Southern Europeans Flee to Germany

The crisis affected European nations or the PIGS (Portugal Italy Greece and Spain) have not just been enduring capital flight from fears of prospective devaluation by a forced exit, but likewise have seen a mass exodus from residents.

As I earlier pointed out, many European emigrants seem to have opted for emerging markets, meanwhile fresh reports tells us that many others have been flocking into Germany at a steepening rate.

From the Wall Street Journal

The influx of Southern Europeans into Germany has gathered pace in recent months, as a growing number of Greeks, Spaniards and Portuguese ventured north to escape deepening recession and growing social tensions.

The biggest increase came from Greece. The number of Greeks moving to Germany jumped 78% in the first half of 2012 from a year earlier, Germany's statistics office said.

In all, more than 16,000 people moved to Germany from Greece between January and June, an acceleration of a trend that began in 2010 after the Greek crisis began. The number of immigrants to Germany from Spain and Portugal was up by 53% for each country.

The trend bodes ill for countries on Europe's southern periphery at a time of worsening economic malaise. Many of those leaving are young professionals with valuable skills. Their departures could have long-term consequences for countries such as Greece and Portugal as they struggle to recover.

"There are absolutely no jobs here—that's the main reason why people move away," said Charalampos Koutalakis, a politics professor at the University of Athens.

Jobs are symptoms of a deeper systemic malaise.

On the one hand, the productive class have been finding diminished economic opportunities from which to go about or to work on, given the political trends of deepening financial and economic repression that has led to the asphyxiation of the business and entrepreneur class

Such includes the risks of the erosion individual savings which has prompted for capital flight—again from the perceived risk of more inflationist policies, the risks of an implosion of the banking system and a wider confiscatory tax dragnet for these insolvent and desperate nations.

On the other hand, the parasitical class have been fighting to retain their entitlements which have been bringing about greater political risks.

Picture from Spiegel Online

Strikes and demonstrations in protest of so-called “austerity” have only been intensifying social frictions that have sparked political violence. This has only worsened the investment climate that has brought Europe down to its knees through a double dip recession.

"The problem with socialism is that eventually you run out of other people's money [to spend]" remarked former UK’s PM Margaret Thatcher. This has been the zeitgeist of the social feud in Europe as welfare and bureaucrats bitterly contest with the ruling political class and the privileged and protected (crony) bankers on how to divvy up the residual spoils from an unsustainable system of mandated plunder.

And for the citizens who refuses to partake of political of the struggles, and who may have chosen to stay or who may have been trapped by the inability to migrate, the desire to normalize life have led to a booming informal economy which now averages 17.3% of the euro GDP or EUR 1.5 trillion.

As I have been pointing out, the informal economy seems like guerrilla capitalism operating under business or investment hostile or adverse political landscape

Bottom line: People respond to developing political trends or political risks. A political trend towards economic repression leads to violence, to capital flight, to the informal economy and to emigration.

Video: Steve Hanke on the Eurozone Crisis

Here is Cato's Steve Hanke's take on the Eurozone crisis (interviewed by Reuters)

Some pointers from the interview:

-Glaring 'lack of sense of history' by "Euro-crats" in dealing with the crisis leaves them unable to accurately diagnose the problems which subsequently means applying wrong prescriptions (2:18)
-the ECB may be forced to provide unlimited support for EU's bond markets (3:08)
-two fundamental scenarios: One, the EU will evolve into a fiscal transfer union which will be very messy and take lots of time (3:50) 'My guess is that the cartel may fall' because of political problems. (4:20) Second, the Eurozone may split (4:40). Prof. Hanke says that the mainstream's popular panacea for an exit option, just to be able to resort to devaluation, would be 'a chaotic situation' as all companies and the households in Greece would effectively go bankrupt (4:56).

War against Short Selling: France, Spain, Italy, Belgium Ban Short Sales

Regulators/Policymakers maintain a delusion of control.

From Bloomberg, (bold highlights mine)

France, Spain, Italy and Belgium will impose bans on short-selling from today to stabilize markets after European banks including Societe Generale SA hit their lowest level since the credit crisis.

“While short-selling can be a valid trading strategy, when used in combination with spreading false market rumors this is clearly abusive,” the European Securities and Markets Authority, which coordinates the work of national regulators in the 27- nation European Union, said in a statement after talks ended late yesterday. National regulators will impose the bans “to restrict the benefits that can be achieved from spreading false rumors or to achieve a regulatory level playing field.”

The watchdogs are trying to stem a rout that sent European bank stocks to their lowest in almost 2 1/2 years and quell concern that European lenders may be struggling to fund themselves. Banks’ overnight borrowings from the European Central Bank jumped to the highest in three months yesterday, a sign some lenders may have need for emergency cash. Regulators imposed similar limits on short sales in September 2008 following the collapse of Lehman Brothers Holdings Inc.

Politicians and regulators want you believe that prices can be fixed by edict or fiat.

They make you believe that a worthless or junk piece of security should have value because they say so.

The countries planning to impose the ban on short sales have all seen their stock prices crashing.

Essentially France (CAC; orange), Spain (MADX; green), Italy (FTSEMB; light orange) and Belguim (BEL20; red) have been in bear market territories. The performance or % yield from the above chart is seen from the year-to-date perspective. This means that the above does not reflect on the peak-trough returns, which should amplify the degree of losses.

As I pointed out in the same recent case as Korea:

1. Bans hardly have been effective. Instead they are mostly symbolical as the “need to be seen as doing something”

2. Regulators react almost always too late in the game (which means that their markets may be at the process of nearly bottoming out.)

3. I would further add current policies have clearly or overtly been in support of the banking system and the stock market.

4. This only validates the theory that the policy direction of governments and global central bankers has primarily been anchored upon the Bernanke ‘crash course for central bankers’ doctrine of saving the stock market.

5. Importantly, applied policies have been meant to preserve the tripartite cartelized system of the welfare state, central banks and the crony banking system.

Global Market Crash Points to QE 3.0

I can already smell QE3. Now we'll see if Mr. Bernanke is a true money printer or an amateur money printer. If he is a true money printer, he's going to start printing soon, markets will rally but not to new highs-Dr. Marc Faber

Important: The US has been downgraded by the major credit rating agency S&P after the market closed last Friday[1], so there could be an extended volatility on the global marketplace at the start of the week. This largely depends if such actions has already been discounted. The first thing on Monday is to watch Japan’s response.

Nevertheless given the actions of the US markets last Friday, where rumors of the downgrade had already circulated[2], there hardly has been any noteworthy action which presages more trouble ahead.

At the start of the week, the mainstream attributed the weakness in the US markets as a function of the risk of a debt default. This, according to them, should arise if a debt ceiling deal would not be reached.

I argued that this hasn’t been so[3], for the simple reason that market signals has been saying otherwise.

A credit rating downgrade means higher costs of financing or securing loans and a possible rebalancing of the balance sheets of the banking system to comply with capital adequacy regulations.

The chart above shows that short term yields initially spiked (1 year note light blue and 3 month bill-light green) during the 11^th hour of the negotiations. But once the debt ceiling deal was reached and the bill was passed, interest rates across the yield curve converged as they fell along with prices of Credit Default Swap.

Instead I pointed to the deteriorating events in Europe as a possible aggravating factor on US markets.

Impact of Downgrades

There are two basic ways to measure credit risks. One is the interest rate, the other is through credit default swaps (CDS) which fundamentally acts as a form of insurance against a default.

It is misleading to think that downgrades drive the marketplace as some popular personalities as my former icon Warren Buffett recently asserted[4]

Financial markets create their own dynamics, but I don’t think we’re facing a double dip recession…Clearly what stock markets do have is an effect on confidence, and this selloff can create a lack of confidence.

Mr. Buffett has gotten the causality in reverse. Downgrades happen when market forces—popularly known as the bond vigilantes[5] or bond market investors protest current fiscal or monetary policies respond by selling bonds—has already been articulating them.

US CDS prices have steadily been creeping upwards[6], this has been indicative of marketplace’s perception of the festering credit conditions by the US. The problem isn’t that “selloff can create a lack of confidence”, but rather too much debt, which is the reason for the downgrade, has been fostering an atmosphere of heightened uncertainty.

Downgrades signify as a time lagged acknowledgement by social institutions of an extant underlying ailment being vented on the markets.

The fact is that 3 credit rating agencies have already downgraded the US[7].

Also downgrades as said above affect financial institutions more, not only because of higher costs of funds but also because of the compliance to capital adequacy regulations.

A fundamental picture of an ongoing market based downside rerating is the unraveling crisis in the Eurozone.

The escalating PIIGS crisis has been causing a panic on Spain and Italian bonds, whose interest yields have been spiking[8] and where European investors can be seen stampeding into Germany’s debt or the Swiss franc.

So how has Europe responded? In mechanical fashion, by inflationism.

Supposedly wrangling politicians/bureaucrats found a common cause or conciliatory ground to work on. The European Central Bank (ECB) commenced with its version of Quantitative Easing (asset purchases) initially buying Irish and Portuguese bonds[9], which the equity markets apparently ignored and continued to tumble.

The ECB now has promised to extend buying Italian and Spanish bonds, this coming week, in order to calm the markets[10].

The Swiss National Bank[11] has gotten into the act ahead of the ECB, by surprising the currency markets with an intervention allegedly meant to control a surging franc. I think that they were flooding liquidity for the benefit banks, with the currency as an excuse for such action.

The Swiss intervention, which has been estimated at CHF 30 billion ($39 billion) to CHF 80 billion[12], by expanding the monetary base, appears as having fallen short of achieving its declared currency goal (see right window). The franc trades at the levels where the SNB initiated the intervention. The result seems as $39 billion down the sink hole.

Japan has likewise followed the Central Bank money printing shindig by engaging in her own currency intervention, allegedly aimed at curbing the rise of the Yen. The Bank of Japan (BoJ) reportedly intervened with a record high amount in the range of $56.6 to $59.26 billion[13]

Total cumulative size of Japan’s QE has now reached 46 trillion yen[14] (US $627 billion)

Hence, the European debt crisis partly explains the recent global market crash.

And importantly the above dynamic demonstrates how central banks respond to a market distress or a mark down in credit standings.

As an aside, one would further note that since central banks of Japan, Eurozone and the Switzerland has now been funneling enormous liquidity into the system, all these funds will have to flow somewhere.

The same dynamics should be expected with the US, where a credit rerating would not only impair US government debt risk profile and the attendant higher costs of financing, but also debt of government sponsored agencies, municipal liabilities and corporate bonds who thrive on subsidies, guarantees, bailouts or other form of parasitical relationship to the US government.

Since many of these securities comprise asset holdings major financial institutions, a US downgrade also means downgrades for US banks, insurance companies and credit unions.

Martin Weiss of Weiss Ratings estimates that a staggering $6.3 trillion of securities constituting of government agency securities $2.2 trillion, $725 billion in municipal bonds and $2.9 trillion in corporate and foreign bonds are subject to immediate or future downgrades in the wake of a U.S. government debt downgrade[15]. This represents one-third of all the financial assets of all US financial institutions

So given the operating manual or basic procedure of central banks in treating downgrades, the S&P action essentially paves way for the next US Federal Reserve’s asset purchasing moves.

Thus, a downgrade on the US is essentially a downgrade on the US dollar.

[Funny how local investors continue to believe in the US dollar as safehaven, when the fundamental problem has been the US dollar!]

Current Environment Seems Ripe for QE 3.0

It’s been a long time theme for me in saying that part of the process to set up interventions has been through what central bankers call as the signaling channel[16].

The fundamental aim is to manipulate the public’s expectations in order to justify prospective policies, usually meant for inflation expectations management.

Over the May-June window, there had been extensive interventions in the commodity markets (raised credit restrictions sharply on various commodity markets, IEA’s release of strategic oil reserves[17] and the ban on OTC trades[18]) and in the debt and equity markets (via restrictions of short selling[19] and proscriptions on US asset sales by US residents through overseas markets[20]) which appears to have been designed as price controls.

This came amidst a spike in academic and research papers which tried to dissociate the Fed’s previous QEs with surges in commodity prices.

The process of interventions as I previously wrote[21],

First is to apply the necessary interventions on the market to create a scenario that would justify further interventions.

Second is to produce papers to help convince the public of the necessity of interventions.

Then lastly, when the 'dire' scenario happens, apply the next intervention tools.

As one can see, signaling channel has also been used to in the political context.

Similar to last week’s haggling for the US debt ceiling deal by two supposedly ‘opposing’ political parties, negotiations appears to have been leveraged or anchored on an Armageddon scenario from a debt default, if a deal had not been reached at the nick of time.

Channeling Mencken’s hobgoblins, fear had essentially been used as lever to reach an 11^th hour deal which means ramming down the throats of the Americans. The debt ceiling bill was predicated on what I called as legal skulduggery or prestidigitation[22] as government spending cuts were all based on promises (baseline projections rather than actual cuts)

Now that the debt ceiling bill has been passed, such jawboning appears to have morphed into a self-fulfilling prophesy. Markets went into a spasm.

This brings us to the core of what I think has been the epicenter of last week’s crisis.

The US equity market, represented by the S&P has been mostly buttressed by the money printing by the US Federal Reserve as shown from the chart from Casey Research[23].

One would note that in the above chart, an almost comparable decline occurred during the five month window since the Fed completed its QE 1.0 on March 2010.

The timeline for QE 1.0 is officially from March 2009 to March 2010, and QE 2.0 from November 2010 to June 2011.[24]

The difference between the actions of the US equities in post-QE 1.0 and post-QE 2.0 has been one of scale and speed.

Global equities functioned in the same manner too.

The closure of QE 1.0 (blue horizontal lines) saw an across the board decline and consolidation phase by global equity markets represented by world (FTSE All World FAW), Europe (STOX50), Asia (P1DOW) and Emerging Markets (EEM)—all marked by red ellipses. These had been reversed once the QE 2.0 was announced and implemented.

Importantly, during that post-QE 1.0 lull window (QE 1.0 blue horizontal lines; QE 2.0 green horizontal line) marked again by the red ellipses, the US dollar surged (USD), gold consolidated, US treasury yields (TNX) had been on a decline while commodities (CCI) likewise had been rangebound.

Today, post-QE 2.0, we see some important difference and similarities. Similar to the post-QE 1.0 environment, global-US equity markets have been under selling pressure as US treasury yields have been on a decline along with the commodity markets.

The difference is that the US dollar remains WEAK and has NOT generally functioned as the previous shock absorber during market stresses or during the post-QE 1.0.

Importantly gold continues to surge!

My point is: this episode of market turbulence seems like a contraption to the next asset purchasing measures by the US Federal Reserve or QE 3.0 (or in whatever name the Fed wishes to call it).

In other words, like the debt ceiling deal of last week, a crisis scenario has been put in place meant to justify the next round of interventions. And this reminds me of the shocking and revolting comment by Emmanuel Rahm, US President Obama’s former chief of staff which seem to resonate strongly today[25],

You never let a serious crisis go to waste. And what I mean by that it's an opportunity to do things you think you could not do before.

With the US debt ceiling bill in place, the unraveling debt crisis in the Eurozone, an “alleged” risk of a sharp world economic growth slowdown or recession (I say alleged because I am not a believer), global equity market in turmoil, plus coordinated interventions by the central banks of Swiss, Japan and the ECB, pieces of the puzzles have been falling into place, as I have previously argued[26], which seem to pave way for Ben Bernanke and the US Federal Reserve to reengage in the next asset purchasing program.

And coincidentally the US Federal Reserve’s FOMC (Federal Open Market Committee) has been slated to meet on August 9^th Tuesday (Wednesday Philippine Time)[27]. And given the current turn of events, we should expect announcements that should reinforce a stronger policy response.

Public Choice and Possible Incentives Guiding Team Ben Bernanke

It’s fundamentally nonsensical to say that team Bernanke won’t engage in QE simply because of the futility or of the inefficacies of the previous QEs programs.

People who say this either fictionalize the role of individuals working for the governments or naively think that political operators operate on the basis of collective interests.

Public choice theory tells us that bureaucrats, like Ben Berrnanke, are equally self interested individuals. This means that since they are not driven by the incentives of profit and losses, the guiding principles of their actions are usually based on the need to preserve or expand their political careers (tenureship) by serving their political masters or by making populists decisions.

Besides, who would like to see a market crash with them on the helm, and not be seen as “doing something”? Today’s politics, embodied by the Emmanuel Rahm doctrine has mostly been about the need to be seen “doing something” even if such actions entail having adverse long term consequences. Actions by the ECB, SNB and BoJ have all revealed and exemplified such tendencies. Even the debt ceiling bill was forged from the need to do something to avert an Armageddon charade.

Moreover, political operators are also most likely to desire acquiring prestige and social clout by virtue of having expanded political control over the economy under the guise of social weal. That’s why more and more regulations are being imposed on the belief that a command and control economy would be more effective than one of free markets. Never mind the experience of Mao’s China and the USSR. Socialist champion billionaire and philanthropist George Soros got a taste of his own medicine when the Dodd Frank law compelled him to close his 40-year hedge fund[28].

Public choice also tells us that the political operators have beholden to vested interest groups such as the banking sector. The US Federal Reserve has thrown tens of trillions of dollars to save both US[29] and foreign[30] based banks. This accounts for as demonstrated preference or deciphering priorities from action over words.

Moreover, since their careers have been erected on the incumbent institutions, why should they enforce radical reforms that would only jeopardize their career or the institution’s existence, whom their allegiance have been impliedly sworn to?

To add, some policymakers operate on the ideological principles such as the theory of wealth effect, where increases in spending that accompanies an increase in perceived wealth[31]. From such pedagogical belief emanates the trend of ‘demand management’ based policy actions.

Take for instance, Ben Bernanke’s chief dogma “Crash course for central bankers” which he wrote as a Princeton Professor[32].

There’s no denying that a collapse in stock prices today would pose serious macroeconomic challenges for the United States. Consumer spending would slow, and the U.S. economy would become less of a magnet for foreign investors. Economic growth, which in any case has recently been at unsustainable levels, would decline somewhat. History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.

Today, most of the central bankers seem to adhere to such principles.

So even if previous QEs didn’t work as planned, what will stop Mr. Bernanke from pursuing the same policies and expecting different results? All he has to do is to assume the academic stance of saying the past policies didn’t work because they have not been enough.

So while I don’t know what’s going on in Team Bernanke’s mind, personal incentives, path dependency and dogmatism all point to QE 3.0 pretty soon.

Political Actions over Economic Data and Technical Picture

Lastly the US economic picture can be seen positively or negatively depending on one’s bias, but in my view, I hardly see the imminence of recession.

In the US, ISM Manufacturing index[33] has fallen steeply but this has not yet gone beyond the 50 threshold which could be an indicator of a recession. Offsetting this view is that recession probability from the yield curve has been very low[34].

Of course looking at economic figures are based on the past (ex post) activities. Since today’s markets have been driven by political actions such as QEs, then past data wouldn’t weigh so much compared to the anticipatory (ex ante) policy directives by central bankers.

Yet the problem with today’s conventional mindset has been that of the chronic addiction to rising prices of anything, be it economic data or asset prices. Anything that falls translates to the necessity or call to action for government intervention.

So false signals can be used as basis to demand political actions.

Nevertheless I also think that technical factors did play a secondary role in last week’s US market crash.

The S&P has been on a bearish head and shoulder pattern.

Given the current market milieu, technically based market participants jumped into the bearish momentum from which this pattern became another self-fulfilled reality.

The pattern basically aggravated the current environment rather than having caused it.

Bottom line:

If the US Federal announces a major policy stimulus anytime soon, then this should be seen as a strong signal to buy both commodities or on ASEAN equity markets and the Phisix.

Otherwise, we should expect more downside market volatility and probably take some money off the table.

Again, profit from political folly.

---

[1] See NO Such Thing as Risk Free: S&P Downgrades US August 6, 2011

[2] Telegraph.co.uk Debt crisis: as it happened, August 5, 2011

[3] See Today’s Market Slump Has NOT Been About US Downgrades, August 3, 2011

[4] Bloomberg.com S&P Erred in Cutting U.S. Rating: Buffett, August 7, 2011

[5] Wikipedia.org Bond Vigilante

[6] See Graphic: US Default Risk—Short and Long Term, August 2, 2011

[7] See How the US Debt Ceiling Crisis Affects Global Financial Markets, July 31, 2011

[8] Danske Bank Mr. Trichet will ECB buy Italy? ECB Preview August 4, 2011

[9] See ECB Intervenes in Bond Markets, More to Follow, August 5, 2011

[10] See ECB Expands QE: Will Buy Italian and Spanish Bonds, August 6, 2011

[11] See Hot: Swiss National Bank Intervenes to Halt a Surging Franc August 3, 2011

[12] Marketwatch.com Swiss central bank battles to halt franc’s rise August 3, 2011

[13] CNBC.com Japan Sells Record $58 Billion in FX Intervention, August 5, 2011

[14] Danske Bank Japan: BoJ tries to draw a line in the sand, August 4, 2011

[15] Weiss Martin, Day of Reckoning! TOMORROW!, August 1, 2011, Moneyandmarkets.com

[16] See War on Precious Metals: The Rationalization Process For QE 3.0, May 7, 2011

[17] See War on Commodities: IEA Intervenes by Releasing Oil Reserves, June 24, 2011

[18] See War on Gold and Commodities: Ban of OTC Trades and ‘Conflict Gold’, June 18, 2011

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

[20] See US Government’s War on US Expats and American Investments Overseas, June 21, 2011

[21] See War on Precious Metals Continues: Silver Margins Raised 5 times in 2 weeks!, May 5, 2011

[22] See Debt Ceiling Bill: Where are the Spending Cuts?, August 2, 2011

[23] Casey Research Too Much of a Good Thing

[24] Ricketts Lowell R. Quantitative Easing Explained Liber 8 Federal Reserve Bank of St. Louis, April 2011

[25] Wall Street Journal In Crisis, Opportunity for Obama, November 21, 2008

[26] See Poker Bluff: No Quantitative Easing 3.0?, June 5, 2011

[27] Mam.Econoday.com FOMC Meeting Announcement 2011 Economic Calendar

[28] See George Soros on Closing Hedge Fund: Do As I Say, Not What I Do, July 27, 2011

[29] See US Taxpayers Could Be On The Hook For $23.7 Trillion!, July 21, 2009

[30] See Fed Audit Reveals US Federal Reserves’ $16 Trillion Bailouts of Foreign Banks, July 26, 2011

[31] Wikipedia.org Wealth effect

[32] See The US Stock Markets As Target of US Federal Reserve Policies, May 11, 2011

[33] Harding Jeff, Destruction of Capital Resulting in Global Manufacturing Slowdown, Minyanville.com August 2, 2011

[34] Moneyshow.com A Red Flag for Emerging Markets... and the US, Minyanville.com August 4, 2011

ECB Intervenes in Bond Markets, More to Follow

Following the global market route, a reportedly reluctant ECB has started intervening in Europe's bond markets.

From Bloomberg,

European Central Bank President Jean- Claude Trichet may be forced to step up his fight against the sovereign debt crisis after a resumption of bond purchases yesterday failed to halt a rout in Italy and Spain.

Over opposition from Germany’s Bundesbank, Trichet yesterday sent the ECB back into bond markets as yields on Italian and Spanish yields soared, threatening the ability of the euro region’s third- and fourth-largest economies to borrow. As the sell-off continued, traders said the ECB purchased only Irish and Portuguese securities, suggesting the central bank is reluctant to put up the funds needed to tame a crisis it says governments are responsible for fixing.

“The ECB is being dragged unwillingly back to the table, having tried originally to palm off responsibility for restructuring the euro zone to governments,” said Peter Dixon, an economist at Commerzbank AG in London. “If the ECB is serious about playing its part in holding the euro zone together, then it’s going to have to spend a considerable sum.”

The ECB, which ceased buying bonds four months ago, was forced back into action after governments failed to convince investors that a package of new measures agreed to last month will prevent the crisis from spreading. The ECB may be hesitant to intervene in Italian and Spanish markets, which according to Bloomberg data have a combined 2.2 trillion euros ($3.1 trillion) worth of outstanding bonds, for fear of starting an engagement it can’t get out of.

As expected, once the distress on the marketplace becomes pronounced, global central banks will set aside political squabbling to give way for more inflationism. [All these meant to save the cartelized global banking system]

Yet if this episode of bloodbath continues, expect the ECB to expand its purchases to include Italian and Spanish bonds. That’s the ECB’s version of QE (asset purchases from money printing) now at work.

So you have 3 major central banks intervening in the financial marketplace over the past 48 hours, the Swiss, Japan (yesterday’s record 4 trillion yen or US $50.6 billion at the forex market) and now the ECB.

Global central bankers appear to be synchronizing their efforts at an escalating scale. Expect even more.

Today’s Market Slump Has NOT Been About US Downgrades

As of this writing the Phisix is down by over 1% and has followed Asia and ASEAN region and global equity markets in deep red.

Chart from technistock

Concerns have been raised that falling global equity markets have been about the risks of US downgrades.

I don’t think so.

One, the passage of the US debt bill temporarily eased US default risks as measured by CDS. That risk has not gone away but will accrue overtime (years).

Two, US credit rating agencies Fitch and Moody’s has affirmed the US credit standings, but has warned of future downgrades if deficits will not be reduced.

Three, the US yield curve has not exhibited signs of US downgrade risks but of fear of recession

Fear of downgrade implies HIGHER interest rates. US interest rates have been tumbling across the curve.

Fourth, if there is an example of the effects of downgrade risks then we should look at Europe

Chart from Bespoke invest.

This is an example of how a downgrade would look like. CDS of France and Italy have spiked.

This means that while everyone’s attention is in the US, they may be missing out that today’s market’s volatility could be a dynamic emanating from Europe

Europe's tanking equity markets (STOX50e, CAC, DAX) appears to have led the US (SPX) and not the other way around.

Lastly, while one day doesn't a trend make, these are seemingly strong signs where when faced with fear from another recession-crisis, the decoupling dynamic vanishes.

Interactive Graph of the European Crisis

Here is a nice interactive chart from the Economist partially depicting the region's strain from the current PIIGS crisis


For a better view and for the complete article please proceed to the Economist page here

I Told You So Moment: The Phisix At Milestone Highs

First they ignore you, then they laugh at you, then they fight you, then you win- Mahatma Gandhi

It’s not that we didn’t see this coming, the Philippine Phisix closed this week at a milestone record nominal HIGH at 4,458.

For me, this signifies another “I told you so” moment, as cynics both from the mainstream economics and the mechanical charting camp have mistakenly stated that this won’t be happening soon.

Epic Breakout on a Divergent Marketplace

Yet such monumental breakout came amidst a wobbly and seemingly discordant global equity market.

It’s not that this epic moment has been isolated or represents a unique trait seen exclusively to the Phisix only, but rather, the ASEAN majors have been one of the best performing equity markets of late. In short, as I have repeatedly been pointing out, this has been a regional dynamic.

By our latest reckoning, the Philippines along with Indonesia, Malaysia and Thailand have been in the top 20[1] among the 78 bourses worldwide.

The abbreviated price actions of the FTSE ASEAN 40 (ASEA) Exchange Traded Fund [ETF], which is a newly constructed bellwether, exhibit this new height.

This has happened as most of Asia seems on the upside, as represented by the Dow Jones Asia Pacific index (P1DOW). Meanwhile, the US S&P 500 (SPX) seems edgy, but still has been manifesting upward inclinations.

Only the European benchmark (stoxx 50) appears to be the odd man out, considering the festering debt crisis which seems to be spreading to the PIIGS.

And nowhere has this seeming exceptional deviation by the ASEAN majors imply of “decoupling”.

As the charts above from CLSA/Businessinsider indicate[2], over the past two decades returns of Asian bourses have been converging.

This gives credence to my repeated assertions[3] that in the world of globalization, the correlation of global equity markets have been tightening.

Yet to view performance digressions as “decoupling” risks false and misleading interpretations of events that may result to wrong prognosis, overconfidence and consequent errant actions that could lead to monetary and psychic losses.

One would further note that divergent actions occur mostly during crisis or recessions, as in the Asian crisis of 1997, the dot.com bust in 2000 and the US mortgage bubble crash of 2008. However, the boom phase of a bubble cycle tends to show signs of re-convergence.

Not every of the market signals I earlier alluded to[4] participated in the confirmation of the local boom. Europe’s ongoing crisis has partly taken some steam off from the global equity market re-convergence.

If there is any lesson from the above, it is that the local and ASEAN boom would likely become stronger if global equity markets would act in consonance. Oppositely, a further widening of divergences would put to doubt the string of current advances.

Gold-Phisix Correlation Redux

There is another noteworthy development that needs to be emphasized, as the Phisix and ASEAN bourses have reached record territories, so has gold prices.

As I previously wrote about how gold’s price actions seem to lead the Phisix[5],

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.

Again correlation does not represent causation. Yet the degree of correlation may vary according the causal relationship dynamics that underpins these markets.

In my view, I see this relationship anchored on the unfolding (Austrian) business cycle or bubble cycle fueled by monetary policies.

And the political process in fostering such boom phase of this bubble cycle has clearly been at work.

In the US, Federal Reserve chairman Ben Bernanke recently placed the QE 3.0 option on the table[6] partially confirming my forecasts[7].

Although Mr. Bernanke partly backtracked[8] from his earlier stance by stating that while QE 3.0 is in the cards it will not be used soon.

I see this as part of the mind conditioning-communication tactical tools used by the central bankers (or the signaling channel) to influence market expectations (aside from indirect market interventions).

The important point is that the Fed seems to be projecting the idea of renewed access to QE which is a sign of imminence. The question isn’t about an IF, but rather a WHEN.

And the commodity markets seem to have been affirming such expectations. Even the perennial laggard Natural Gas (NATGAS) appear to be on the rise. Silver, oil (WTIC) and the CRB Reuters (CCI) have been on climbing higher, despite the string of recent interventions.

Of course I don’t think Mr. Ben Bernanke would automatically employ QE or its variant, that’s because QE is a political tool designed at attaining political ends.

QE 3.0 will likely be tied to the congressional vote on the US debt ceiling, the deadline[9] of which is on August 2^nd is fast approaching.

The political pressure to raise the debt ceiling continues to intensify as major credit rating agencies as the S&P and Moody’s has warned of a possible downgrade[10] if a deal won’t be reached.

Higher prices of Credit Default Swaps (CDS)—an insurance against default risks—on US sovereign debt (see left window below[11]) has been attributed to the recent political impasse.

Although in perspective, the rising prices of US CDS can be seen amidst a backdrop of general concerns over credit risks for most of the world[12] (including the Philippines which is two notches below the US), but especially for many European countries over a one month frame. In short, politicking may have led to the misplaced focusing effect for many politically blinded observers.

The above reveals that the causation link of higher US CDS prices and political stalemate over the debt ceiling seems unclear.

The other major factor that could prompt Ben Bernanke to reactivate QE 3.0 soon is if the debt crisis in the Eurozone escalates to the point of putting US banks at risk. As pointed out in the past[13], QE 2.0 has reportedly benefited foreign banks or had been used as an indirect channel to conduct bailouts of Eurozone banks through the Eurodollar market.

I wouldn’t know which of these events would prompt Mr. Bernanke to trigger the next version of QE, but one thing is certain, given the trillions of bailouts thrown to US banks (demonstrated preference or actions as proof of the order of priorities), combined with ideological or doctrinal leanings and path dependency, plus reluctance to adapt fiscal discipline as the necessary path for reform, all these point towards the QE option to secure or safeguard the tripartite government-banking system-central bank political structure.

All these imply that monetary accommodation will prevail over marketplace for a longer period of time which should support the current risk environment.

And given that the global transmission of credit easing (QE) policies and artificially suppressed interest rates everywhere would have different impacts on different asset classes, the gold-phisix correlations, unless the latter would be influenced more by domestic factors, will likely be sustained.

Market Breadth and Internals Point to Further Strength

Since financial markets are driven by psychology, underpinned by the above forces, people’s outlook can be measured from actions being undertaken from different financial market indicators.

The milestone breakout by the Phisix has been bolstered by the broader market.

Market breadth has been broadly positive as all sectors posted gains (left window).

Again the Philippine composite has been elevated by mostly the mining sector followed by the financial sector, particularly led by Metrobank [PSE: MBT].

Advance decline spread (weekly basis) has likewise turned significantly positive (right window).

Market internals have also demonstrated broad bullishness.

Average daily trades (weekly basis) and daily number of issues traded (weekly basis) has dramatically improved.

While no trend goes in a straight line, such congruent positive actions are likely signs of continuity. Importantly, such trends could reaccelerate.

Philippine Peso Driven by Portfolio Investments

This week the Philippine Peso has partially departed from its tight correlation with the Phisix.

The monumental advance of the Phisix saw the Peso soften instead. The Peso seems to reflect more on the region’s actions than to confirm the Phisix’s vigorous advances. Or maybe currency intervention by the local central bank could also be a factor.

Although one week does not a trend make, I think that the Peso should eventually make more confirmations of the actions of the Phisix and vice versa.

As I keep saying[14],

this has been premised mostly on the favorable relative demand for Peso assets, aside from the lesser inflationary path by the Peso based on the supply side.

There is no proof stronger than this.

The chart above from the World Bank[15] and yahoo finance shows that Philippine Peso has hardly been driven by remittances, which has been peddled by the mainstream, but by virtue of correlations based causal logic the net capital flows (manifested mostly by portfolio investments).

For as long as the net capital flows (again mostly by portfolio investments) continue to expand, some of which will be evidenced in the actions of the Philippine Stock Exchange, we should then expect that this would be reflected on a rising Peso.

Bottom line: Again momentum, via various market signals, favors the confirmation of this week’s epic breakout.

We should see the Phisix at 4,900-5,000 by the yearend barring any exogenous shocks.

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[1] See How Global Equity Markets have Measured Up to the PIIGS Crisis, July 13, 2011

[2] Weisenthal, Joe This Is What Global Market Correlation Looks Like, Businessinsider.com, July 11, 2011

[3] See ASEAN’s Equity Divergence, Foreign Fund Flows and Politically Driven Markets, June 5, 2011

[4] See I Just Can’t Get Enough: Philippine Phisix Emits Intensely Bullish Signals, July 3, 2011

[5] See How External Forces Influence Activities of the Phisix, May 29, 2011

[6] See Ben Bernanke Hints at QE 3.0 June 13, 2011

[7] See Poker Bluff: No Quantitative Easing 3.0?, June 5, 2011

[8] See Ben Bernanke on QE 3.0: Not Now, But An Open Option, July 15, 2011

[9] Reuters.com Obama, lawmakers press ahead for elusive debt deal, July 16, 2011

[10] Bloomberg.com Moody’s Downgrade Warning Adds Pressure on U.S. Debt Deal, July 14, 2011

[11] Zero Hedge, US Default Risk Jumps To Highest Since February 2010 On Debt Ceiling Worries, July 14, 2011

[12] Bespoke Invest, Changes in Sovereign Debt Default Risk Over the Last Month, July 16, 2011

[13] See Political Interventions has Led to the Widening of Divergences in Global Asset Markets, June 26, 2011

[14] See I Just Can’t Get Enough: Philippine Phisix Emits Intensely Bullish Signals, July 3, 2011

[15] Worldbank.org, Generating More Inclusive Growth, Philippine Quarterly Update June 2011