consumer confidence”.

Besides, government’s fiscal spending to are likely to rev up in order spruce the economic landscape and financial marketplace for a Potemkin Village effect [see previous discussion in Philippine Peso: Interesting Times Indeed].

Well, Governor Tetangco in terms of policymaking would likely seek the comfort of the mainstream crowd once such policies start to unravel.

Hence he is likely to take heed of the insights from the mainstream icon at heart, this from John Maynard Keynes, ``Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

Anyway, comfort of the crowd it is for Asian policymakers.

From China’s Premier Wen Jiabao (Reuters) ``Therefore, we must maintain continuity and consistency in macroeconomic policies, and maintaining stable and quite fast economic growth remains our top priority. This means we cannot afford the slightest relaxation or wavering."

Or From South Korea’s Finance Minister Yoon Jeung Hyun (Bloomberg/Credit Bubble Bulletin) ``There is a risk that the economy may fall into a double dip if the government shifts the stance of policy too fast…It’s premature to discuss the timing of an exit strategy.”

However, even if Asian authorities have qualms on tightening present policies, the interest rate markets suggest that they will be tightening soon.

According to the Wall Street Journal, ``Asia's central bankers say they have no timetable for raising interest rates. But some investors already are placing bets to the contrary, speculating that India will go first, followed by China and Korea.

``The money is being put down in the huge interest-rate-swaps market, where the yields on two-year maturities across much of Asia have risen sharply in the past few months.

``This market, which had $403 trillion of contracts outstanding at the end of 2008, draws a range of investors, from hedge-fund managers to companies looking to hedge against a change in monetary policy. About a quarter of its volume is traded in Asia.”

Nonetheless even if Asian authorities begin to tighten for as long the US maintains ultra loose rates, pump the prime (deficits expected to reach $9 trillion in 2019!) and flood the global system with greenback emissions (Warren Buffett), we should expect the continued stickiness from inflation to be reflected on financial asset prices.

While markets could indeed show episodes of outsized volatility, as in the case of China or in the past in Russia, the impact from the present policies, in support of the Ponzi based global economic system, which are likely to be stretched way into the future for political motivated reasons should cushion or even give a boost to the reflation in asset prices.

Timing markets won’t be a recommended approach given the swiftness of market action.

Bottom line: Situational Attribution is all about policy induced inflation.