Quote of the Day: Standing Up Against Prevailing Beliefs

Would you rather be an honorable person perceived to be a fraudster, or a fraudster mistaken for an honorable person? The answer can help you understand why otherwise good people do devious things to avoid standing up against prevailing beliefs.

This is from Black Swan author Nassim Nicolas Taleb at Facebook

Shopping Mall Bubble: Will Remittances, BPOs and the Informal Economy Save the Day?

Investing Against Popular Wisdom

In the world of investing, the wisdom of the crowds, especially during inflection periods, represents as a potential hazard to one’s portfolio. This is where the Wall Street axiom applies, “bulls make money, bears make money, but pigs get slaughtered”.

This happens for the simple reason that abdicating independent reasoning or analysis for groupthink increases the risks of overconfidence, which tends to influence people’s decision making by underestimating risks while simultaneously overestimating rewards.

Moreover, as I wrote on crowd thinking[1],

Groupthink fallacy is the surrender of one’s opinion for the collective. This accounts for as a loss of critical thinking and is reflective of emotional impulses in the decision making of the crowd. When groupthink becomes the dominant mindset of the crowd, an ensuing volatile episode can be expected to occur applied to both markets and politics (bubble implosion or political upheaval).

Veteran, battle hardened and successful investing gurus have all recommended to avoid populism. For them the herding effect signifies unsustainable crowded trades and or that the most profitable opportunities lie within themes that have hardly been seen by the crowds.

For instance, the billionaire George Soros via his reflexivity theory[2] wrote that we should be alert to the crucial psychological features of boom bust sequence; particularly

-The unrecognized trend,

-The beginning of the self-reinforcing process

-The successful test

-The growing conviction, resulting in the widening divergence between reality and expectations

-The flaw in perceptions

-The climax and

-The self-reinforcing process in the opposite direction

The point is that during the pinnacle or the troughs of booms and bubble bust episodes, people’s perception of reality become greatly distorted by biases.

One of the distinguished mutual fund investor John Neff similarly advised that[3]

It's not always easy to do what's not popular, but that's where you make your money.

Warren Buffett also said

Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well.

The bottom line is that when everyone thinks the same then no one is thinking. And when we do not think, we lose money.

The Myth of the Consumption Economy

When everyone thinks that today’s boom is sustainable, since the public has been made to believe that current market dynamics have been founded on sound social policies and genuine economic growth, then this for me represents Mr. Soros’ “the growing conviction, resulting in the widening divergence between reality and expectations and the flaw in perceptions” which eventually leads to the “climax”.

And part of today’s Philippine boom has been predicated on supposedly a ‘consumption economy’, where the popular narrative holds that consumption, which has been portrayed as an independent force from producers, drives the economic prosperity.

In reality, every producer is a consumer. The world is interconnected such that production and consumption represent as people’s activities for survival and for progress. But not every consumer is a producer. The government is an example.

As the great Austrian economist Professor Ludwig von Mises wrote[4],

Economics does not allow of any breaking up into special branches. It invariably deals with the interconnectedness of all the phenomena of action. The catallactic problems cannot become visible if one deals with each branch of production separately. It is impossible to study labor and wages without studying implicitly commodity prices, interest rates, profit and loss, money and credit, and all the other major problems. The real problems of the determination of wage rates cannot even be touched in a course on labor. There are no such things as "economics of labor" or "economics of agriculture." There is only one coherent body of economics.

The reason people work is to earn (or implied production) in order to consume. In today’s modern economy one’s earnings, as expressed by money, indirectly represents real savings from our production or services provided.

Yet simple logic holds that if everyone consumes and no one produces then there will be nothing to consume. Thus we can only consume what we produce. In short, real prosperity arises from the acquisition of real savings or capital accumulation from production.

As the great French economist Jean Baptiste Say wrote[5], (italics original)

That which is called productive capital, or, simply, capital, consists of all those values, or, if you will, all those advances employed reproductively, and replaced in proportion as they are destroyed.

It is easy to see that this term capital has no relation to the nature or form of the values of which capital is composed (their nature and form vary perpetually); but refers to the use, to the reproductive consumption of these values: thus a bushel of corn forms no part of my capital if I employ it to make cakes to treat my friends, but it does form part of my capital if I use it in maintaining workmen who are employed on the production of that which will repay me its value. In the same manner a sum of money is no longer a part of my capital if I exchange it for products which I consume: but it does form part of my capital if I exchange it for a value which is to remain and augment in my hands…

Capital is augmented by all that is withdrawn from unproductive consumption, and added to aconsumption which is reproductive.

Importantly consumption does not increase wealth, instead unproductive consumption destroys wealth

Again Jean Baptiste Say[6],

It must be remembered that to consume is not to destroy the matter of a product: we can no more destroy the matter than we can create it. To consume is to destroy its value by destroying its utility; by destroying the quality which had been given to it, of being useful to, or of satisfying the wants of man. Then the quality for which it had been demanded was destroyed. The demand having ceased, the value, which exists always in proportion to the demand, ceases also. The thing thus consumed, that is, whose value is destroyed, though the material is not, no longer forms any portion of wealth.

A product may be consumed rapidly, as food, or slowly, as a house; it may be consumed in part, as a coat, which, having been worn for some months, still retains a certain value. In whatever manner the consumption takes place, the effect is the same: it is a destruction of value; and as value makes riches, consumption is a destruction of wealth.

So to argue that consumption leads to wealth is like pulling a wool over one’s eyes.

But of course the principal reason behind the populist consumption economy narrative has been to justify myriad government interventions via ‘demand management’ measures applied against the supposed insufficient “aggregate demand” from so-called “market failures”.

Moreover, the consumption story aims to buttress mostly indiscriminate debt 

acquisition as a means of attaining statistical rather than real growth based on value creation.

Since politics is mainly short term oriented, thus populist short term policies via inflationism and via assorted interventions only distorts and obstructs the economy from its natural path. Instead, the typical ramification has been wealth consumption, part of it as consequence from boom bust cycles.

The implicit design behind the debt consumption policies has been to support the politically privileged banking system, whom provides financing to the redistributionist government through bond purchases, and the government and the political class, who not only profits from continued forcible extraction of resources from the private sector but likewise resort to debt generation to fund pet projects to ensure their hold on power.

Central banks, essentially, act as guarantor and as lender of last resort to both government and the banking system.

The same fiction of the consumption economy has been used to rationalize not only credit financed domestic property bubble[7] but also a shopping mall bubble. 

By the way property and shopping mall are of the same lineage.

Will Remittances Sustain the Consumption Story?

Last week in dealing with the shopping mall bubble I concentrated on the supply side of the industry[8].

For this week, my focus will be on the consumption side.

As previously explained, there are three ways to finance consumption, through productivity growth, through consuming of savings or through contracting of debt.

On the productivity side, one of the popular mainstream meme is that remittances from Overseas Foreign Worker (OFW) have been responsible for most of the economic growth expressed via the consumption economy.

For most news accounts, consumption has been strongly associated with remittances, or said differently, remittances drives Philippine consumption.

According to the BSP[9], remittances in November of 2012 grew by 7.6% over the same period, totalling $21.6 billion for 11 months or 6.1% from last year.

The Philippine economy according to World Bank Development indicator in 2011, as cited by the Wikipedia.org[10], was at nominal $224.8 billion, this effectively means remittances through November translates to about 10% of the economy.

Only in media do we see 10% as mathematically greater than 90%. Even if we assume that all money sent by overseas workers are spent on consumption and or partially on investments (sari sari stores and etc…), there is little to show that the supposed multiplier effect of remittances will lead to 50% of current consumption levels.

Yet of course, I would posit that some of the remittances could have partially been “saved” in the banking system and perhaps even through the non-bank system. This is what media and their experts consistently ignore.

While the BSP did not provide the average growth, Yahoo Singapore[11] quotes one of the Singaporean financial institution, the DBS Bank as estimating the monthly average growth based on October data, at 5.8%. 

Granting that media and their experts have been indeed correct in saying that remittances serves as the core force for consumption, then unfortunately 5.8% would hardly cover the gap with the supply side’s or shopping mall operator or developer’s baseline growth of 10%.

One may add that there hardly has been a nominal or real sustained 10% growth based on Peso or US dollars since 2009 based on World Bank’s chart[12].

And given that remittances is essentially latched to the productivity growth of the global economy, which means that wages of OFW workers and OFW deployment depends on the domestic economies the OFWs are employed at, the prospects of lower economic growth would hardly transform into magic for remittances.

Note that the global remittance growth trend[13] has essentially tracked the remittance growth trend of the Philippines and the World GDP’s past growth[14].

Even if we add up the estimated 30-40% of remittance channelled through the informal economy, which is according to the Asian Bankers Association[15], where the real remittance level balloons to $31 billion (to include both formal and informal avenues), this will account for only 14% of the GDP. Remember informal remittances have not been a onetime event but a longstanding factor.

And if the consensus is right that global economic growth will remain sluggish, then remittances will hardly fill the void unless the growth in the informal remittances will intensely surprise to the upside.

So even if there should be a change in preferences in consumption and savings patterns by OFWs to favor more remittances (or transfers), the consumption story funded by mainly remittances will remain inadequate.

How about BPOs?

Another less popular but more potent consumption story is the Business Process Outsourcing (BPO)

The BPO industry has reportedly generated foreign exchange revenues of about $11 billion in 2011[16] and the industry’s growth has been expected to earn more than double to $25 billion in 2016. This translates to a Compounded Annual Growth Rate (CAGR) of 17.85%. If true, then BPO will surpass remittances in no time. But I believe that such projections seem wildly optimistic.

The National Economic and Development Authority (NEDA) also estimates the industry’s growth at 15%[17] 

Depending on the analyst, estimates of growth for the BPO industry have had wide divergences. 

The Philippine BPO association along with the Philippine government says they expect a 15% compounded annual growth rate for the global BPO market[18] (right window). Whereas Slovakia’s Soften-Accenture quoting the estimates of technology research giant Gartner[19] says that BPO and IT CAGR to grow 6.3% and 5.9% respectively. Research firm AT Kearney seems to conform to the Gartner estimates[20].

I believe that the fundamental reason for such patent disparity is that the association of the local BPO industry along with the government simply reads past performance into the future.

Nevertheless, where I believe they gone astray is that they have ignored the S-Curve cycle of the technology industry

The S-Curve as defined by Wikipedia.org[21]

The s-curve maps growth of revenue or productivity against time. In the early stage of a particular innovation, growth is relatively slow as the new product establishes itself. At some point customers begin to demand and the product growth increases more rapidly. New incremental innovations or changes to the product allow growth to continue. Towards the end of its life cycle growth slows and may even begin to decline. In the later stages, no amount of new investment in that product will yield a normal rate of return

In short, unless there will be assimilation of more productivity through newer innovation, the industry’s growth diffusion levels, as it ages, is bound to slowdown. I have used this curve to rightly predict the slowdown in telecom penetration levels.

Further, the Philippine competitive advantage has not been etched on the stone. While Philippine adaptation of the American English language has represented as the main competitive edge for her to supplant India on BPOs as global leader[22], but not in the ITOs, labor costs could be a factor.

In addition, the outsourcing industry is highly competitive, highly sensitive to technological changes and is likewise anchored to global growth. So while we might see more businesses adapt to the digital environment, it isn’t clear that BPOs can deliver the consumption story to cover the deficiencies from the formal economy and from the remittances.

So while I am highly optimistic on the technology industry, I have great reservations on industry estimates, which I hope will prove me wrong.

Will the Informal Economy Surprise?

This leads me to the informal economy.

Informal economy, for me, covers all the sectors that elude the government, whether they are the small scale vendors, manufacturers, service industry or smugglers and also those in formal industries that resort to tax avoidances.

Money excluded from forced redistribution can mean savings, investment and or consumption.

So far the statistical measures of the informal economy has been through labor which accounts for about 50% of the Philippine work force.

Agriculture is said to constitute the largest informal sector estimated at 64% according to a study[23] by the National Statistical Coordination Board. While I believe that statistics have most likely downplayed the important role played by agriculture, I believe much of the consumption story may have been from this sector which has partly piggybacked on the global commodity bullmarket. I say partly, because the sector has been tightly regulated and this applies not only to the Philippines but abroad too[24]

And given that the different estimates of banking penetration level, nonetheless all of them reveals of the lack of access by the average Filipinos to financial institutions, I believe that government statistics may not have captured the off banking savings rate which may have contributed to the consumption story.

The US Agency for International Development[25] suggests that only 26.56 percent of Filipinos aged 15 years old and above have accounts with banks or financial entities whereas the McKinsey Quarterly[26] estimates that only 35% of Filipinos has bank accounts or accounts with a financial institution.

In other words while I believe that there has been more savings for the consumption story, I think that productivity growth even in the informal economy may not sustain the supply side growth of the shopping malls.

So unless the government will dramatically liberalize the agricultural sector given its tightly controlled conditions, there is unlikely the possibility for a fill in the gap role for the informal sector considering the steep projected growth in the shopping mall supply.

The other way is for the bulls to hope that all statistics are wrong.

Finally the Philippine productivity growth story over 4 decades has hardly shown the stuff required to support the consumption story. Growth of over 10% has been an outlier.

The good news is that the author of the study makes the case for the openness of the economy[27] as one of the pillars to improve on productivity, something which today’s government does not see as a priority.

I will end this rather lengthy report with an update[28] from the Bangko ng Pilipinas on domestic banking credit conditions, which again reported a strong credit growth in November (14%) but has been modestly down from October (15.8%) [bold mine]

Loans for production activities—which comprised more than four-fifths of banks’ aggregate loan portfolio—grew by 14.6 percent in November from 16.4 percent in the previous month. Similarly, the growth of consumer loans eased to 12.1 percent from 13.9 percent in October, reflecting the slowdown across all types of household loans.

The expansion in production loans was driven primarily by increased lending to the following sectors: real estate, renting, and business services (24.8 percent); wholesale and retail trade (by 26.9 percent); financial intermediation (37.3 percent); manufacturing (13.6 percent); transportation, storage, and communication (26.5 percent); and public administration and defense (48.9 percent). Meanwhile, declines were observed in lending to mining and quarrying (-39.5 percent) and agriculture, hunting, and forestry (-41.8 percent).

The growth rate reported by the BSP on the banking sector’s credit growth for real estate and retail trade seems consistent with the baseline of 10% supply side growth for the shopping malls. Shopping malls are essentially real estate business, while the retail segment are the lessees of the malls (aside from ex-mall outlets). So developers and retail operators continue to see double digit consumer growth for them to indulge in a massive buildup of debt.

Yet if the loans by the real estate and retail trade sectors grow by 20% per year as baseline, then their exposures with the banking sector effectively doubles in the fourth year. Of course this view excludes the past loans that have already been incurred.

The bottom line is that while there are many imponderables which this analysis may not secure, the seeming amplification of the asymmetric growth between demand and the supply malls may lead to serious economic imbalances which eventually will be reflected on the markets through a tumultuous backlash. Entrepreneurial errors, mostly fed by social (central banking) policies via distorted prices, and from popular but flawed theories, have only worsened the situation. The fingerprints of the (Austrian) business cycle seem everywhere.

As a final note, bubble cycles are market processes influenced by social policies and are shaped over time. The persistence of the trend will be conditional to the forces that have triggered them. If the current supply side trend persists without accompanying material real growth in productivity (i.e. not based on credit and from government expenditures) and if both sides will continue to accrue more debt in response to the present suppression of the interest rate environment, then the risks of a bubble bust will loom larger as time goes by. The other factor will be how authorities respond to changing conditions.

---

[1] See The UNwisdom Of The Crowd August 15, 2010

[2] George Soros The Alchemy of Finance p.58

[3] Businessinsider.com 22 Insights From The Most Successful Investors In History, January 15,

[4] Ludwig von Mises, XXXVIII. THE PLACE OF ECONOMICS IN LEARNING 4. Economics and the Universities Human Action Mises.org

[5] Jean Baptiste Say Catechism of Political Economy Mises.org

[6] Ibid

[7] See Philippine Overseas Workers Help Fuel Philippine Property Bubble, June 14, 2012

[8] See Philippine Economy’s Achilles Heels: Shopping Mall Bubble (Redux) January 13, 2013

[9] Bangko Sentral ng Pilipinas Remittances Sustain Growth in November 2012, January 15, 2013

[10] Wikipedia.org Economy of the Philippines

[11] Yahoo Singapore Philippines' remittances from overseas workers spike by 8.5%, January 15, 2013

[12] World Bank PHILIPPINE QUARTERLY UPDATE INVESTING IN INCLUSIVE GROWTH AMID GLOBAL UNCERTAINTY

[13] World Bank Outlook for Remittance Flows 2012-14 Migration and Development unit December 1, 2011

[14] The Economist World GDP Graphic detail January 15, 2013

[15] Businessmirror.com ‘Informal’ OFW remittances P242 billion higher, November 14, 2012

[16] Rappler.com BPO industry welcomes Obama win despite anti-outsourcing threat, November 10, 2012

[17] East Vantage.com 15% in Annual Growth in BPO Philippines Says NEDA

[18] NCC.gov.ph Philippine IT-BPO Road Map 2016: Driving to Global Leadership

[19] Softec.sk Global Off Shoring and Outsourcing Market Dynamics

[20] Avaya Blog Statistics of the Global BPO Industry

[21] Wikipedia.org Diffusion Innovation

[22] New York Times A New Capital of Call Centers, November 25, 2011

[23] Jose Sibal Measuring the Informal Sector in the Philippines and the Trends in Asia National Statistical Coordination Board October 2007

[24] See Agricultural Boom Fuels Farmland Protectionism, May 28, 2011

[25] Inquirer.net Philippines lags behind peers in bank penetration, survey shows, May 3, 2012

[26] See The Rise of Mobile Banking, May 23, 2012

[27] Gilberto M. Llanto Philippine Productivity Dynamics in the last 5 decades Philippine Institute for Development Studies and factors influencing

[28] Bangko Sentral ng Pilipinas Bank Lending Continues to Grow in November, January 17, 2013

Bob Farrell’s 10 Timeless Investing Guides

When in investing in the financial markets, particularly in the stock markets, there are times which necessitates contrarian positioning and their are occasions which require crowd following.

Retired wall street veteran and stock market guru Bob Farrell in his 10 “Market Rules to Remember” lays out when we should assume on such positions: (bold mine)

1. Markets tend to return to the mean over time
2. Excesses in one direction will lead to an opposite excess in the other direction
3. There are no new eras — excesses are never permanent
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
5. The public buys the most at the top and the least at the bottom
6. Fear and greed are stronger than long-term resolve
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend
9. When all the experts and forecasts agree — something else is going to happen
10. Bull markets are more fun than bear markets.

Explanations of the above can be found in Stockcharts.com, Investment Postcards and Marketwatch.com 

Weather Forecasters are Better Forecasters than Stock Market Experts

Weather forecasters are said to have markedly better batting average making predictions or are far more accurate prognosticators than most stock market experts. (Well this applies to foreign private weather forecasters and not the Philippine government counterpart.)

Justin Rohrlich at the Minyanville writes,

According to New York Times statistical wunderkind Nate Silver, the National Hurricane Center’s accuracy has improved 250% over the last 25 years.

More accurate weather predictions benefit the economy, boosting the efficiency of businesses like FedEx (FDX), which employs 15 in-house meteorologists, as well as companies working offshore, like BP (BP) and Transocean (RIG). Weather is such an important factor in financial markets that Goldman Sachs (GS) employs staff meteorologists, as do Citigroup (C) andJPMorgan Chase (JPM).

While meteorologists have improved, other analysts -- specifically financial ones – are still off the mark more often than not.

“In November 2007, economists in the Survey of Professional Forecasters -- examining some 45,000 economic-data series -- foresaw less than a 1-in-500 chance of an economic meltdown as severe as the one that would begin one month later,” Silver writes.

“Why are weather forecasters succeeding when other predictors fail? It’s because long ago they came to accept the imperfections in their knowledge. That helped them understand that even the most sophisticated computers, combing through seemingly limitless data, are painfully ill equipped to predict something as dynamic as weather all by themselves. So as fields like economics began relying more on Big Data, meteorologists recognized that data on its own isn’t enough.”

So the admission of the knowledge problem is one crucial factor contributing to the weather forecaster’s edge.

I’d add that the unwillingness to think outside the box has been another key variable to why stock market experts underperform.

More…

In a slightly larger than usual nutshell, the crux of the issue was this: Weather forecasters have an “awareness of uncertainty” about the natural world that “causes these experts to manifest a lower overconfidence effect than experts from the other domain.”…

Further, financial analysts were also found to be unwilling or unable to be self-critical after a failure -- something that Raymond Dacey, Professor of Finance and of Statistics and Adjunct Professor of Philosophy at the University of Idaho, suggested to the authors “could pertain to the clients.”

Simply put, the “Disposition Effect” has to do with risk attitude and what Shefrin and Statman colloquially term “get-evenitis” -- an aversion to loss realization.

Another major obstacle is the overconfidence bias

I’d add that egotism has always been a hurdle to self discipline.

Here is a relevant investment ‘war’ tip from Sun Tzu’s Art of War

If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle

Mainstream Analysts Capitulates on Bear Market Views

From Bloomberg,

Strategists at the biggest banks are capitulating on their bearish forecasts after the best start to a year for global stocks since 1994 and gains of more than 7 percent in emerging-market currencies.

Just two weeks after saying that investors should “remain cautious,” Larry Hatheway, the chief economist at UBS AG (UBSN), raised his recommendations on global shares and high-yield bonds in a Jan. 23 note to customers entitled, “Wrong, but not too late.” Royal Bank of Scotland Group Plc (RBS), and Benoit Anne, the global head of emerging-markets strategy at Societe Generale (GLE) SA, said their estimates for developing nations were proven wrong.

The MSCI All-Country World Index (MXWD) climbed 5.7 percent in January, surprising strategists at Bank of America Corp. (BAC),Goldman Sachs Group Inc. (GS) and Barclays Plc (BARC) who had forecast first-half losses because of Europe’s debt crisis. JPMorgan Chase & Co. (JPM) and Citigroup Inc. (C), which predicted the rally in stocks, say it will continue as the U.S. housing market rebounds and China eases lending restrictions to bolster economic growth.

Another instance where the mainstream admits to have gotten their analysis, and subsequently their predictions, all so wrong. Independent (usually contrarian) thinking pays. And most important is adhering to the methodology taught by Professor Ludwig von Mises.

There is only one way of dealing with all problems of social organization and the conduct of the members of society, viz., the method applied by praxeology and economics. No other method can contribute anything to the elucidation of these matters.

War Against Market Prices: South Korea Imposes Ban on Short Sales

Regulators generally have deep aversion for falling prices (deflation), or applied to financial markets, they fear bear markets.

So they apply all sorts of price control measures to prevent the required adjustment in prices that essentially reflects on the underlying fundamentals of the securities or markets.

Today, South Korea copycats Greece.

Here is Bloomberg, (emphasis mine)

South Korea banned equity short sales for three months while the two biggest state-run funds said they may boost investments as the government seeks to shore up a market that’s had its biggest six-day drop in three years.

The Financial Services Commission said it will ban short selling on all shares until Nov. 9 from today. The National Pension Service, the country’s biggest investor, said yesterday it plans to buy more stocks this month than it originally targeted. Korea Teachers Pension said it purchased about 70 billion won of stocks amid the sell-off and may buy more.

South Korea joins Greece this week in banning short selling after the Kospi Index (KOSPI) slumped 17 percent in six days. The gauge reached an intraday level yesterday that was 24 percent below its May 2 record close. Domestic institutions should play a bigger role to contain volatility that is often caused by sell- offs by overseas investors, the FSC’s Chairman Kim Seok Dong told lawmakers in parliament yesterday.

The current ban exhibits the same attempt made in September 2008.

From the same article,

South Korea imposed a ban in 2008 on short sales following similar actions taken by U.S. and U.K. regulators in the aftermath of Lehman Brothers Holdings Inc.’s collapse. Korea lifted the rule from June 2009, while keeping the ban for financial stocks. The nation already bans so-called naked short sales, where investors don’t need to borrow the shares.

How effective has the been the ban which South Korean authorities imposed in September 30^th of 2008?

Apparently a big failure as the Kospi index’s crash even accelerated when the ban was imposed (blue arrow).

Korea wasn’t alone, she was accompanied by Taiwan and Indonesia who also imposed short trading prohibitions.

And the results were identical.

Like South Korea, both Taiwan (TSEC black candle) and Indonesia (JKSE-blue candle) fell sharply during the final phase of the bear market of 2008, in spite of the short selling ban. In short, regulators failed to control their respective equity markets.

The good news is that actions of regulators are almost always mechanically reactive to unfolding events (present and past events). Usually the failed policies they implement occur during the culmination of major inflection points.

Another good example of this was UK’s Gordon Brown infamous “bottom” selling of the Bank of England’s gold reserves in 1999. BoE’s loss has been the market gains.

An important lesson is that actions of politicians may function as good or reliable contrarian indicator.

Applied to the short selling ban by South Korean authorities, if the past will rhyme, short-term market pressures may still proceed, but this may also signal the near conclusion of the current selling pressure (mid term) cycle.

Phisix: Panicking Retail Investors Equals Buying Opportunity

“Without education we are in a horrible and deadly danger of taking educated people seriously.” G.K. Chesterton (1874-1936), English author

One of the important sentiment indicators that I use in examining short term trends is measuring the actions of small retail investors.

This group comprise mostly the unsophisticated market participants, whose decisions are mostly swayed by emotions. Market tops (greed) and bottoms (panic) are frequently associated with aggressive actions undertaken by them.

Pigs Get Slaughtered

And there’s even this famous Wall Street axiom which alludes to them: “Bulls and Bears make money, but pigs get slaughtered”.

Pigs, according to Investopedia[1], are high-risk investors looking for the one big score in a short period of time. Pigs buy on hot tips and invest in companies without doing their due dlligence. They get impatient, greedy, and emotional about their investments, and they are drawn to high-risk securities without putting in the proper time or money to learn about these investment vehicles. Professional traders love the pigs, as it's often from their losses that the bulls and bears reap their profits.

While I don’t have sufficient data to substantiate this phenomenon today, except that market breadth has considerably deteriorated, my sense is that the recent correction in the local markets may have incited some retail investor’s into panic selling.

Figure 1: Net Foreign Trade

Since the peak of the Phisix in October, foreign trade have been mixed (figure 1).

Last week foreign trade reported net buying, reversing almost half of the outflows seen from the previous week. This means that most of the selling pressure came from local investors. With the broad deterioration of the market’s breadth, this likely signals panic selling by retail investors.

And for whatever reasons which may have prompted for their actions I see this as an opportunity to accumulate rather than to flee.

Where weak hands dominate the activities, taking the contrarian stand would be the most prudent path. It seems almost the same case where we successfully called for “top” in the US bonds and the “bottom” in US stocks[2] based on the activities of the Pigs.

Phisix (and ASEAN)-Global Market Divergences

We have to remember market actions have never been a one-way street, as buyers and sellers reacting to perpetually changing conditions, always struggle to tip the scale of balance in their favor.

I’d have to admit that over the short-term even global markets may take a reprieve. As to whether this would materially influence the actions in the local equity market, which appears to have foreshadowed the global trend, is something I can hardly predict.

And gold prices, which in my view, has functioned as a very important barometer of global equities, seems to have augured for this hiatus (see figure 1).

But the point is: the major drivers of global financial marketplace, particularly inflationism and globalization, remain intact which means likely a consolidation phase first, as a consequence to last year’s fiery run up, before the next leg up.

Figure 1: Growing Divergences In The Financial Marketplace?

One thing we can observe, so far, is that the Philippine Phisix, along with our Southeast Asian contemporaries, which has been one of the world’s best performers in 2010[3], appears to be diverging from the trends of the global equity markets[4].

This can be seen in based on the actions of the Dow Jones World Index (DJW) and Dow Jones Asia Ex-Japan (P2DOW), which means bourses of major economies have been sustaining the rise of global markets, via the DJW, aside from the other non BRIC emerging markets.

In fact, many of the today’s best performers have been last year’s laggards, which only implies of the rotational effects on equity asset prices as corollary from central banks inflationism.

Yet with most countries still showing advances more than those suffering from losses measured on a year to date basis, it’s hard to argue for bearishness unless current conditions dramatically degenerate.

Peso-Phisix Divergence

Another source of a slight divergence appears to be in the tight correlation of the Phisix and the Philippine Peso (see figure 3)

Figure 3 Peso-Phisix Divergence?

Almost each time we see the Phisix fumble, the Peso follows. The chart demonstrates this relationship where a peak in the US dollar coincides with the bottom of the Phisix and vice versa.

This week we saw a sharp rally in the Peso even as the Phisix just eked out inconsequential gains. This implies that foreign investors buttressed Phisix as locals sold the market resulting to a broad based selloff.

My point is that if foreign investors increase their accumulations in the equity markets as the locals sell, we should see a consolidation (bottoming).

And where negative sentiment eases, and locals reverse from selling, we’d probably see a substantial recovery.

By then the Pigs will likely jump on the bandwagon.

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[1] Investopedia.com Stocks Basics: The Bulls, The Bears And The Farm

[2] See US Markets: What Small Investors Fleeing Stocks Means August 23, 2011

[3] see How Global Equity Markets Performed in 2010, January 14, 2011

[4] See Global Stock Market Update: Advancers Still Dominate, January 25, 2011

A Video Account of A Contrarian's Ordeal: Peter Schiff Was Right in 2006-2007!

Mr. Peter Schiff of Euro Pacific Capital is an iconoclast economist who subscribes to the Austrian school of economics and has served as economic adviser to Ron Paul’s presidential campaign in the recently concluded elections, and has been one of the grizzly bears who successfully predicted today’s crisis during the boom days of 2006-2007.

The purpose of my posting this video is to show you how contrarians suffer from the ordeal of challenging mainstream or popular thinking at the risk of being mocked, heckled and or excoriated. But of course, Mr. Schiff gets sweet vindication overtime. (Hat Tip: Robert Murphy)

Lesson: Be wary of mainstream or popular views. Most of the popular thinking have been influenced by an oversimplified comprehension of complex problems, the “rear view mirror syndrome” outlook or the “ticker tape performance” outlook where recent performance are interpreted as tomorrow’s outcome.

Enjoy!