Tuesday, May 31, 2011

Will Derivatives Cause the Next Financial Crisis?

So predicts investing guru Mark Mobius

According to this Bloomberg report,

Mark Mobius, executive chairman of Templeton Asset Management’s emerging markets group, said another financial crisis is inevitable because the causes of the previous one haven’t been resolved.

“There is definitely going to be another financial crisis around the corner because we haven’t solved any of the things that caused the previous crisis,” Mobius said at the Foreign Correspondents’ Club of Japan in Tokyo today in response to a question about price swings. “Are the derivatives regulated? No. Are you still getting growth in derivatives? Yes.”

The total value of derivatives in the world exceeds total global gross domestic product by a factor of 10, said Mobius, who oversees more than $50 billion. With that volume of bets in different directions, volatility and equity market crises will occur, he said.

The global financial crisis three years ago was caused in part by the proliferation of derivative products tied to U.S. home loans that ceased performing, triggering hundreds of billions of dollars in writedowns and leading to the collapse of Lehman Brothers Holdings Inc. in September 2008. The MSCI AC World Index of developed and emerging market stocks tumbled 46 percent between Lehman’s downfall and the market bottom on March 9, 2009.

A financial crisis may be around the corner, but I highly doubt if derivatives will be the principal cause of it.

Derivatives were symptoms of the 2008 crisis rather than the cause. A bubble in the US housing prices had been pricked by rising interest rates which eventually got vented on the marketplace, part of which had been seen on derivatives.

Prescribing regulations, which for some function as an elixir, seems oversimplistic and naïve.

Regulators and the markets have played a perpetual cat and mouse game. Regulators usually apply regulations premised on the past events and markets usually find ways to circumvent them. Eventually fueled by monetary inflation, such loopholes become conduits for the next bubble. So regulations would look like the whack-a-mole game. Regulators hit the moles only as they appear.

And as pointed in the post below, regulations and complex relationships between politically privileged groups and regulators functioned as main causes to the last US mortgage crisis. History may rhyme but not necessarily repeat. Players and markets involved may be different, but principle will be the same. Bubble cycles from inflationism.

Besides, regulators are people too and so with market participants. While both may differ in their respective operating incentives, shared relationships and interactions will cause difficulties in the administration or implementation of regulations. Not even a total ban on derivatives will erase or reduce the risks of another financial crisis caused by inflationism. That would be barking on the wrong tree.

2008 US Mortgage Crisis: The US Federal Reserve and Crony Capitalism as Principal Causes

Stanford University’s John B. Taylor reviewed Gretchen Morgenson and Joshua Rosner’s newest book, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon.

He finds that the Ms. Morgenson and Mr. Rosner placed the blame mostly on a complex crony based system between the financial industry and US Federal Reserve.

Mr. Taylor writes, (hat tip David Boaz) [bold emphasis mine]

The book focuses on two agencies of government, Fannie Mae and the Federal Reserve. The mutual support system is better explained and documented in the case of Fannie, the government-sponsored enterprise that supported the home mortgage market by buying mortgages and packaging them into marketable securities which it then guaranteed and sold to investors. The federal government supported Fannie Mae — and the other large government-sponsored enterprise, Freddie Mac — by implicitly backing up those guarantees and by providing favorable regulatory treatment and protection from competition. These benefits enabled Fannie to rake in excess profits — $2 billion in excess, according to a 1995 study by the Congressional Budget Office.

Fannie Mae was established as a government agency but became a private, shareholder owned company with a charter from Congress requiring the company to support the housing finance system. During the culmination of the crisis in 2008 Fannie Mae along with another Government Sponsored Enterprise (GSE) Freddie Mac was nationalized.

The point is that politically motivated enterprises operate distinctly from the incentives of free market forces. Such entities are wards of the state.

Yet none of this is new to followers of the Austrian school.

Murray N. Rothbard narrated on a parallel unholy relationship between the US Federal Reserve and the commercial banks [bold emphasis mine]

It should now be crystal clear what the attitude of commercial banks is and almost always will be toward the Central Bank in their country. The Central Bank is their support, their staff and shield against the winds of competition and of people trying to obtain money which they believe to be their own property waiting in the banks' vaults. The Central Bank crucially bolsters the confidence of the gulled public in the banks and deters runs upon them. The Central Bank is the banks' lender of last resort, and the cartelizer that enables all the banks to expand together so that one set of banks doesn't lose reserves to another and is forced to contract sharply or go under. The Central Bank is almost critically necessary to the prosperity of the commercial banks, to their professional career as manufacturers of new money through issuing illusory warehouse receipts to standard cash.

So whether it is the politically backed GSEs or the commercial banks, the US Federal Reserve implicitly treats them as natural political constituents.

Mr. Taylor adds,

The book then gives examples where Fannie’s executives — Jim Johnson, CEO from 1991 to 1998, is singled out more than anyone else — used the excess profits to support government officials in a variety of ways with plenty left over for large bonuses: They got jobs for friends and relatives of elected officials, including Rep. Barney Frank, who is tagged as “a perpetual protector of Fannie,” and they set up partnership offices around the country which provided more jobs. They financed publications in which writers argued that Fannie’s role in promoting homeownership justified federal support. They commissioned work by famous economists, such as Nobel Prize-winner Joseph Stiglitz, which argued that Fannie was not a serious risk to the taxpayer, countering “critics who argued that both Fannie and Freddie posed significant risks to the taxpayer.” They made campaign contributions and charitable donations to co-opt groups like the community action organization ACORN, which “had been agitating for tighter regulations on Fannie Mae.” They persuaded executive branch officials — such as then Deputy Treasury Secretary Larry Summers — to ask their staffs to rewrite reports critical of Fannie. In the meantime, Countrywide, the mortgage firm led by Angelo Mozilo, partnered with Fannie in originating many of the mortgages Fannie packaged (26 percent in 2004) and gave “sweetheart” loans to politicians with power to affect Fannie, such as Sen. Chris Dodd of Connecticut. The authors write that “Countrywide and Fannie Mae were inextricably bound.”

The above only shows that political distribution, whether it is in the Philippines or in the US, are apportioned not by merits but by political affiliations. And on the same plane, the gaming of the system by vested interest groups.

Again from Mr. Taylor,

The Fed takes a beating throughout the book. Early on the authors take on the Boston Fed, and in particular its research director Alicia Munnell, for using a study documenting racial discrimination in mortgage lending to justify the relaxation of credit standards, even though the study’s findings were found to be flawed by other researchers. And they criticize the very low interest rate set by the Fed when Alan Greenspan was chairman and Ben Bernanke was a Fed governor, saying it “contributed mightily to the mortgage lending craze,” adding that “with the Fed on a rate-cutting rampage, demand for adjustable-rate mortgages with relatively low initial interest costs had become incendiary.”

Well aside from low interest rates and the administrative policies to boost homeownership, there had been many other factors that has likewise contributed to the bubble, such as tax policies which encouraged exposure on debt rather than equity, agency problems and moral hazard (implicit backing from the Fed or the Greenspan Put), regulatory arbitrage which resulted to the creation of the (off balance sheet) shadow banking system, regulatory capture which played a substantial part of the crony relationships, the conflict of interest on credit rating agencies which had skewed incentives in favor debt issuers (investment banks) and many more.

Inflationism compounded by various forms of interventions represents as the anatomy of a bubble.

Massive Power Outages Looms on China’s Price Controls

China’s government is predicting a massive power outage which according to Forbes’ columnist Gordon Chang

a shortfall larger than the total installed capacity of Argentina—will be the worst ever, even more serious than the one in 2004.

In an earlier post, I mentioned that policies of price controls will definitely lead to unintended consequences, one of which will be shortages. Here is my comment on China’s reactionary policy to fix prices to combat inflation last April

This serves as a politically convenient short-term approach but nonetheless a foolish one because it defies basic economics that comes nasty repercussions (rationing, long lines, more political instability).

The Romans tried it, US President Nixon tried it and many political authorities spanning 4 centuries tried it but all of them failed. Venezuela’s Hugo Chavez has also recently implemented this but has even worsened inflation and shortages.

And these have been so predictable.

First politicians create inflation by debasing the currency.

Next, politicians blame the market for self inflicted ills, thereby, superficially react to such imbalances by imposing price controls which eventually backfires.

Forbes’ Gordon Chang narrates on how China’s price controls have been affecting her energy economics (bold emphasis mine)

The more important factor is that the cost of this commodity has been soaring. Spot coal is up 20% this year, in part because Japan is buying more of it to replace the output of nuclear power stations that have recently gone offline. Yet China’s electricity tariffs have risen only 2.5% this spring.

This mismatch has also been evident for the last half decade when coal prices have more than doubled while Chinese electricity charges have increased by only a third. As a result, electricity producers have been squeezed hard. Coal-fired plants lost 10 billion yuan during the first four months of the year. The chairwoman of China Power International, a utility, recently warned that a fifth of China’s 436 coal plants could go bankrupt.

Beijing created this crisis by fixing the price of electricity. At a time when inflation would be out of control were it not for price controls—formal and informal—Chinese leaders are especially determined to hold the line on power charges.

Technocrats can tell producers what they can charge, but they cannot prevent the inevitable. Because power companies are losing money generating each kilowatt of electricity, they have acted to minimize losses. They are not going ahead with expansion plans, they are not running at full capacity, and some of them are not running their plants at all. Many generating stations—an abnormally large number of them—are now closed for maintenance despite the desperate need for electricity.

Which businesses are getting juice? Technocrats in the Chinese capital can’t help but meddle, and they are favoring state-owned energy-intensive industries—chemicals, construction materials, iron and steel, and non-ferrous metals, for instance—over others—private businesses, exporters, and service industries. The result is that the economy is becoming even more dominated by the state.

It’s worth repeating that price controls have been futile experiments continually exercised by political leaders around the world for over FOUR centuries! The attempts to defy demand and supply always end in repeated failures which eventually penalize the citizenry.

Politicians and bureaucrats think that they can apply Lenin’s dictum where “a lie told often enough becomes a truth”. Unfortunately, such lies ultimately unravels in the face of economic reality. As Winston Churchill once said “The biggest mistake leaders can make is to give people false hope that melts like snow”. Such false hope has always been meant to obtain people’s approval over the short term. And overtime, this will likely turn into despair and rage.

In addition, like any redistributive measures based on inflationism, benefits accrue to the government at the expense of the private sector. Metaphorically speaking, China has been killing “the goose that laid the golden eggs”.

Chinese authorities appear to be blindsided by overconfidence, basking from her recent economic successes. Yet overconfidence is a conventional trait that hallmarks the pinnacle of the boom phase of the bubble cycle.

To add, China appears to be reverting back to her old ways which makes me even more a skeptic on predictions that China will trigger the end of “the Age of America” in 2016.

At the end of the day, the above developments only reinforce my view of the maturing phase of China’s bubble cycle. China may not yet implode, but the writings on the wall suggest that we are likely headed on that direction.

Monday, May 30, 2011

How Multilateral Agencies Profit From Global Taxpayers

I have suggested that we should end or abolish the IMF, for many reasons such as the seeming perpetual advocacy of various forms of interventionism, incompetence, wealth transfer, moral hazard and political inequality.

This suggestion should also apply to the other multilateral agencies as well.

Pajama Media reveals how these institutions have used politics to foster wealth inequalities (bold emphasis added, italics original)

Many of Washington’s 2,600 technocrats working at the International Monetary Fund do not regard Dominique Strauss-Kahn’s lavish lifestyle as an anomaly.

Privately they admire it, recognizing it as a description of their own standard of living. They call their many unseen perks “golden handshakes.” At the World Bank, Inter-American Development Bank, the African Development Bank, and at the IMF, you find extravagantly paid men and women who masquerade as anti-poverty fighters for the Third World. As one World Bank vice president said upon his resignation: “Poverty reduction is the last thing on most World Bank bureaucrats’ minds.”

These global institutions are supposed to act as non-profits, but big salaries and big perks rule as the norm. And you’re paying for them: as the largest single contributor, American taxpayers pick up the tab.

By now everyone knows about DSK’s extravagant $420,000 employment agreement that included an additional $73,000 for living expenses — a provision explained thusly by the IMF: “To enable you to maintain … a scale of living appropriate to your position.” Most of the non-profit development world remained silent when the Fund announced a $250,000 “golden parachute” severance for the indicted managing director.

A PJM survey found that a common annual compensation package for senior management at the anti-poverty banks exceeds $500,000 — tax-free. World Bank President Robert Zoellick currently receives $441,980 in base salary and $284,500 in other benefits. Strauss-Kahn’s deputy, John Lipsky, receives $384,000 in base salary plus “living allowances.”

Some may argue as the IMF did that global financial leaders — even from governmental organizations – should be highly compensated. But the IMF and World Bank payments for their executives are three times the annual salary for U.S. Federal Reserve Chairman Ben Bernanke, and four times the salary of America’s Federal Reserve governors: Bernanke’s gross annual salary is set at $199,700; his governors receive $179,000.

The global banks’ stratospheric governmental salaries are not limited to chief executives. Ten of Zoellick’s deputies receive tax-free base pay of $321,00 to $347,000, plus enjoy an additional $210,000 in benefits. Even mid-level World Bank employees earn well into six digits: the average salary for a professional manager is $181,000, plus $97,000 in benefits. A senior adviser receives on average $238,000 plus $127,000 in benefits. A vice president receives $286,000 plus $153,000 in benefits.

The biggest hidden benefits are the off-the-book perks called “living allowances.” These perks can nearly double a stated salary. Of the 2,600 IMF and 10,000 World Bank full-time employees, all receive some form of supplemental living allowances in addition to their base pay. These include home leave grants, dependent allowances, travel perks, and education “grants” for their children to attend private schools. In addition, they offer generous pensions and health insurance policies.

Where do they get their lavish “golden handshakes”? From us, the productive sector, the taxpayers.

True, I am delighted that some of them have rediscovered the importance of economic freedom. But this isn’t anything new, as economic freedom has been long been advocated by classical liberals since the 19th century.

In other words we don’t need to have highly paid bureaucrats to tell us something our ancestors knew, long ago.

Yet if economic freedom is to be nurtured, then the more these institutions are hardly needed because the services that they offer can sufficiently be provided for by the private sector.

Remember, the resources used to finance “golden handshakes” are resources that could have been used to generate productive rather than consumptive activities.

Worst, the above only shows of how the political divide from these institutions increases social inequality.

And as Cato’s Dan Mitchell aptly points out,

Redistribution from rich to poor is not a good idea, but it is far more offensive when the coercive power of government is used to transfer money from ordinary people to the elite.

This serves as another instance of politically based parasitism.

Quote of the Day: Focusing Effect

Focusing effect is a mental heuristic where

we tend to weigh attributes and factors unevenly, putting more importance on some aspects and less on others

Again from the prodigious Matt Ridley on interpreting events, (emphasis added)

Another way of making the same point is that good news tends to be gradual, incremental and barely visible, while bad news almost by definition comes in sudden, newsworthy lumps: wars, crashes, disasters, epidemics. It is impossible to see a field of wheat growing, but easy to see it washed away by a flood.


Are Renewable Energy ‘Renewable’?

One of the most valuable lessons I have learned in life is not to see things as presented or as they are. That’s because things or events that we see or sense does not cover on how they existed or how they got there in the first place.

I am indebted to the late great proto-Austrian Frederic Bastiat, who inspired an overhaul of life’s outlook personified by this stirring passage

In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause - it is seen. The others unfold in succession - they are not seen: it is well for us, if they are foreseen. Between a good and a bad economist this constitutes the whole difference - the one takes account of the visible effect; the other takes account both of the effects which are seen, and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favourable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, - at the risk of a small present evil.

This applies to everything we do.

And these have been most pronounced especially in the domain of politics where populist political solutions are sold on the merits of superficiality or visibility.

In the realm of environmental politics, one good example would be the politically correct populist practice of ‘Earth Hour’.

We are told to close lights for an hour so that we can symbolically celebrate on ‘saving the environment’ by reducing carbon footprints.

However in reality, unless we decide to stop living, we will be using energy. PERIOD.

And the alternative to using ‘environmental hazardous’ conventional fossil based energy would be to revert to the medieval age and use candles. People hardly see that candles signify as more environmental unfriendly than the conventional energy.

Of course by proposing to cut lights also extrapolates to stopping or to reducing production and trade. Doing so means creating shortages in people’s needs. This means widespread hunger and famine. This brings the Malthusian nightmare to a reality.

How do you suppose that we would be able to survive 6.77 billion people by reverting to the medieval age of economic system?

So saving the environment means we end up killing one another (politics of plunder-via war) or killing ourselves (man made catastrophe).

It isn’t that Malthus was right. Instead, it is because political correctness founded the concept of saving earth signifies as concealed misanthropy.

The same blight haunts proponents of renewable energy.

From the surface, renewable energy would seem as environmental friendly. That is what is seen. What is not seen is how environmental damaging renewable energy would be when they are constructed for commercial operations.

Matt Ridley eloquently explains, (bold emphasis added)


It turns out that the great majority of this energy, 10.2% out of the 13.8% share, comes from biomass, mainly wood (often transformed into charcoal) and dung. Most of the rest is hydro; less than 0.5% of the world's energy comes from wind, tide, wave, solar and geothermal put together. Wood and dung are indeed renewable, in the sense that they reappear as fast as you use them. Or do they? It depends on how fast you use them.

One of the greatest threats to rain forests is the cutting of wood for fuel by impoverished people. Haiti meets about 60% of its energy needs with charcoal produced from forests. Even bakeries, laundries, sugar refineries and rum distilleries run on the stuff. Full marks to renewable Haiti, the harbinger of a sustainable future! Or maybe not: Haiti has felled 98% of its tree cover and counting; it's an ecological disaster compared with its fossil-fuel burning neighbor, the Dominican Republic, whose forest cover is 41% and stable. Haitians are now burning tree roots to make charcoal.

You can likewise question the green and clean credentials of other renewables. The wind may never stop blowing, but the wind industry depends on steel, concrete and rare-earth metals (for the turbine magnets), none of which are renewable. Wind generates 0.2% of the world's energy at present. Assuming that energy needs double in coming decades, we would have to build 100 times as many wind farms as we have today just to get to a paltry 10% from wind. We'd run out of non-renewable places to put them.

You may think I'm splitting hairs. Iron ore for making steel is unlikely to run out any time soon. True, but you can say the same about fossil fuels. The hydrocarbons in the earth's crust amount to more than 500,000 exajoules of energy. (This includes methane clathrates—gas on the ocean floor in solid, ice-like form—which may or may not be accessible as fuel someday.) The whole planet uses about 500 exajoules a year, so there may be a millennium's worth of hydrocarbons left at current rates.

Read the rest here.

What you see isn’t always what you get.

Prudent Investor Newsletters at the Stock Market Pilipinas Forum

Stock Market Pilipinas has willfully opened a (discussion) thread on their forum for my articles on the domestic and global stock markets.

So aside from my insights, anyone interested in investing in the Philippine Stock Exchange may find this forum as a rich and valuable source of info and a good venue to exchange ideas.

Proceed to Stock Market Pilipinas here (registration required)

Thanks Ollie.

Sunday, May 29, 2011

How External Forces Influence Activities of the Phisix

There are secrets to our world that only practice can reveal.-Nassim Nicolas Taleb, Anti Fragility, Chapter 4 How (Not) To Be A Profit

We definitely live in interesting times.

It has long been my position that gold and global equity markets including the Philippine Phisix have been strongly correlated where the price actions of the gold market frequently leads equity markets.


Look at the beauty of such correlationship.

The above 2- year chart represents the price actions of the Phisix (PSEC red-black candlesticks) and gold prices in US dollar (black line). The relationship even looks like a 5-wave Elliott Wave count.

One would note that the oscillations may not be in exactitude, but clearly a symmetric cadence has been in motion.

The implication is: for as long as the trend of gold prices remains to the upside, the Phisix will likely follow unless domestic factors become powerful enough to impel a disconnect.

Prices of gold have served as reliable barometer so far.

Alternatively, this also means that accrued corporate earnings or micro economics or mainstream’s macro views can hardly explain this phenomenon.

Consumption demand, which has been the popular perspective, can hardly explain the broad based increases in commodity prices along with equity prices.

Of course correlation does not imply causation or that there presents no causal relationship between gold and the Phisix.

The point is: both gold and the Phisix account for as symptoms of an underlying pathology, which has largely been an unseen factor.

The Phisix-gold phenomenon has not been isolated.

This can also be observed elsewhere.


This relationship appears evident also in the global equity markets: commodities (represented by the CCI) have strongly been correlated with the S&P 500 and the Dow Jones World (DJW).

Financial Repression and Inflationism

Anyone can say what they want but it can’t be denied that the price actions in the commodity markets have been tightly connected with actions in the global equity markets.

Meanwhile the divergences in bond markets can be explained. Bond markets have essentially been rigged, have been heavily distorted and used as main instruments by governments to conduct financial repression[1]. They hardly account for as signs of deflation as deflation exponents argue.

Government interventions have been rampant almost everywhere: in the commodity markets[2] by the precipitate doubling of credit margins over a very short time frame, on the bond markets by banning short sales[3] and even seizing of private pensions such as in Argentina, Hungary, Ireland and demanding partial control of private savings in Bulgaria and Poland[4].

Even the construction of Consumer Price statistics [CPI] in the US has been severely contorted[5] which has largely been skewed towards housing.

The general incentive appears to be to keep CPI low so as to continually justify the policy of inflationism, which benefits the banking sector and the bureaucracy most.

Furthermore, the ongoing problems in the Eurozone (fiscal reforms), in China (inflation), in Japan (aftermath of the triple whammy calamity) and in the US (fiscal reforms) will likely prompt US authorities to avoid the risk of a bond market auction failure and similarly the potential risk posed by a further downslide in the housing industry which could destabilize the balance sheets of the highly protected banking industry[6]. This suggests of the likelihood of more Quantitative Easing (QE) programs to come.

Yet clamor for more QE from the mainstream has grown louder[7] which I think is part of the mind conditioning of the public meant for its acceptance.


Incidentally, the US Federal Reserve has been the largest buyer of US treasury [8]. This implies that without the QE, and with lower purchases from foreign entities, interest rates in the US will rise.

Hence, the overall direction of policies by global governments has been to expropriate private sector savings via printing money, keeping interest rates artificially down and outright confiscation (taxation or nationalization of pensions).

The leakages from these activities have percolated into commodity and stock markets.

Yet stock markets have also served as a target[9] of government policies considering their predominant guiding policy of the “wealth effect” doctrine.

So the traditional metrics to evaluate stock markets investments has been eclipsed by the direction of government policies as I have been predicting since 2008[10].

The Currency-Equity Link

If you should doubt such transmission mechanism, there are more proofs that the Phisix has been driven mainly by external forces.

It has also been a position of mine that the Philippine Peso and the Phisix have long had a symbiotic relationship.


Such actions are apparently being reinforced anew.

On the upper window, the recent feebleness in the Phisix (black candle stick) seems also reflected on the USD-Peso (green line).

In the past, a rising Peso would mirror a buoyant Phisix and vice versa. Recently both the Phisix and Peso seems to have hit the wall simultaneously (red trend lines) at the start of May (violet vertical line)!

And this has NOT been confined to a Peso-Phisix relationship. The same equity-currency collegial relationship pervades in Asia (see lower window).

The rally in the JP Morgan-Bloomberg Asian Dollar basket (ADXY- yellow line) and the MSCI Asia Pacific (MXAP:IND) has also been foiled at the start of May! So the rallies in both Asian currencies and Asian equity markets have been thwarted also on the first week of May.

Globalization Decoupling and Political Tea Leaves

The above only exhibits the depth of the interdependence of the global financial markets.

Those who extrapolate ‘decoupling’ on this highly globalized environment, will get the analysing and predicting the directions of the markets all wrong.

Globalization should not be seen only as a function of trade, labor, investment and capital flows but also on the transmission effects of global monetary policies (financial globalization) where the US as the world’s de facto currency reserve has the most influence.

Also the above price weaknesses share a common denominator: the early days of May 2011.

It is during this period where administrative interventions against the markets transpired, such as the war on commodity markets.


So whether it is the commodity markets or Asian currencies and Asian equities the coordinated reaction from interventions has been quite evident.

The chart also suggests that a seeming reprieve in the interventions has palpably led to a bounce.

Whether this rally is a function of a dead cat’s bounce (a natural counter reaction to a previously extended action) or simply a reversion to the major trend has yet to be established. Of course governments may use such occasion to further intrude on the marketplace that may add to market’s instability.

It’s not in my crystal ball to go for short term trends. Although in the understanding that politics drives the markets today, governments could use market volatility to justify prospective money printing programs. So markets could go either way from here.

Of course, it is true that seasonal factors (such as “Sell on May and Go Away”[11]) can affect the market’s activities. These signify as statistical metrics that are subject to margins of error.

In other words, there would likely be more significant variables that may influence the markets than plain seasonality. And as said above, a major force will be politics.

Bottom line:

The actions in the Phisix reflect on its tight connection with the global financial markets. And these activities have likewise echoed the actions of commodity markets.

These conjoint motions represent as symptoms or signs of major forces operating beyond the superficial understanding of the consensus on what propel the actions in the marketplace. Such force is the policy induced boom bust cycles.

Because of this tight correlations, any extrapolations or predictions of decoupling will likely be falsified when the markets undergoes another episode of spasms. Decoupling under today’s US Dollar based system will prove to be a charade.

For now, the stalled rally in the Phisix has coincided with the weakness of global equity markets and commodity prices. Such infirmities appear to have been orchestrated, perhaps specifically designed to achieve unannounced political goals.

Yet a rally in the commodity sphere, which should manifest mostly a decline of the US dollar, will translate to a rally in the Phisix and the Peso.

This rally could happen anytime.

[1] See Financial Repression Drives The Bond Markets, May 23, 2011

[2] See War on Commodities: Intervention Phase Worsens and Spreads With More Credit Margin Hikes!, May 14, 2011

[3] See War on Speculators: Restricting Short Sales on Sovereign Debt and Equities, May 18, 2011

[4] nation.foxnews.com Watch Out! Feds Could Seize Your Private Retirement Savings, May 23, 2011

[5] See US CPI Inflation’s Smoke and Mirror Statistics, May 18, 2011

[6] See The US Dollar’s Dependence On Quantitative Easing, March 20, 2011

[7] See Mainstream Calls For More Quantitative Easing, May 24, 2011

[8] Wood, Christopher The new bond conundrum, Greed & Fear, CLSA May 6, 2011 scribd.com

[9] See The US Stock Markets As Target of US Federal Reserve Policies, May 12, 2011

[10] See Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?, November 30, 2008

[11] See Global Equity Markets: Sell in May and Go Away?, May 16, 2011

Phisix: Market Consolidation and Rotational Process

It was a seesaw week for the Phisix. The local benchmark fumbled at the start but rallied strongly to close marginally lower (.25%). Year to date the Phisix remains on a positive ground up 1.75%.

The pressure encountered by the Philippine market appears to have been mainly influenced by the activities in the global equity markets where, except for Latin America, most of the major world indices posted losses for the week.

Though the markets have been biased towards the profit takers, the balance has not been lopsided.


Market breadth as shown by the advance decline spread reveals of a consolidation phase.

This means that the market sentiment, while slightly tilted towards decliners, has been mostly mixed.


The varied performances can even be seen from the sectoral performance perspective which continues to manifest signs of rotation.

Except for the mines which have been on ablaze for the NINETH consecutive week, the only sector that outclassed the mines had been the service industry, led by PLDT and Globe Telecoms.

Meanwhile the industrial sector piggybacked on the advances of URC and Meralco to squeeze out marginal gains.

On the other hand, the property, financial (last week’s outperformer) and holding firms accounted for most of the losses.

The mixed market performance also indicates that the balance of prices, in terms technicals (particularly overbought or oversold conditions) as a function of profit-taking activities, appear as being resolved on a specific issue basis that are likewise being reflected on the sectoral indices.

The Phisix appears to be waiting for a second wind or the right moment to flex her muscles.

Finally the actions in the oil sector appears to validate my projections.

Has China’s Bubble Popped?

Is something important because you measure it, or is it measured because it's important? Seth Godin

Some market observers have rightly pointed out to China as a possible principal source of concern.

Given the more mature stage of China’s inflation cycle, for me, she is more prone to a bust than her developed economy contemporaries. A China bubble bust would have a far reaching effect on many economies and on financial markets.


China’s major bellwether the Shanghai index [SHCOMP] has been on a rapid downswing (chart courtesy of Bloomberg) after a major bounce off a key resistance level last April.

The Shanghai index seems on path to test its critical support levels on what seems as a pennant chart formation.

The SHCOMP has been on tight trading range since its meltdown from the October 2007 peak at the 6,000 levels. From the said zenith, the index trades at loss of about 52% based on Friday’s close.

And following this week’s 5% rout, the Shanghai index has been down 3.5% on a year to date basis.

Chinese authorities have been tightening monetary policies to curb heightened risks of inflation.

According to a Bloomberg report[1],

The government has increased reserve requirements for banks 11 times and boosted interest rates four times since the start of 2010 to cool consumer prices

And if we go by the conditions of money supply as potential barometer to China’s economic directions, then it would appear that these compounded efforts against further ballooning of the evolving bubble may have began to affect the economy.


China’s falling money supply (right) appears to have triggered a slowdown on import growth, while consumer prices are also expected to decline according to a Danske Bank report[2].

As an aside, another option which China seems to have used on her fight against inflation has been to reduce her holdings of US treasuries for the fifth month[3] (but added on Japanese debts) and subsequently allowed for her currency the yuan to appreciate[4]. All these could also have added to the China’s process to “normalize” her monetary environment which translates to a potential slowdown.

In a discourse about current state of the US economy Austrian economist Dr. Frank Shostak writes[5],

Ultimately it is fluctuations in the growth momentum of the money supply that set in motion fluctuations in the pace of formations of bubble activities. As a result, various bubble activities that emerged on the back of the rising growth momentum of the money supply will come under pressure — an economic bust will be set into motion.

The above tenet has a universal application which means this applies to China as well.

And a possible evidence of such dynamics could be signs of deceleration in some segments of China’s property sector.


Residential sales in the elite or first tier cities have been on a downtrend.

According to the US Global Investors[6],

Residential house sales are seeing a slowdown in major Chinese cities this year. With the tightening of lending to property developers and restriction of purchases by the governments in China, developers are forced to raise money by selling at lower prices.

However, the current slowdown has not been apparent on China’s yield curve (as shown below[7]), which appears to have even steepened—manifesting signs of further inflation ahead.


Unlike Vietnam, whose unfolding stock market crash[8] appears to have dramatically flatten her yield curve over a short time span and seem to emit early signs of tipping over to an inversion (where long term interest rate are lower than the short term)—which could presage a recession over the coming year or so.

China’s immensely high rate of savings (as shown in the below chart[9]), has contributed substantially to the deferment of the unraveling of its policy induced homegrown bubble.


For as long as these savings would be able to finance economic activities that are both productive or not, the bubble activities may continue.

Nonetheless continued exposure to non-productive activities or malinvestments will eventually lead to wealth or capital consumption or the erosion of the pool of real savings which will force a painful adjustment via crisis or recession.

For now, predicting a bursting of China’s bubble may seem tricky. And I won’t tread on this path yet.

Aside from the yield curve, commodities prices appear to be rebounding, which according to the global-emerging market consumption demand story[10], China plays a significant role in the setting of prices.


Besides, the BRIC (Brazil Russia India China) story seems to share quite a strong correlation (except for Russia) in terms of stock market performance. The vertical lines exhibits the near simultaneous important turns on their respective benchmarks.

With signs that Brazil (BVSP), India (BSE) and Russia (RTSE) recently bouncing off their lows along with the current signs of recovery in commodity prices, China could as well experience an oversold rebound and return to its trading range.

Nevertheless I would need to see more signs or evidences of accelerated deterioration on several markets or economic indicators from which to predict (and take necessary action) on the imminence of a recession or a bubble busting environment.

For now, China’s market volatility could just be representative of the correction phase seen in many of the key global equity markets.

[1] Bloomberg.com China Stocks May Extend Slump, ICBC Credit Suisse, Goldman Say, May 24, 2011

[2] Danske Research China: Growth slows but inflation eased less than expected, May 11, 2011

[3] People’s Daily Online China trimmed holdings of US debt again, May 18, 2011

[4] Bloomberg.com Yuan Completes Weekly Gain on Signs Appreciation to Be Allowed, May 27, 2011

[5] Shostak Frank The Effects of Freezing the Balance Sheet, Mises.org, May 20, 2011

[6] US Global Investors Investor Alert, May 27, 2011

[7] asianbondsonline.adb.org, China, People’s Republic of

[8] See Vietnam Stock Market Plunges on Monetary Tightening, May 24, 2011

[9] Chamon, Marcos Liu, Kai Prasad, Eswar The puzzle of China’s rising household saving rate voxeu.org, January 18, 2011

[10] See War On Commodities: China Joins Fray, Global Commodity Politics Intensifies, May 14, 2011

Saturday, May 28, 2011

The Peripheral Plays of the Agriculture Boom

Speaking of the boom in agriculture, such buoyancy hasn’t been limited to commodities and farmlands but almost across the other agricultural spectrum.

For instance agri based equipments have been surging too. Other calls this a pick and shovel or peripheral play.


The Bloomberg observes,

The CHART OF THE DAY compares the shares of two equipment makers, Agco Corp. and CNH Global NV, with the price of corn on the Chicago Board of Trade, which has more than doubled in the past year. This month, the stocks have fallen further than the commodity, which has recouped most of a 10 percent loss.

Demand for farm machinery is rising along with prices, according to a report yesterday by Henry Kirn, a UBS analyst. He based this conclusion on a semiannual survey of U.S. dealers for Agco, CNH and Deere & Co. equipment.

“Dealers are generally optimistic,” Kirn wrote. Seventy- one percent of the survey participants expect sales to increase this year. The percentage is the highest since 2004. Prices for new and used farm machines are generally rising, the report said, and inventories of older gear are below normal levels.


The upswing can also be seen in fertilizer and seed stocks, food processing and many other agri related products.

I will be guilty of representative bias here. The above (stockchart.com) chart shows of some performances of Agri based ETFs and stocks which I think could represent most of the price actions of the industry

The Market Vectors Agribusiness ETF (NYSE:MOO) will give you a broader exposure to the agricultural sector.

Agrium Inc. (NYSE:AGU) A fertilizer producer that sells direct to farmers in the U.S., Argentina, Chile and Uruguay.

Potash (NYSE:POT), the largest fertilizer company in the world

Archer Daniels Midland Company (NYSE:ADM) A food processing company, Archer Daniels takes raw products like corn, wheat and oilseeds and turns them into food and agricultural products.

(my sources here here and here)

Bottom line: The agriculture inflation boom has been broadening.

The Occupational Hazards of Caregiving

Caregiving to my misimpression seems as one of the popular overseas job for Filipinos. However, according to this news, only about 140,000 Filipinos are employed as caregivers in the US.

Yet this Gallup report reveals that a career in this health sector has been presented with more hazard than other type of work in terms of well-being, physical and emotional health.

Gallup on Caregiver’s Well Being

Americans who work a full-time job and say they care for an elderly or disabled family member, relative, or friend -- 16% of the full-time workforce -- suffer from lower wellbeing than those who work a full-time job but do not have additional caregiving responsibilities. Caregivers' 66.4 overall wellbeing score is significantly lower than the 70.2 among non-caregivers.

Gallup on Caregiver’s Physical Health

Americans who work a full-time job and say they care for an elderly or disabled family member, relative, or friend, suffer from poorer physical health than those who work a full-time job but do not have additional caregiving responsibilities. Caregivers, who represent 16% of the full-time American workforce, have a Physical Health Index score of 77.4, which is significantly lower than the 83.0 found among non-caregivers.


Gallup on Caregiver’s Emotional Health

Americans who work a full-time job and say they care for an elderly or disabled family member, relative, or friend, suffer from poorer emotional health than those who work a full-time job but do not have additional caregiving responsibilities. Caregivers, who represent 16% of the full-time American workforce, have an Emotional Health Index score of 78.0, which is significantly lower than the 81.9 found among non-caregivers.


I don’t know if the above dynamics also applies to Filipinos.

Nevertheless, given the high degree of mental stress involved perhaps this type of work commands a high pay based on high turnovers.

Here is an estimate of caregiver pay.


However compared to other jobs (above chart from money-zine.com), caregivers which belongs to the Healthcare support work, seems to be on the lowest quartile.

I have less data on this work to make a comprehensive commentary, except that I just find the state of the caregiving job as intriguing (and so is the reason for this post)