Friday, July 31, 2009

Philippine Real Estate In 1st Quarter 2009, Down But Not Out

Philippine real estate prices declined (based on inflation adjusted prices), during the 1st quarter of the year.

That's according to, (all bold highlights mine)

``In early 2009, luxury condominium prices, and sales, both fell in Manila. Compared to the previous quarter, the average price of luxury three-bedroom condominiums in the Makati Central Business District dropped by 0.7%, according to Colliers International (a fall of 0.6% in real terms).

``During the year to Q1 2009 the average price has appeared to increase by 4.6%, to PHP101,000 per sq.m. But this increase is illusory, because when adjusted for inflation, the average price has in fact fallen by 2.2%.

``Two of the biggest real estate developers in the country, Ayala Land and Megaworld, experienced declining real estate sales in Q1 2009. Sales of residential projects of Ayala Land declined by 10%. Megaworld reported that a decline in its real estate sales was offset by rental income growth, and posted flat net earnings growth from the same period last year.

``Housing demand from US-based overseas Filipinos weakened significantly, due to the economic recession. This was slightly offset by demand from Overseas Filipinos Workers (OFWs) in the Middle East and Asia. But this may not last long, since most of these countries are in or near recession.

Nonetheless the study appears to rely heavily on remittances as the main driver for the domestic property market.

Again from Globalpropertyguide, ``There are approximately 9 million Overseas Filipinos (OF) worldwide, or around 10% of the Philippine population. Of all OFs, 42.3% are permanent.

``Among permanent OFs, 68.2% reside in the US, followed by Canada (11.1%), Europe (7.7%), Australia (6%), and Japan (3.6%). The economies of these countries are in deep recession.

``Saudi Arabia has the most OFWs, at 25.3% of the total, and followed by UAE (11.9%). Housing demand from OFWs in the Middle East is expected to weaken, because the economies of the major OFW employers, Saudi Arabia, UAE, and Kuwait, have weakened.

``Remittances from OFs are major drivers of consumption and investment in the Philippines. Remittances reached US$16.4 billion in 2008, around 9.7% of GDP. A significant portion of remittances is spent on housing.

``Although remittances grew 2.7% y-o-y to Q1 2009, total remittances in 2009 are expected only to match 2008 levels, in sharp contrast to double-digit growth rates in the past. In 2008, remittances rose 13.7%, following 13.2% growth in 2007, 19.4% in 2006 and 25% in 2005.

``Even if remittances continue growing in 2009, purchases of residential property may be delayed, until the economy recovers."

A view of the global recession from the Economist

Nonetheless, the study also reveals the other obstacles in the Philippine property market development.

Again from

``In the Philippines, most buyers pay in cash, or buy during the pre-sale period. With remittance-fed demand weakening, local demand is hampered by an underdeveloped mortgage system.

``The ratio of housing loans to GDP remains small, at less than 2%. Outstanding real estate loans for acquisition of residential property grew by an average of 14% annually from 2001 to 2007, to PHP112.2 (US$2.4) billion. Data for 2008 is still unavailable but growth is expected to exceed 10%, because the BSP relaxed rules on real estate lending in December 2007 to support the property industry.

``Despite this growth, several factors still hamper local mortgage market expansion. Banks impose restrictive lending conditions, and approval of loan applications takes a long time. Few major banks offer housing loans, and loans have similar terms and conditions. Land titling and registration problems are prevalent, as are delays in the foreclosure process.

``Housing loan rates charged by major commercial banks remain high, at around 9.5% for loans fixed for one year, and at least 11% for mortgages with rates fixed for five years or more. In-house financing offered by developers involves even higher rates of between 15% and 22%.

``The government-owned Pag-ibig Fund (Home Development Mutual Fund) offers lower interest rates of between 6% to 11.5%, depending on the amount borrowed and loan conditions. Compared to bank loans, the amount that can be borrowed is lower, but the payment periods are longer and loan-to-value ratios are higher. Membership requirements have to be fulfilled to get a loan.

But, the study suggest that yields from investment remain attractive

``In October 2008, the average rental yield for condominiums in CBDs in Metro Manila was around 9.4%, according to Global Property Guide research. The highest returns were achieved on condominiums measuring between 70 and 120 sq. m., with yields typically exceeding 10%. Rental yields are expected to remain high, as property prices are expected to fall faster than rents."

Here are my additional comments:

1. While I don't have the details of the entire property market, the stereotyped generalization of remittances driving consumption and investment (of the economy) and property prices seems vastly exaggerated.

As to how 10% of an economy is greater than the composite 90% of the economy is certainly beyond me. Up to now, I have yet to see figures (even estimates) from the so-called multiplier effects from remittances as a share of consumption or investments.

Also how much of property pricing dynamics are from remittances?

2. Property prices aren't the same. OFW's are likely to be buyers of low and middle cost housing than the luxury condo market. In short, different products for different markets.

3. There seems to be a much ignored factor-an inflationary environment that is symptomatic of the falling US dollar worldwide.

This suggests that for condominiums, aside from local residents or OFW remittance money, foreign money could pose as prospective buyers especially considering the attractive relative yield as mentioned above.

4. Ultra loose monetary policies here and abroad are likely to stimulate an asset chasing phenomenon. Aside from stocks, this should include the property sector.

Hence, buying from local residents, considering the immense liquidity in the domestic financial system, could boost property prices.

5. I don't share the view that property prices depends on economic recovery as to clear oversupply and push prices up. Inflationary monetary policies in a low leveraged environment could do the trick of inducing speculative money flows into property.

Here, economic recovery will lag property prices but will be subjected to the local boom bust cycle.

6. Lastly, some reasons why the development in the Philippine property sector has lagged the world has been addressed above: underdeveloped mortgage or capital market (which has led to few suppliers with tight standards and high rates) and stifling red tape.

Tuesday, July 28, 2009

Equity Premium: Product of Monetary Policy Interventions

In our previous article Why Stocks Could Outperform Bonds Over The Next Decade

However, Mr. Gerald Jackson of Brookesnews has an excellent theoretical dissertation underpinning this so called equity premium debate, (bold highlights mine)

we laid the case why I think stocks could outperform bonds (mostly from the inflation perspective)Let me quote Mr. Jackson,

``However, we live in the real world of uncertainty where markets exist because we do not have perfect foresight. Therefore the role of the market is to coordinate and distribute expectations and masses of incomplete knowledge to market participants who will then act according to their own expectations and experience. The world of uncertainty brings us to the nature of profit and its effect on shares. In a progressing economy — one that enjoys rising per capita investment — aggregate profits will always exceed aggregate losses."

``Obviously, if firms consistently make profits then the value of their shares must steadily rise. This means that equity returns must exceed the return on bonds. The reason is the nature of profit. Ludwig von Mises explained that profits are maladjustments between supply and demand. Hence factors become underpriced in relation to the value of their products whenever a genuine profit appears."

``Let us assume a general equilibrium position where all returns have been equalised. There would be no profits or losses and uncertainty would have disappeared. Let us now introduce uncertainty and losses but not profit into our model. Obviously a risk premium would now emerge. It should be equally obvious that the difference between the return on bonds and equities would be pure risk.

``The final step takes us into the real world of profits and losses where economic progress is the order of things. We would now find that the difference between bonds and equities has widened further because we now have to account for aggregate profits exceeding aggregate losses. Therefore profit equals any return over the rate of interest plus any attendant risk. In a progressing economy new ideas, inventions, techniques, innovations, etc, are being constantly applied through new capital combinations. This process constantly renders older capital combinations obsolete and leads to their dissolution thereby creating profitable opportunities."

In short, the fundamental difference between stocks and bond is profit. And by nature stocks, due to its claim on capital goods or earning streams, should outperform bonds.

But the so-called equity premium is the attendant volatility emanating from government policies from which Mr. Jackson defines as the ``gross monetary mismanagements distorts markets and inflates share prices. Sooner or later unavoidably painful corrections have to be made. When this happens the market gets the blame and calls are made on politicians to take action. This invariably results in highly damaging interventionist policies. All because basic truths about how shares are truly valued and how bad monetary policies cause financial crises have been forgotten."

Warren Buffett: Invest In Yourself, Stocks Over Cash

CNBC interviews Warren Buffett about a TV cartoon series which he stars in "The Secret Millionaire's club" and gets gobs of advise on inflation, stock investing and personal virtues.

Global Stock Market Performance Update: Proof of Rotational Effects and Tight Correlations

This is an example of how experts use specific time frames to prove a point.

This from Bespoke Invest,

(bold highlights mine)

``The S&P 500 is up 11.24% since July 10th, which is a significant move in such a short period of time. The recent gains also put the index up nicely at 8.28% year to date. As shown below, the US has performed well relative to the rest of the world. Since July 10th, it ranks 22nd out of 82 countries. Russia is up the most with a gain of 24.23%, followed by Hungary, Poland, Norway, Romania, and Germany. Middle and Eastern European countries have seen some of the biggest gains in recent weeks."

Justify FullAdds Bespoke, ``While China has been the second best performing country (behind Peru) year to date, it is only up 10.32% since July 10th. This is better than most countries, but it hasn't been the worldwide leader that it was earlier in the year. Five of the G-7 countries have outperformed China, and all seven G-7 countries are in the top 50% in terms of performance. This is a sign that developed markets have been holding their own against emerging markets in recent weeks. Only ten out of 82 countries are down since July 10th, with Slovakia leading the way at -5.67%."

We are grateful to Bespoke for their wonderful graphics.

However, with China's year to date gains at a mindboggling 88.66% and with the Shanghai benchmark at grossly overbought conditions, it would be a puzzle or an irony to expect a continuation of such torrid pace of advances or even make a worthwhile comparison. 88% versus 9% (year-to-date) is just a wide wide chasm.

As we earlier wrote in Global Stock Market Performance Update: Rotational Effects and Tight Correlations

``If global markets have been driven by liquidity or monetary forces or inflation dynamics then it is quite obvious that there will be rotational effects and secondly, for the early movers some tight correlation, as global liquidity transmission interlinks divergent markets."

Hence, our views seem to get validated where we appear to be indeed witnessing rotational effects from inflationary policies as the market leadership has temporarily switched from (leaders) emerging markets to the (laggards) developing markets.

Another, as Bespoke likewise observed, only 10 out of 82 since July 10th are down, or 17 out of 82 global benchmarks on a year-to-date basis-signifies further proof of the "global liquidity transmission interlinks divergent markets", we earlier posited. Market gains seem to broadening on a worldwide basis, but not all.

Russia's RTS outperformance appear to be a function of a typical bullmarket trend.

As we commented in the same article, ``Russia's hefty decline exhibits overheating. The Russian benchmark is still the 5th best year to date performer IN SPITE of the recent (21%) downturn. It trails Peru, Sri Lanka, China and India."

Indeed, after a 50% fibonacci retracement since the March lows, Russia has used its recent reprieve and the opportune windows provide by developed markets as fulcrum to stage another gala rendition (even at the face of a mighty performance by developed economies.)

Bottom line: ``developed markets have been holding their own against emerging markets" because of the rotational effects and global liquidity transmission of the global inflation dynamics more than representative of idiosyncratic strength or traits.

At the end of the day, emerging markets has still patently outperformed its developed counterparts under present "ultra loose monetary" conditions.

Monday, July 27, 2009

Mises University: The Life And Work Of Ludwig Von Mises

From the Mises University, the life and work of Ludwig von Mises by Guido Hulsmann.

Learn the basics of the Austrian economics. (Source Mises Blog)

Sunday, July 26, 2009

Asia Sows The Seeds Of The Business Cycle

``All of us are ignorant of most of what there is to know." Professor Richard Dawkins, British Ethologist, Evolutionary Biologist, and popular science author

Anybody arguing that stock markets are strictly determined by traditional fundamental metrics should look at the current earnings environment of the US S&P 500 in figure 1.

Figure 1: Annual S&P 500 Earnings Collapsed!

As you would notice, the inflation adjusted earnings has essentially fallen off the cliff.

According to, the ``chart illustrates how earnings are expected (38% of S&P 500 companies have reported for Q2 2009) to have declined over 98% since peaking in Q3 2007, making this by far the largest decline on record (the data goes back to 1936). In fact, real earnings have dropped to a record low and if current estimates hold, Q3 2009 will see the first 12-month period during which S&P 500 earnings are negative.” (bold highlights mine)

Yet, with the S&P 500 up 11% over the last two weeks (+8.4% year to date and 43.8% since the March trough), many would probably impute a sharp earnings recovery for S&P component companies, and with it the US economy.

But such rationalization overlooks the obvious.

One, the S&P valuations appear to be priced for perfection.

And most importantly, as discussed in “Should We Follow Wall Street?” and “Worth Doing: Inflation Analytics Over Traditional Fundamentalism!”, stock market prices are increasingly being driven by inflation!

So any analysis which ignores the deepening significance of the inflation component in financial asset pricing would seem like ‘looking at the sun and calling it the moon’.

As Dr. Marc Faber aptly commented in a recent CNBC interview, ``The worst the economy becomes the more governments will print money and people will say, "well, the output gap will prevent inflation from occurring" Do you know what the output gap is in Zimbabwe? 99% below potential GDP and there you have the highest inflation."

This means that as global governments continue to maintain loose monetary policies, which encourages a speculative environment to revive the so-called “animal spirits”, and at the same time undertake expansion in fiscal spending, financial asset prices are most likely to exhibit dynamics which increasingly disconnects with economic and micro-fundamentals or where financial asset prices will detach from popular mainstream economic theories.

And distortions from government policies have always been vented in the currency (see Figure 2) and transmitted to various asset classes.

Figure 2: US Dollar Index At Cusp Of A Breakdown

As the US dollar index sags to the point of testing the massive “descending triangle” support level, global stocks (DJW) and commodities (CRB) have been benefiting from the ongoing risk realignment-where money has apparently been shifting away from the US dollar and US sovereigns.

The yields from 10 year US Treasury Notes (TNX) has been rising to reflect on a transition from a deflationary scare and a deep recession to what mainstream deems as “transition to moderate economic recovery”.

However to my mind, the confluence of price signals in the above markets seems increasingly a manifestation of the inflation genie becoming unshackled from the proverbial oil lamp.

With the prospective breakdown of the US dollar trade weighted index, we are likely to witness the acceleration of such inflationary bias.

In his Credit Bubble Bulletin, Doug Noland says it best (bold emphasis mine),

``The problem only seems to get clearer. The maladjusted US Bubble economy is sustained by $2.0 to $2.5 Trillion of new Credit – Credit that must largely be issued or guaranteed in Washington. This reflation (a.k.a. Credit inflation/currency devaluation) drives massive flows to China, Asia and the emerging markets that have few takers other than the central banks. And as economies recover and inflationary distortions reemerge, these enormous dollar flows can be expected to foment increasing policymaker angst. Asian reflation is poised to take on a wild life of its own, forcing policymakers at some point to confront today’s reality that dollar flows are destabilizing and unmanageable. China, in particular, faces tough choices when it comes both to managing its Bubble and accumulating massive quantities of IOUs of deteriorating quality.”

More Evidences Of China’s Bubble Conditions

Indeed, China’s “run away train” markets has significantly been exuding evidences of bubble like conditions [as previously discussed in China In A Bubble, ASEAN Next Leg Up?] see Figure 3, which should pose as a dilemma for policymakers.

Figure 3: US Global Funds: Hot Money Flows And Property Bubble

``The specter of hot money may have re-entered China. An increasing portion of China’s foreign reserve accumulation in recent months cannot be explained merely by trade inflows and foreign direct investment,” observes the US Global Investors, “betting on a strengthening Chinese currency, hot money from overseas added to the excess liquidity problem in China several years ago, and might be used again as another excuse for policy tightening in the future”

Meanwhile, the apparent euphoric mood has enchanted and drawn retail investors into the frenzied punting activities in their domestic stock market, according to Bloomberg, ``Individual investors opened 484,799 stock accounts last week, data from the nation’s clearing house showed today, the most since the five days ended Jan. 25, 2008, and almost five times this year’s low in January.”

And with a savings rate of 49.5% in 2007, according to the PBOC, (WSJ) the shifting of a substantial part of savings into the stockmarket could indeed power up a gargantuan bubble.

Hence, the transmission mechanism from US Federal Reserve inflationary monetary policies seems evident from the standpoint of momentum based international money flows which has bidded up both the stock market and the property market, while domestic policies in China have aggravated the national inflation dynamics.

And this hasn’t been limited to a China only affair.

We appear to be witnessing the same dynamics at work in Asia. As anticipated, Asia’s benchmark bourses saw a mighty succession of breakouts last week from their resistance levels in Hong Kong, South Korea, Australia, New Zealand, Sri Lanka, Indonesia, Singapore, Malaysia and the Philippines.

Meanwhile, Taiwan, Pakistan, Thailand and India are likewise drifting at resistance levels gearing up for the same upside thrust.

A Bank Financed Regional Bubble?

We have argued that low systemic private sector leverage, as represented by the corporate and household sectors, fused with high savings are likely to respond materially to national monetary policies (See figure 4).

Figure 4: ADB Economic Outlook: Asia’s Policy Rates and Bank Lending Growth

The point of our interest in the ADB chart, is that except for Taiwan and Hong Kong which saw a growth contraction in bank lending (upper left window), most of Asia, namely Singapore, Korea, and the ASEAN-4 which includes the Philippines, only saw a moderation- even in the face of the crisis.

Notice too that when ASEAN-4 policy rates had been cut from its peak in 2006 (bottom right window), bank lending growth on a year to year basis zoomed up in 2007 until it crested (upper right window) during the September 2008 Lehman bankruptcy.

Nonetheless, with artificially depressed policy rates as a function of the adaptation of myopic mainstream economics, which had been intended to spruce up consumption or the so called “aggregate demand”, bank lending growth seems poised for an explosive takeoff.

Figure 5: ADB: Importance of The Bank System In Asia

Unfortunately instead of sound investments which should translate to real economic growth, the public’s search for yield will redirect resources mostly to needless speculation.

And since bank lending has been the main credit intermediary for ASEAN (see Figure 5) or even for most of Asia’s economies we are going to possibly see a bank financed regional stock market bubble - where a big portion of the bank lending could be diverted into the stock market in an effort to extract marginal yield.

The Boom-Bust Business Cycle

And so the policy shaped investing landscape had been engineered to lure away the public from savings and into speculation and punting.

Essentially, the seed of business cycles has likewise been sown in Asia as the result of the aversion by global policymakers to face the consequences from previous policy errors.

As Professor Shawn Ritenour rightly argues in When Stimulus Does Not Stimulate (bold highlights mine),

``Artificial credit expansion — credit not funded by savings — creates the business cycle by spawning capital malinvestment. Artificial credit expansion makes many unwise investments (say, in residential and commercial real estate and financial derivatives) look profitable because of the accessibility of cheap credit, so business activity expands, manifesting itself in an inflationary boom. Bad investments, however, are not made economically sound merely because there is more money in existence. These bad investments eventually must be liquidated. The boom resolves itself in a bust whose twin children are capital consumption and unemployment. The moral of the story is that monetary inflation is not a way to sustainably generate economic prosperity.

``One thing the government does do, however, by increasing the money supply is discourage saving. This is because, as prices rise, money saved becomes worth less and less, so people are more likely to spend it on present consumption while the spending is good. Promoting consumption is the last thing we need to build up a capital stock that has been woefully depleted thanks to malinvestment. The old economic saw cuts true: there is no such thing as a free lunch, and there is no costless way to fund government spending.”

Policies that serially blows bubbles have never been sound or productive or generate sustained wealth. Moreover it serves to benefit a privileged few at the expense of the rest of the society.

Nevertheless, in an era of central banking, a policy engendered boom bust cycle is a hallmark feature that must be understood by any serious investors.

This is especially important considering the rapidly expanding role of inflation in financial asset pricing.

And Asian governments are likely to maintain present policies until the financial asset boom permeates to the real economy. From here, this would be interpreted by policymakers as having triumphantly reduced the risks of economic growth recession by reigniting economic growth through artificial credit expansion.

Sadly any perceived growth will be temporary, from where another crisis will emerge in the next few years ahead (2012 or 2013?).

For the interim, Asia’s stockmarket, under the guidance of policy induced incentives, seems likely to power up ahead.

Emotional Intelligence Tops Fundamentalism

``A good trader has to have three things: a chronic inability to accept things at face value, to feel continuously unsettled, and to have humility.” -Michael Steinhardt, American investor and Philanthropist

If there are any traits that need to be emulated from Wall Street savants are the ability to think objectively and independently, to engage in process analytics and most importantly to refrain from indulging in cognitive bias traps.

As Warren Buffett once observed, ``A great IQ is not needed to do well as an investor, what is needed is the ability to detach yourself from the crowd.”

Esteemed Trader and prolific newsletter writer Dennis Gartman also has the same insight in his 22 trading rules, ``An understanding of mass psychology is often more important than an understanding of economics. Markets are driven by human beings making human errors and also making super-human insights.”

This simply means instituting successful market positions requires the discipline of Emotional Intelligence (EI) over the fa├žade of knowledge.

That’s because investors of all discipline essentially never get the markets always right.

And if the objective is to maximize profits and minimize losses, then damage control extrapolates to admitting wrong decisions which subsequently mean accepting the emotional angst of financial losses.

And that’s where emotional intelligence counts more than economics or financial analysis.

And that’s where most of Wall Street didn’t get it right during the recent meltdown.

Organizational behavior Professor Philip Tetlock in an interview at CNN Money expounds (underscore mine),

``But hubris may have played a bigger one. Remember Greek tragedy? The gods don't like mortals who get too uppity. In this case the biggest source of hubris was the mathematical models that claimed you could turn iffy loans into investment-grade securities. The models rested on a misplaced faith in the law of large numbers and on wildly miscalculated estimates of the likelihood of a national collapse in real estate. But mathematics has a certain mystique. People get intimidated by it, and no one challenged the models.” (Hat Tip: Gully)

So yes, hubris founded on the context of pretentious “technical” knowledge has immensely exposed the vulnerability Wall Street from which many has suffered from the recent collapse.

After all, success in investing would all be about the probabilities in terms instituting discipline over trading positions. As the legendary Peter Lynch once said, ``Six out of ten is all it takes to produce an enviable record on Wall Street.”

Why Stocks Could Outperform Bonds Over The Next Decade

``The investment world has gone from underpricing risk to overpricing it. Cash is earning close to nothing and will surely find its purchasing power eroded over time. When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary."-Warren Buffett, annual letter to Berkshire shareholders

Despite the surfeit of available information via cyberspace, much of these do not necessarily account for as knowledge, since pieces of information could be irrelevant or just plain rubbish or built around flawed presumptions.

In last week’s Should We Follow Wall Street?, we disputed the idea of a universally accepted technical wisdom from Wall Street.

We made as one of our example the polemics about the equity premium or the comparison of the returns of bonds versus stocks.

Nitpicking over hundreds of years of data, for us, would seem like another exercise of vanity.

Unless humanity will reach a state of human-machine convergence or Singularity soon, from which futurist Ray Kurzweil predicts that ``our intelligence will become increasingly nonbiological and trillions of times more powerful than it is today—the dawning of a new civilization that will enable us to transcend our biological limitations and amplify our creativity,” looking at an investment horizon of 100 years or more is downright impossible or impractical to put in practice.

Moreover, given the rapidly evolving dynamics, largely supported by technological innovation, such devotion to interpret a mountain of market historical data defeats Wall’s Street’s basic mantra of “past performances doesn’t guarantee future outcomes.”

So even if bonds have been proven to outperform stocks in the longest run, it doesn’t necessarily translate to the same outcome over the next coming decades.

Lastly, it’s about data mining too. Advocates of one particular cause tend to use time reference points that support their underlying bias, as different time periods yield different results.

However, over the next decade or so we believe that stocks should outperform bonds.

Here are the reasons why.

One, global government in an attempt to reflate the markets has imposed policies, such as massive stimulus spending, a cheap money environment as shown by the steepening of the yield curve [see Steepening Global Yield Curve Reflects Thriving Bubble Cycle] and quantitative easing, that has indirectly been supportive of the equity assets.

Second, under the onus of over indebtedness, afflicted governments have been tacitly inflating away these burdens through inflationary policies. And since inflation erodes a currency’s purchasing power, higher inflation thereby reduces real gains on fixed income.

Third, as governments take on more debt to substitute for declining private sector demand, inflationary policies serve as an indirect way to default on debts.

Fourth, global supply of debt will transcend available capital.

Fifth, the mercantilist inclinations of global governments will employ measures to prevent the necessary adjustments in the values of their respective domestic currency so as to protect “export markets”.

Hence, inflation will likely be a global phenomenon than one limited to debt scourged nations.

Sixth, even in the US, financial asset pricing has increasingly been influenced by inflation more than capital gains.

In fact, it is nearly catching up with dividends. [see our earlier discussion on Worth Doing: Inflation Analytics Over Traditional Fundamentalism!]

Figure 6: 10 Year Treasury In A Bond Bull Market For 27 years!

Seventh, bonds have been in a bullmarket since the early 80s [see Figure 6], hence ``it would be almost impossible for bonds to generate the same amount of capital gains as they did in the past” argues Peng Chen, Ph.D., CFA, and Roger Ibbotson, Ph.D. (HT: Gully)

This suggests too that the US treasury bearmarket could likely be as long as the last bullmarket (27 years) or the previous bearmarket (30 years).

Figure 7: Manual of Ideas’ Instablog: Tobin’s Q

Lastly, in an inflationary environment the cost of replacing company’s assets would increase, hence stock prices should also adjust to reflect on this changes, based on the Tobin’s Q ratio, or a measure defined by, ``comparing the market value of a company's stock with the value of a company's equity book value. The ratio was developed by James Tobin (Tobin 1969). It is calculated by dividing the market value of a company by the replacement value of the book equity.”

If the derived value is greater than one then this suggest of overvaluation [as market prices are greater than the company’s assets] and if the value is less than one then it is an indicator of undervaluation.

Notice that during the stagflationary decade of the 70s to the early 80s the Tobin’s Q had largely been undervalued or that stocks were priced below their replacement costs, although stocks and bonds had marginal differences in returns, according to Shawn Allen of Investor’s Friend ``The 20 years from 1966 through 1985 were ugly all around. Stocks came out slightly ahead but were the best of a dismal lot.”

As a caveat, since inflation impacts asset prices relatively, stocks won’t likely perform in a uniform manner and would likely be distinguished based on the industry.

So yes, like Warren Buffett, we think stocks will outperform bonds over this cycle.

Friday, July 24, 2009

How Innovation Have Improved Our Lives

In "100 Things Your Kids May Never Know About" Nathan Barry enumerates the casualties of rapid technological innovation.

From wired magazine, ``There are some things in this world that will never be forgotten, this week’s 40th anniversary of the moon landing for one. But Moore’s Law and our ever-increasing quest for simpler, smaller, faster and better widgets and thingamabobs will always ensure that some of the technology we grew up with will not be passed down the line to the next generation of geeks.

``That is, of course, unless we tell them all about the good old days of modems and typewriters, slide rules and encyclopedias …"

The 100 list...

Audio-Visual Entertainment

  1. Inserting a VHS tape into a VCR to watch a movie or to record something.
  2. Super-8 movies and cine film of all kinds.
  3. Playing music on an audio tape using a personal stereo. See what happens when you give a Walkman to today’s teenager.
  4. The number of TV channels being a single digit. I remember it being a massive event when Britain got its fourth channel.
  5. Standard-definition, CRT TVs filling up half your living room.
  6. Rotary dial televisions with no remote control. You know, the ones where the kids were the remote control.
  7. High-speed dubbing.
  8. 8-track cartridges.
  9. Vinyl records. Even today’s DJs are going laptop or CD.
  10. Betamax tapes.
  11. MiniDisc.
  12. Laserdisc: the LP of DVD.
  13. Scanning the radio dial and hearing static between stations. (Digital tuners + HD radio b0rk this concept.)
  14. Shortwave radio.
  15. 3-D movies meaning red-and-green glasses.
  16. Watching TV when the networks say you should. Tivo and Sky+ are slowing killing this one.
  17. That there was a time before ‘reality TV.’

Read the rest here

The lists simply shows how our quality of life have vastly been improved by market based innovation.

Thursday, July 23, 2009

Morgan Stanley's Stephen Roach: Market's Faces Rude Awakening

Morgan Stanley's Stephen Roach, in a CNBC interview says that markets could be faced with a "rude awakening"

Some excerpts from the interview:
-Visible manifestation of all the excess liquidity that monetary authorities have poured into the system

-Markets are priced for a recovery that’s gonna end up disappointing earnings

-Financial Crisis isn’t over

-75% of global economy still contracting

-Markets are in for a rude awakening

-Green shoots...simplistic way to look at the world

-we are going to have an anemic recovery

Presidential Approval Ratings and Stock Market Returns

An interesting insight by Bespoke Invest on the correlations of Presidential approval ratings and stock market returns.

This from Bespoke Invest, (bold highlights mine)

``When looking at the complete history of approval ratings, it was hard to believe that even though he left office as one of the most unpopular Presidents ever, at one point George W. Bush's approval rating was higher than any other President in the post-WWII era. Ironically, the prior record appears to be held by his father, whose popularity also hit its lowest levels near the end of his first and only term. Likewise, while Reagan has been viewed positively by both Republicans and Democrats, he and Nixon (and Obama so far) are the only post-WWII Presidents who never saw their approval ratings break above 70%.

``Taking the USA Today's look at Presidential approval ratings one step further, we added a chart of the S&P 500's year over year (y/y) performance during each President's term to see how a President's popularity was tied to the stock market. Not surprisingly, there is a strong relationship between the stock market's performance (which reflects the economy) and how a President is viewed. Presidents who were in office while the stock market was strong typically have been more popular and vice versa."

``In recent history, however, the relationship has been less consistent. For example, George W. Bush's popularity peaked when the market was weak, and as the stock market improved up until 2007, his popularity continued to decline. Likewise, while it's still early in his first term, President Obama came into office with an approval rating of 64%, but even though the markets have shown considerable improvement, his approval rating has seen a decline to 55%."

Think of it, the last paragraph suggests that falling popularity for President Obama has been coincidental with rising stock markets so there seems to be a loose connection.

Aside from the attractively colored chart which are meant to amuse, popularity measures seem to be an inaccurate way to evaluate, gauge or predict stockmarket activities, trends or returns. That's because popularity is mostly about superficiality and inherently fickle.

For instance, a popular president who undertakes populist policies may generate short term gains, but reap long term pains and vice versa.

What seem to matter more is the substance and direction of the policies employed.

INO's Adam Hewison on Gold: New Highs in Seven Weeks!'s Adam Hewison makes a bold prediction based on technical perspective: Gold will reach a new high by the end of August or early September.

Click on image below for Mr. Hewison's explanation:

Disclosure: this blog is a member of INO's affiliate partner program

Wednesday, July 22, 2009

Filipinos Killed In Afghan Chopper Crash Manifestation Of Failed Migration Policies

The recent deaths of 10 Filipinos in a helicopter crash in Afghanistan is a conspicuous example of the failed policy of migration controls.

This from the Associated Press (bold highlights mine) ``Ten Filipino workers were among the civilians killed in a helicopter crash at NATO's largest air base in Afghanistan, officials said Tuesday.

``All 16 people aboard the Russian-owned civilian Mi-8 helicopter died Sunday when it slammed into the tarmac at Kandahar Air Base shortly after takeoff....

``The Philippines has banned its overseas workers from Afghanistan, but many still end up employed at military bases there.

``A Filipino carpenter at Kandahar Air Base was killed in a rocket attack in March.

``The Filipinos killed Sunday had been working at the NATO base for several years. They did not return to the Philippines because the government had imposed a ban on travel to Afghanistan, the head of the Overseas Workers Welfare Administration, Carmelita Dimzon, told the Philippine Star daily"...

``Last week, Manila airport authorities intercepted 13 workers bound for Afghanistan. Vice President Noli de Castro said they had been recruited illegally as carpenters, plumbers and electricians at the Kandahar base for a monthly salary of $1,300 — about 10 times what they would make back home...

``Apart from Afghanistan, Filipino workers are not allowed to seek jobs in Iraq, Lebanon and Nigeria. About 6,000 were thought to be working illegally at military bases across Iraq.

Another from the Philippine Inquirer,

``[Philippine Vice President] De Castro agreed with the OWWA that the fatalities were not entitled to full benefits from the government for being undocumented workers.

``However, he said the DFA and the Department of Labor and Employment (Dole) would follow up their benefits from their employers...

``Asked why the Filipino workers were lured to work in this war-torn country despite the deployment ban, De Castro said it could be due to the withdrawal of American forces from Iraq.

“The problem is the concentration of jobs has shifted to Afghanistan because Americans are withdrawing from Iraq,” he said, adding that most of the foreign workers in Afghanistan were employed by US bases and NATO.

``He said the Task Force on Illegal Recruitment, which he heads, has decided to go after the recruiters of the Filipino fatalities."

Our comments:

-the ban on the deployment of Overseas Filipino Workers to places considered as dangerous has not stopped or prevented local laborers in search of "greener pastures" in spite of the increased risks.

This means OFWs in prohibited areas had opted on their own accord to assume security risks in exchange for higher pay.

-It also exposes the impossibility to control people's desire to seek ways to improve one's well being, aside from exposing institutional inefficiencies despite the tomes of regulations and maze of procedures aside from charges and fees slapped on OFWs allegedly for their supposed benefits.

-Because there is a demand for our OFW, a labor black market has emerged.

-And if the demand for local labor in high risk places comes mostly from official institutions as the US or NATO military bases then all the directives to contain illegal recruitment seems like a pretentious witchhunt.

Our regulators appear barking at the wrong tree! Official channel coordination and not a ban should be the answer.

-So instead of helping aggrieved OFWs, the ban has only deprived OFWs of the so called death benefits.

Government policies designed to help the OFW turn out to only punish them.

In A Bernanke Market, Comparisons With The 80s Are Like Apples And Oranges

This is another example why I wouldn't be listening to Wall Street.

The Bloomberg chart of the day tries to simplistically associate today's market rally with 1980s.

According to Bloomberg, ``The CHART OF THE DAY compares the Standard & Poor’s 500 Index’s advance since March 9, when the benchmark fell to its lowest level in 12 years, with its recovery from a two-year low set on Aug. 12, 1982. The S&P 500 rose 15 percent for all of 1982 and moved higher every year for the rest of the decade.

``“Investor sentiment today is quite similar” to what prevailed 27 years ago, James W. Paulsen, chief investment strategist at Wells Capital Management, said yesterday in an interview.

``“There’s nothing but doubt” about the economy’s ability to recover from its slump even as consumer and business confidence, retail sales, exports and other indicators point to a rebound, not depression, Paulsen said. The S&P 500 reached its August 1982 low during the second U.S. recession in three years."

But the financial and economic environment 1980s is entirely different than today.

In the past debt levels had not been as disproportionate as today relative to GDP.

Another, globalization and "Reaganomics" has taken off in the 80s. Today, the "Obamanomics" or the growing role of government/s in the economy via a slew of new regulations and welfare programs funded by higher taxes will curb globalization trends and politicize vital sectors of the national economic system which will reduce productivity and returns.

More, the 80s had analog cellphones in contrast to today where internet and digital phones rule.

So it would seem like an apples-to-oranges comparison or simply clustering illusions- a cognitive bias of looking for patterns where non exist.

Importantly, much of today's rally has evidently been liquidity driven as shown by chart above from the WSJ article.

As former hedge fund manager Andy Kessler rightly observes,

``At the end of the day, only one thing has worked -- flooding the market with dollars. By buying U.S. Treasuries and mortgages to increase the monetary base by $1 trillion, Fed Chairman Ben Bernanke didn't put money directly into the stock market but he didn't have to. With nowhere else to go, except maybe commodities, inflows into the stock market have been on a tear. Stock and bond funds saw net inflows of close to $150 billion since January. The dollars he cranked out didn't go into the hard economy, but instead into tradable assets. In other words, Ben Bernanke has been the market."

Tuesday, July 21, 2009

US Taxpayers Could Be On The Hook For $23.7 Trillion!

A US official says that the US government has placed as much as $23,000,000,000,000 (trillion) of taxpayers money in support of the US financial system.

This from Bloomberg (bold highlights mine), ``U.S. taxpayers may be on the hook for as much as $23.7 trillion to bolster the economy and bail out financial companies, said Neil Barofsky, special inspector general for the Treasury’s Troubled Asset Relief Program.

``The Treasury’s $700 billion bank-investment program represents a fraction of all federal support to resuscitate the U.S. financial system, including $6.8 trillion in aid offered by the Federal Reserve, Barofsky said in a report released today.

“TARP has evolved into a program of unprecedented scope, scale and complexity,” Barofsky said in testimony prepared for a hearing tomorrow before the House Committee on Oversight and Government Reform.

``Treasury spokesman Andrew Williams said the U.S. has spent less than $2 trillion so far and that Barofsky’s estimates are flawed because they don’t take into account assets that back those programs or fees charged to recoup some costs shouldered by taxpayers.

``“These estimates of potential exposures do not provide a useful framework for evaluating the potential cost of these programs,” Williams said. “This estimate includes programs at their hypothetical maximum size, and it was never likely that the programs would be maxed out at the same time.”

``Barofsky’s estimates include $2.3 trillion in programs offered by the Federal Deposit Insurance Corp., $7.4 trillion in TARP and other aid from the Treasury and $7.2 trillion in federal money for Fannie Mae, Freddie Mac, credit unions, Veterans Affairs and other federal programs."

Table From WSJ

WSJ's Matt Philips also rushes into the defense noting that, ``It’s important to keep in mind the $23.7 trillion doesn’t really represent “spending.”

``It takes into account run-of-the-mill TARP programs such as loans to industries — the $79.3 billion lent to troubled auto giants for example — as well as exposure in the form of backstops to loans, such as the projected $1 trillion worth of backing for loans available through the TALF program. Also, we should point out that the mega-figure referenced above also includes a projected $500 billion to $1 trillion for to help banks shed their balance sheets of those toxic — oh, right, sorry … legacy assets through the Public Private Investment Program, or PPIP."

``Beyond that, the $23.7 trillion figure also includes total forecast exposure of the Fed, the FDIC, the Treasury — outside the TARP program — as well as the cost of swallowing up Fannie Mae and Freddie Mac, not too mention the potential cost of the enlarged guarantees tied to agencies such as Ginnie Mae. (For the full rundown on everything thrown into the number check out this section of the watchdog agency’s quarterly report.)

``The thing is, not all of the funding tied to financial crisis programs is going to get used. For instance, The Journal had a story on how the Fed’s lending has ebbed since the worst of the financial crisis, which suggests that the Fed won’t have to use all the ammo it set aside to combat the financial collapse."

Defenders of the faith are looking at an optimistic outcome. We don't share the same enthusiasm.

Sunday, July 19, 2009

Should We Follow Wall Street?

``There are two requirements for success in Wall Street. One, you have to think correctly; and secondly, you have to think independently." - Benjamin Graham

For some, there is the impression that the workings of Wall Street have to be piously followed by the letter.

The general notion is that Wall Street has devoted unremitting years of research on the subjects of risk management, portfolio allocation and asset pricing or valuations such that these need to be incorporated into conventional analysis.

That is the reason why guild like certification standard as the Chartered Finance Analyst (CFA) has emerged.

Hence, should we follow what Wall Street does?

While technically Wall Street can be identified as a symbolic location for the operating platforms of the various asset markets, it has been generally been associated with the investment community.

However, Wall Street, for me, is a broad, vague and complex issue.

Wall Street Models Are For Convenience, Myth of Blue Chip Investing

From the recent crisis, we learned that Wall Street has been ground zero for the financial alchemy crisis of turning the proverbial stones into bread via the traditional models of mortgage credit risk management of “originate and hold” into the latest model of “originate and distribute”. Where risks had been passed like a hot potato the impact has been contagion-globalized crisis.

It has been likewise the birthplace of the Shadow Banking System, which encompassed the circumvention of regulations and signified as the gaming of the system (regulatory arbitrage) in cahoots with credit ratings agencies, whose mandated revenue model had been derived from the issuers- than from the risks buyers-from whose interests it protected (Agency Problem), and regulators (regulatory capture)-who refused to take the proverbial punch bowl away.

Wall Street has most importantly played a critical role in the transmission of the US Federal Reserve policies in overextending the credit system intermediation…globally.

Here we quote Prudent Bear’s Doug Noland, ``to create Trillions of instruments (chiefly Treasuries, agency debt, MBS, and “Repos”) perceived as safe and liquid by our foreign trading partners that accommodated our massive current account deficits (and attendant domestic and international imbalances). It was contemporary risk intermediation at the heart of a historic mispricing of finance for, in particular, mortgages and U.S. international borrowings. And it was the potent interplay of contemporary risk intermediation and contemporary monetary management/central banking (i.e. “pegged” interest rates, liquidity assurances, and asymmetrical policy responses) that cultivated unprecedented financial sector and speculator leveraging.” (emphasis added)

It had likewise operated on the psychology predicated on the Greenspan or Bernanke Put or the principle of Moral Hazard that has emboldened speculation or expanded risk taking capacity.

In sum, Wall Street has been THE EPICENTER and THE EPITOME of bubble dynamics- where the rigors of long term discipline has been exchanged with short term profit and fun at the expense of the US and global economy.

The great value investor Benjamin Graham, Warren Buffet’s mentor once sardonically remarked on the same shortsightedness, ``That concerns me, doesn't it concern you?... I was shocked by what I heard at this meeting. I could not comprehend how the management of money by institutions had degenerated from the standpoint of sound investment to this rat race of trying to get the highest possible return in the shortest period of time. Those men gave me the impression of being prisoners to their own operations rather than controlling them... They are promising performance on the upside and the downside that is not practical to achieve.” (emphasis mine)

So how effective has Wall Street been to predict and respond to the crisis?

From Bruce Bartlett, author and former US Treasury department economist in a recent Forbes article, ``Economists were slow to see a recession coming and often didn't see one at all until we were already well into it.”

From Robert Samuelson, economist and contributing editor of Newsweek in his latest article Economist Out Of Lunch (bold highlights mine), ``Well, if you de-emphasize financial markets and financial markets are decisive, you're out to lunch. Financial markets pumped up the real estate bubble; greater housing and stock market wealth inspired a consumer spending boom; losses on "subprime" mortgage securities triggered a collapse of confidence. Some economists have grudgingly, if obscurely, conceded error. A study by the International Monetary Fund called "Initial Lessons of the Crisis" admits: There "was an under-appreciation of systemic risks coming from . . . financial sector feedbacks onto the real economy." That's an understatement.

``Overshadowing the misunderstanding of finance is a larger mistake: ignoring history. By and large, most economists don't care much about history. Introductory college textbooks spend little, if any, time exploring business cycles of the 19th century. The emphasis is on "principles of economics" (the title of many basic texts), as if most endure forever. Economists focused on constructing elegant, mathematical models.”

Or how about from one of my favorite contrarians Black Swan author Nassim Taleb with Mark Spitznagel in an article at the Financial Times “Time to tackle the real evil: too much debt”, ``Relying on standard models to build policies makes us all fragile and overconfident. Asking the economics establishment for guidance (particularly after its failure to see the risk in the economy) is akin to asking to be led by the blind – instead we need to rebuild the world to make it resistant to the economist’s mystifications.”

Considering the vast armies of financial experts (accountants, CFAs, economists, quant risks modelers and managers, statisticians, actuarial, research and security analysts and etc…) employed in the banking and financial industry, common sense inference suggest that we wouldn’t have seen the disappearance of the US Investment Banking Sector (bankruptcy of Lehman Bros, the acquisition of Bear Stearns and Merrill Lynch and the conversion to Bank holding companies of Goldman Sachs and Morgan Stanley) and the government takeover of AIG-once largest insurance company in the US and the 18th largest in the world, had these models or theories worked.

The fact that the crisis occurred and heavily impacted the US financial system occurred demonstrates that as the experts quoted above, Wall Street failed!

This also utterly demolishes the MYTH of BLUE CHIP investing- where the public have been ingrained to believe that investing in blue chips are safe and sound and least subjected to risks.

In bubble cycles, particularly with growing relevance today [see last week’s Worth Doing: Inflation Analytics Over Traditional Fundamentalism!], industries exposed to the extremities of misallocation due to policy based distortion are all subjected to heightened risks regardless of their stature.

The oldest of the 30 elite members of Dow Jones Industrials ( are the Proctor and Gamble (1932), United Technologies (1939), Exxon Mobil (1928) and Du Pont (1935). All the rest have been included in since 1959 and above, and where the 30 member composite index has undergone several changes- 49 alterations according to (since May 26,1896).

This means that in the US, blue chips aren’t exactly “blue” in the sense that they been exposed to the variable changes in technology or management or bubbles or other factors which prompted for the restructuring of the blue chip index.

So what has been the problem with Wall Street?

As noted in the past in How Math Models Can Lead To Disaster and in the above, “elegant” mathematical and or scientific models that has reinforced the public’s tendencies to rely on heuristics or mental shortcuts.

Like government policies, the theoretically or math constructed models served as intellectual justification or cover to advance on their biases.

Essentially it isn’t about what works or not, it is about what needs to be believed that counts. In short, it has all been about convenience.

For instance, in a bullmarket you need an excuse to push up stocks, instead of relying on gossip based information, the public embraced Wall Street’s models.

Value investor Ben Graham in his 1949 classic the Intelligent Investor castigated on the industry’s inclination towards this, when he wrote, ``security analysts today find themselves compelled to become most mathematical and 'scientific' in the very situations which lend themselves least auspiciously to exact treatment." (bold highlight mine)

Stocks For The Long Run?

One of the hardcore or popular beliefs in Wall Street is that investing in stocks would have led to an outperformance of a portfolio relative to Treasury Bonds, Bills or Gold as shown in Figure 1.

Figure 1: Jeremy Siegel: Stocks For The Long Run

Recently at a Wall Street Journal article Mr. Jason Zweig wrote to challenge the conventional Wall Street conviction which has relied on Siegel’s chart. He stated that the data used during the earlier days had been cherry-picked (or data mined) and were therefore NOT accurate.

``There is just one problem with tracing stock performance all the way back to 1802: It isn't really valid,” wrote Mr. Zweig, ``What, then, are the odds that stocks will continue to lag behind bonds for the long run? The sad truth is that history can't tell us the answer. The 1802-to-1870 stock indexes are rotten with methodological flaws. So we have only the period since then, or four distinct and complete 30-year stretches of stock returns, to base our long-term investment decisions on. Another emperor of the late bull market, it seems, has turned out to have no clothes.” (emphasis added)

If Mr. Zweig is correct then imprecise data alone could shatter the very foundations of Wall Street’s most consecrated canon.

And this doesn’t end here.

Contrarian investor Rob Arnott has also confronted the alleged supremacy of the returns of stocks over bonds in the long run, see figure 2
Figure 2: Stocks Lacks Real Appreciation

In the Journal of Portfolio Management (published by, Mr. Arnott, wrote, ``Stocks for the long run? L-o-n-g run, indeed! A mere 20 percent additional drop from February 2009 levels would suffice to push the real level of the S&P 500 back down to 1968 levels. A decline of 45 percent from February 2009 levels— heaven forfend!—would actually bring us back to 1929 levels, in real inflation-adjusted terms.”

In short, stocks could invariably underperform bonds if it continues to fall in real adjusted terms.

If Wall Street icon and guru, Fidelity Investment Peter Lynch once said that, ``In stocks you've got the company's growth on your side. You're a partner in a prosperous and expanding business. In bonds, you're nothing more than the nearest source of spare change. When you lend money to somebody, the best you can hope for is to get it back, plus interest,” on the contrary, Mr. Arnott concludes, (all bold highlights mine), ``Many cherished myths drive our industry’s equity-centric worldview. The events of 2008 are shining a spotlight, for professionals and retail investors alike, on the folly of relying on false dogma.

-For the long-term investor, stocks are supposed to add 5 percent per year over bonds. They don’t. Indeed, for 10 years, 20 years, even 40 years, ordinary long-term Treasury bonds have outpaced the broad stock market.

-For the long-term investor, stock markets are supposed to give us steady gains, interrupted by periodic bear markets and occasional jolts like 1987 or 2008. The opposite—long periods of disappointment, interrupted by some wonderful gains—appears to be more accurate.

-For the long-term investor, mainstream bonds are supposed to reduce our risk and provide useful diversification, which can improve our long-term risk-adjusted returns. While they clearly reduce our risk, there are far more powerful ways to achieve true diversification—and many of them are out-of mainstream.”

So NO, there isn’t any universally accepted Wall Street wisdom, instead they seem to be conditional (cycles) and subject to time referenced debate. This also means that despite the years of drudging research, such insights risks being defective or if not outmoded.

The fact that they are constantly vulnerable to policy induced business cycles exemplifies such shortcomings.

Bluntly put, Holy Grail investing is a delusion even in Wall Street standards.

The Significance Of Policy Based Or Inflation Analytics

Today’s crisis has provoked rapid policy responses among governments.

This entails a material shift in the operating economic and financial environment which should impact the underlying drivers to the risk reward tradeoffs or to the asset pricing mechanics of diverse financial markets.

And any analysis that foregoes these changes and sticks to the old paradigms will likely misinterpret the risk return environment see Figure 3.

Figure 3: CSFI: The Road To Long Finance

Take for instance this splendid observation from Centre for the Study of Financial Innovation CSFI’s Michael Mainelli and Bob Giffords ``Unexpected regulatory intervention may destroy a long-short market neutral hedge, as when short selling was suddenly restricted in several jurisdictions in late 2008. The efficiency of a diverse portfolio may similarly morph into something quite different in a bear market panic. At night all cats are black, no matter how colourful and distinctive they may appear in the daylight.” (emphasis added)

The problem is that risk managers frequently respond only to ex-post (after the fact) events rather than preparing for the ex-ante (before the event).

From the same authors, ``Most risk managers deal with the bottom loop of reacting to accidents and danger. "A one-sided concern for reducing accidents without considering the opportunity costs of so doing fosters excessive risk aversion – worthwhile activities with very small risks are inhibited or banned. Conversely, the pursuit of the rewards of risk to the neglect of social and environmental ‘externalities’ can also produce undesirable outcomes," wrote Adams [John Adams “Risks”, UCL Press London 1995]. This illustrates how easy it is for risk management to yield unexpected consequences.” (emphasis added)

In other words, risk managers like any human being tend to get swayed by emotions that foster extreme pendulum swings of fear and greed.

And why the difficulties in analyzing the dynamics of government policies? Because of the complexities derived from the interweaving feedback loops of human interactions from the web of regulations.

According to Jeffrey Friedman in his paper, A Crisis of Politics and Not Economics: Complexity, Ignorance and Policy Failure, ``The task of researching such interactions, however, illustrates the practical difficulties of minimizing the disasters to which they might lead. Just as a major problem that regulators face is their ignorance of the effects of their actions, especially in conjunction with past regulatory actions, the main problem scholars of regulation may face is that there are so many regulations, and so many historical circumstances explaining them—and so many theories about their effects—that inevitably, the scholars will, here as everywhere, be compelled to overspecialize. The predictable cost is that most scholars will overlook interactions between the rules in which they specialize and the rules studied by specialists in a different subfield—even if they are deliberately attempting (like the super-systemic regulator) to keep the big picture in mind.” (bold highlight mine)

That’s why any risk return analysis from today’s rapidly evolving conditions should always take into the account the evolving policy dynamics.

And policy dynamics tend to differ from country to country, which implies that the impact to markets or the economy could be expected to be dissimilar.

Another favorite iconoclast, Jim Rogers, hits the nail on the head in an interview at the Economic Times, ``I don't pay any attention to things like emerging markets premium. You talk about it on TV, but every market is different. Why can't I just go out and buy emerging markets when it is likely to go broke. Every market is different, every country is different, every economy is different and every sector of the economies is different. Just because you are in an emerging country does not mean you are going to make money if you get the wrong sector.”