Has the Phisix has Gone Ballistic?!

14.66% in 8 straight weeks of unwavering ascent has truly been spectacular!!

Whether parabolic or vertical, the Phisix seems to have gone ballistic.

February has already racked up 6.8% with this week’s 2.2% gains. Yet there are still four trading days to go.

As I said last week, should 7% return per month persist, then the Phisix 10,000 will be reached within the second semester of this year.

Again I am NOT saying it will, but we cannot discount the likelihood of such event, considering what appears to be the deepening of the manic phase in the Philippine Stock Exchange. 

Signs of Mania: Friday’s Marking the Close

I highlighted this week’s actions (via red ellipse) because of what appears to be a botched attempt by the Phisix to correct.

In what appears to be a sympathy move with US markets which closed lower Thursday, on Friday, the Phisix has been down through most of the session, by about 1.5% (chart from technistock). That’s until the last few minutes before the closing bell window, where the losses had precipitately been wiped out to close the day almost unchanged (or a fraction lower)

Whether what seems as “marking the close” has been another attempt “manipulate” the Phisix for whatever ends (I would suggest political), or that bulls have taken the opportunity to conduct a massive counterstrike against the bears, such refusal to allow for a normal profit taking mode simply has been an expression of the intensifying du jour bullish frenzy.

Net foreign activity posted marginal selling last Friday (Php 36 million). Index heavyweights exhibited mixed performance in terms of foreign activity, which may suggest that local buying could have been mostly responsible for the last minute rebound.

To boost the Phisix means to bid up major blue chip issues. This requires heavy Peso firepower that can emanate mostly from institutions rather than from retail participants, regardless of nationality, whether foreign or local.

The scale of actions from Friday reflects on either hugely expanded risk appetite or the increasing symptoms of desperation to chase momentum from so-called professional money managers, or that parties responsible for Friday’s action could have been conducted by largely price insensitive taxpayer financed institutions.

Yet given the current election season and perhaps the desire to generate upgrades in the nation’s credit rating in order to justify political spending binges, one cannot discount on the potential influences played by public institutions in the stoking of today’s frenetic markets.

To elaborate, marking the close is the practice of buying a security at the very end of the trading day at a significantly higher price[1] is considered illegal by Philippine statutes[2]. Although personally speaking, I consider insider trading[3] and related rules and regulations as arbitrary, repressive, unequal and immoral form of laws.

For instance, the legality or illegality of what appears as “marking the close” could depend on the identity or of the class of executor/s. If public institutions may have been involved, then I doubt if such regulations will apply or will be enforced. Such rules get activated only when there has been a public outcry or when authorities want to be seen as doing something or when used for assorted political goals.

Either way, yield chasing or politically motivated actions to artificially prop markets arrive at a similar conclusion: a policy induced mania.

Mounting Publicity Hysteria

Of course, the manic phases are essentially reinforced through public’s psychology. The public has been made to believe that prices represent reality which tells of the perpetual extension of such boom. Such resonates on the mentality that “this time is different”: the four most dangerous words of investing, according to the late legendary investor John Templeton

Hysteria about the boom phase has been building up.

Proof?

This Bloomberg article entitled “Philippines Trounces Global Stocks in Aquino-Led Rally[4]”, even sees the current rally as “structural”.

I wonder how valid will the “structural” foundations of this bull market be when faced with significantly higher interest rates.

Nevertheless it is a fact that the Philippines have “trounced” the world in terms of returns.

In my radar screen of the equity benchmarks of 83 nations, on a year-to-date basis Venezuela’s Caracas Index has been on the top of the list, with an astronomical 31% nominal currency gains which essentially compounds on 2012’s stratospheric 302%.

Yet as I have repeatedly been pointing out[5], what seem as rip-roaring stock market gains are in fact an illusion.

Venezuela has most likely been suffering from seminal stages of hyperinflation, where the stock market becomes a shock absorber or a lightning rod of a massively devalued or inflated currency. Venezuela’s recent official devaluation by 32% has only triggered a steeper fall in the unofficial rate of her currency, the bolivar.

The official rate has been recently readjusted to 6.3 bolivar per US dollar, but the black market for the bolivar trading has been trading at around 22 per US dollar[6] from 19 less than two weeks back[7]. As typical symptom of hyperinflationary episodes, Venezuela has been suffering from widespread shortages of goods.

Venezuela’s skyrocketing stock market from hyperinflation has been reminiscent of Zimbabwe in 2008. In 2008, as the world plumbed to the nadir as consequence to the contagion effects from the US housing bubble bust, Zimbabwe became the top performer, nominally speaking.

Yet Kyle Bass, a prominent hedge manager, captures the zeitgeist of such a boom[8] (italics added)

One of the best performing equity markets in the last decade has been Zimbabwe. But now your entire equity portfolio only buys you three eggs.

Yes, thousands of percent in returns buys you three eggs.

This shows how stock markets, as surrogate or as representative of real assets, serve as refuge to monetary inflation. This has been especially elaborate at the extremes—hyperinflation.

This also implies that monetary inflation, which has been neglected by the mainstream, plays a very important role in establishing price levels of the equity markets.

Outside Venezuela, the rest of the top ranked equity bellwethers have been far beyond their respective nominal record highs. This makes the local equity bellwether, the Phisix, the likely global crown holder or the current world champion. The Manny Pacquiao of international stock markets. The $64 trillion question is its sustainability.

From Friday’s close, the Phisix has been up 256% since the last trading day of 2008. This translates to around 35% CAGR.

Even among the top ASEAN peers, from a 5-year perspective or from a starting point in mid-2008 from the Bloomberg chart, the Phisix [PCOMP: red orange] has outclassed by a widening margin, Thailand [SET: Green], Indonesia [JCI: orange] and Malaysia [FBMKLCI: red].

So the feedback loop between prices and media cheerleading entrenches the public’s belief and conviction of the flawed views of realty. Such perceptions translate to actions: more debt.

Bubble Mentality Leads to Bubble Actions

As I have pointed out last week, manias signify as the stage of the bubble cycle where the yield chasing phenomenon has become the prevailing bias. Manias are essentially underpinned by voguish themes unquestioningly embraced by the public and most importantly enabled, facilitated and financed by credit expansion.

I pointed out how the booming stock markets have reflected on the growing imbalances in the real economy of the Philippines

The stock market boom has similarly been reinforced by the expansion of credit at exactly where such imbalances have been progressing: property-finance-trade, or simply, the property-shopping mall-stock market bubble.

Such extraordinary growth in credit may have already percolated into the domestic money supply 

The monetary aggregate, M3 or as per BSP definition[9], constitutes currency in circulation, peso demand deposits, peso savings and time deposits plus peso deposit substitutes, such as promissory notes and commercial papers, has jumped by 16.22% in 2012. From 2008 CAGR for M3 has been at 11.51%.

On the other hand, M0 or narrow money or as per tradingeconomics.com[10], the most liquid measure of the money supply including coins and notes in circulation and other assets that are easily convertible into cash, spiked by 24% in 2012, which on a 5 year basis grew by 13.2% CAGR.

Although there have been many intermittent instances of peculiar outgrowth, such outsized move appears to be the largest.

Moreover, it remains to be seen if this has been an anomaly.

If this has indeed been an aberration, then this implies that the coming figures should show a decline which should revert M3 and M0 back to the trend line. If not, recent breakout may establish an acceleration Philippine monetary aggregate trend line: an affirmation of the classic bubble.

Considering that both the private sector, lubricated by expansionary credit, and the domestic government, whom will undertaking $17 billion of public works spending, will be competing for the use of resources, we should expect that pressures to build on either relative input prices (wages, rents, and producers prices), particularly on resources used by capital intensive industries experiencing a boom, and or, but not necessarily price inflation.

Such dynamics would exert an upside pressure on interest rates that would eventually put marginal projects, including margin debts on financial assets operating on leverage, on financial strains which lay seeds to the upcoming bust.

Yet the idea that price inflation is a necessary outcome of an inflationary boom has been misplaced.

In the modern economy, many things such as productivity growth, e.g. informal economies and or technological innovation) or today’s financial quirks, e.g. as excess banking reserves held at the central banks, such as the US Federal Reserve, can serve to neutralize its effects.

As the great dean of Austrian school of economics Murray N. Rothard wrote[11],

Similarly, the designation of the 1920s as a period of inflationary boom may trouble those who think of inflation as a rise in prices. Prices generally remained stable and even fell slightly over the period. But we must realize that two great forces were at work on prices during the 1920s—the monetary inflation which propelled prices upward and the increase in productivity which lowered costs and prices. In a purely free-market society, increasing productivity will increase the supply of goods and lower costs and prices, spreading the fruits of a higher standard of living to all consumers. But this tendency was offset by the monetary inflation which served to stabilize prices. Such stabilization was and is a goal desired by many, but it (a) prevented the fruits of a higher standard of living from being diffused as widely as it would have been in a free market; and (b) generated the boom and depression of the business cycle. For a hallmark of the inflationary boom is that prices are higher than they would have been in a free and unhampered market. Once again, statistics cannot discover the causal process at work.

Nonetheless, while price inflation may not be the necessary and sufficient factor for upending a boom, the lack of its presence does not prevent business cycles from occurring.

Moreover, the yield chasing boom will likely spur greater demand for credit that will similarly put pressure on interest rates.

In addition, competition for resources by both the government and the private sector will likely increase demand for imports that subsequently leads to wider trade deficits. Eventually bigger trade deficits may impact the current account that could put pressure on foreign exchange reserves.

And as noted last December[12],

And since the prolonging of the domestic boom requires foreign capital or that trade deficits would need to be offset by capital accounts or increasing foreign claims on local assets, either the BSP loosens up or keeps an eye closed on foreign money flows. Most of which will likely come from hot money inflows seeking refuge from inflationism and financial repression.

By then the Philippines could be vulnerable to “sudden stops” which may arise from a domestic or regional if not from a global event risks.

And as pointed out last week, today’s global pandemic of bubbles will most likely alter the character of the next crisis.

Instead of many nations offsetting bursting bubbles of some nations, the coming crisis would translate to a domino effect.

Wherever the source or origins of the crisis, the leash effect means cascading bubble implosions over many parts of the world. The escalation of bubble busts would prompt domestic political authorities to intuitively embark on domestic bailouts and fiscal expansions (or the so-called automatic stabilizers), and for central bankers to aggressively engage in monetary easing for domestic reasons—or a genuine “currency war”.

In contrast to what seems as phony “currency wars”, real currency wars have had broad based carryover effects from expansionist political controls. This usually includes price and wage controls, capital and currency controls, social mobility and border controls, trade controls or protectionism and other financial repression measures[13] (e.g. taxes, regulations on banks, nationalizations, caps on interest rates, deposits and etc…).

How inflationism leads to forex controls and the spate of other political controls, the great Ludwig von Mises explained[14]

But the government is resolved not to tolerate any rise in foreign exchange rates (in terms of the inflated domestic currency). Relying upon its magistrates and constables, it prohibits any dealings in foreign exchange on terms different from the ordained maximum price.

As the government and its satellites see it, the rise in foreign exchange rates was caused by an unfavorable balance of payments and by the purchases of speculators. In order to remove the evil, the government resorts to measures restricting the demand for foreign exchange. Only those people should henceforth have the right to buy foreign exchange who need it for transactions of which the government approves. Commodities the importation of which is superfluous in the opinion of the government should no longer be imported. Payment of interest and principal on debts due to foreigners is prohibited. Citizens must no longer travel abroad. The government does not realize that such measures can never "improve" the balance of payments. If imports drop, exports drop concomitantly. The citizens who are prevented from buying foreign goods, from paying back foreign debts, and from traveling abroad, will not keep the amount of domestic money thus left to them in their cash holdings. They will increase their buying either of consumers' or of producers' goods and thus bring about a further tendency for domestic prices to rise. But the more prices rise, the more will exports be checked.

In short, one form of interventionism breeds other forms interventionism.

For now, the domestic yield chasing mania means an increasing pile up on winning trades.

And instead of the rotation to the mining sector as has been for the past years, the latter of which has been smacked by a double black eye from the Semirara landslide and from the recent blowup in metal prices, dampened appetite for the mines has shifted the public’s attention back to the last year’s biggest winners.

The trio: property, financial and banking and property weighted holding firms has reclaimed their leadership positions.

Thus the checklist for the manic phase of stock market bubble:

Deepening price or yield chasing dynamics √

Popular themes √

This time is Different mentality √

Expansionary credit √

Every Bubble is a Thumbprint

And it’s not just me.

One analyst from the S&P credit rating agency recently raised his concern over Asia’s growing appetite for debt where he says many Asia-Pacific countries have raised debt “well above the levels in the mid-2000s”, importantly, credit to GDP ratios of few nations has been “high relative to peers at similar income levels”

S&P KimEng Tan at an interview with Finance Asia further adds[15],

Real estate downturns may be less of a threat to financial institutions in the key economies than they were in the worst-hit developed economies. Nevertheless, credit losses can still increase rapidly if general economic conditions weaken materially. The top concern is that China’s growth could slow sharply before the developed economies recover sufficiently to contribute to maintaining moderate growth. The slowdown is likely to have a material negative effect on economic activities across the Asia-Pacific.

Although the seemingly disinclined Mr. Tan downplays the imminence of the risks of a crisis by making apple-to-orange comparison with debt levels in Europe.

Let me improve by saying that each nation have their own unique characteristics or idiosyncrasies, therefore it may not be helpful to make comparisons with other nations or region. Moreover, while many crises may seem similar, each has their individual distinctions.

For instance, one Bloomberg article I came about highlights the portentous troubles that lie ahead for Asia. The article[16] relates on the symptoms: South Korea’s household debt “rose to a record 959.4 trillion won last quarter”, and equally such debt has “reached 164 percent of disposable income in 2011, compared with 138 percent in the U.S. at the start of the housing crisis”.

South Korea’s domestic credit provided by the banking sector[17] (shown above), as well as, domestic credit to the private sector[18] as % of has reached over 100% GDP, although slightly below the recent peak.

China’s mounting debt problem and property bubble has also been daunting. Recent easing and government intervention via stealth spending programs[19] has prompted a recovery in housing prices. According to a Bloomberg report[20] (italics mine)

Average per-square-meter prices in 100 cities tracked by SouFun are five times average monthly disposable incomes.

In addition,

Home sales in China’s 10 biggest cities almost quadrupled to 8.5 million square meters in the first five weeks from last year, property data and consulting firm China Real Estate Information Corp. said in an e-mailed statement Feb. 19.

Either China and South Korea’s productivity growth has to catch up with the lofty levels of debt or that untenable debt dynamics will eventually lead to self-destruction whether triggered by an upsurge in interest rates or by weakening of the economic conditions or from a global contagion or simply unsustainable debt.

Interventions can only delay the day of reckoning but worsen the longer term entropic impact.

These are debt levels when “credit events” occurred via the Asian Crisis (left window) and of the other emerging market debt crisis (right window). Data from Harvard’s Carmen Reinhart as presented by Ricardo Cabral at the Voxeu.org[21]

First, there has been no definitive line in the sand for credit events. South Korea has for instance very low external debt when the crisis struck, although Argentina’s debt crises shared the same debt levels during 2 crises within 10 years.

Second, external debt may or may not function as an accurate gauge today. Many economies have resorted to amassing debts based on internal local currency units and from local currency bond markets which has been unorthodox relative to the past.

In addition, financial innovation may mean risks have spread to other potential channels as securitization and derivatives.

Nonetheless, external debts have indeed been swelling in Philippines, Thailand, Indonesia and even in South Korea with the exception of Malaysia.

The implication is that there are many potential sources of black swan events.

The Wile E Coyote Moment

Yet the current booming environment has been prompting policymakers of several economies to pull back on current easing programs. 

The Chinese government has recently withdrawn funds from the financial system. In addition, the Chinese government has recently ordered more property curbs[22]. Such perception of tightening has prompted for a 4.86% plunge in the Shanghai Index (SSEC) over the week, which reverberated throughout the commodity markets (see CRB line behind SSEC).

Prior to February, Chinese authorities were loosening up on the monetary spigot, then all of a sudden the change of sentiment. As one would note, this is an example of how markets has been held hostage to the actions of authorities.

Of course it is also important to point out that the European Central Bank (ECB) has been draining funds from the system since October of 2012 which has coincided with the peak in gold prices. February’s dramatic shrivelling to March lows of the ECB’s balance sheet has mirrored the collapse in gold prices[23].

And it’s not only the ECB.

Swiss banks have been required only this month to up their capital reserves by 1%.

And in the face of credit fueled property boom in Europe’s richer nations as Switzerland, Sweden and Norway, Sweden’s regulators have warned that they are ready to tighten more given the recognition of a brewing debt bubble. “Swedish households today are among the most indebted in Europe” the Bloomberg quotes a Swede official[24].

Meanwhile, Hong Kong’s government has doubled sales tax[25] on high end real estate worth HK$2 million and above, as well as, commercial properties in her attempt to suppress bubbles that has spread from apartments to parking spaces, shops and hotels

As one would note, wherever one looks there have been blowing bubbles: a global pandemic of bubbles

So contradicting policy directions can became a headwind and increased volatility for financial markets, including the Phisix. Although domestic dynamics are likely to dictate on momentum.

Nonetheless bubbles eventually peak out regardless of interventions.

Again in Hong Kong, prior to the sales tax hike, bankruptcy petitions has risen to 2 year highs[26]

Things operate or evolve on the margins. And so with puffing bubbles. Deflating bubbles always commences from the periphery that eventually moves into the core.

The US housing bubble cycle should serve as a noteworthy paradigm.

US home prices represented by the National Composite Home Price Index peaked (lower window blue line) at the close of 2005, as interest rates increased (red line). The Fed controlled Fed fund rate topped in 2007.

Notice that the mild descent of home prices in 2006 steepened or accelerated in 2007. The housing bear market fell into a trough only in 2011 and began showing signs of recovery in 2012.

Yet the US stock market (S&P 500 blue line top window) continued to ignore the developments in the housing markets in 2006-2007, as well as, the interest rate hikes. In fact, gains of the S&P seem to have accelerated when interest rates peaked. 

The stock market came to realize only of the flawed perception of reality when home prices affected the core, or when the banking and financial system began to implode. It was like cartoon character wile e coyote running off a cliff.

From hindsight, the divergence between housing and the stock market, the massive debt buildup on the housing, mortgage, banking and financial sectors, the denial by authorities of the existing problem, the transition of deflating bubbles from the periphery to the core and the public’s persistent yield or momentum chasing dynamics, all meets the criteria of a manic phase in motion.

But as I said last week, the next crisis may not be similar to the US housing crisis of 2008.

Then policymakers have been mostly reactive, today policymakers are pro-active, pre-emptive and considered as activists. The outcome isn’t likely to be the same.

Importantly, given that almost every nations have been serially blowing bubbles, a domino effect from a bubble bust would either mean the path to genuine reform (bankruptcies and liberalization) or more of the same troubles but in different templates (stagflation, protectionism, controls of varying strains and etc…). I am leaning onto the latter outcome, although I am hoping for the former.

Everything now depends on the Ping Pong feedback loop between markets and international policymakers.

Although from the lessons of US bubble, I believe that the Phisix in spite of several increases in interest rates may go higher.

Momentum will initially mask the traps that have been set, until of course, economic reality prevails; eventually. Or going back to wile e coyote analogy, wile e coyote will continue to chase after Road Runner to the cliff until he realizes that there is no more ground underneath.

Again bubbles signify a market process.

---

[1] USLegal.com Marking the Close Law & Legal Definition

[2] Republic of the Philippines Security Exchange Commission Chapter VII Prohibitions on Fraud, Manipulation and Insider Trading

[3] See In Defense of Insider Trading March 22, 2012

[4] Bloomberg.com Philippines Trounces Global Stocks in Aquino-Led Rally, February 19, 2013

[5] See Inflationary Boom Powers Phisix to Milestone Highs, November 26, 2012

[6] Wall Street Journal Ailing Chávez Returns to Caracas February 18, 2013

[7] See Venezuela Devalues Currency by a Third; Symptoms of Hyperinflation February 9, 2013

[8] Kyle Bass Why Inflation Could Eat Into Stock Gains: Kyle Bass Klye Bass Blog February 1, 2013

[9] Bangko Sentral ng Pilipinas Monetary Policy - Glossary and Abbreviations:

[10] Tradingeconomics.com PHILIPPINES MONEY SUPPLY M0

[11] Murray N. Rotbhard Part II The Inflationary Boom: 1921-1929 America’s Great Depression

[12] See E-Vat 15%: Possible Consequence from Current Quasi Boom Policies December 10 2012

[13] Wikipedia.org Financial repression

[14] Ludwig von Mises 6. Foreign Exchange Control and Bilateral Exchange Agreements XXXI. CURRENCY AND CREDIT MANIPULATION, Human Action Mises.org

[15] Finance Asia Growing risks to sovereign creditworthiness in Asia February 21, 2013

[16] Bloomberg.com S. Korea’s Poisoned Chalice of Household Debt Restricts Park February 21, 2013

[17] Tradingeconomics.com DOMESTIC CREDIT PROVIDED BY BANKING SECTOR (% OF GDP) IN SOUTH KOREA

[18] Tradingeconomics.com DOMESTIC CREDIT TO PRIVATE SECTOR (% OF GDP) IN SOUTH KOREA

[19] See Global Financial Markets Party on the Palm of Central Bankers January 21, 2013

[20] Bloomberg.com China Housing Slaves Helping Property Rebound: Mortgages February 20, 2012

[21] Ricardo Cabral The PIGS’ external debt problem, voxeu.org May 8, 2010

[22] Bloomberg.com China Orders More Cities to Restrict Housing Purchases February 21, 2013

[23] See Are Central Bankers Poker Bluffing the Gold Markets? February 22, 2013

[24] Bloomberg.com Debt Bubble Born of Easy Cash Prompts Swedish Rule Review February 18, 2013

[25] Bloomberg.com H.K. Doubles Stamp Duty on All Properties on Bubble Risks February 23, 2013

[26] Bloomberg.com Hong Kong’s Bankruptcy Requests Climb to Almost Two-Year High, February 15, 2013

Venezuela Devalues Currency by a Third; Symptoms of Hyperinflation

Venezuela’s stock market has been a favorite example of mine in projecting two things:

First, stock markets hardly represents what public sees as economic “growth” conditions but about the state of monetary disorder. This has been especially pronounced today as political interventions has been intensifying across the globe.

Two, how statistics have been patently incompatible with the real state of economic affairs.

From Bloomberg, (bold mine)

Venezuela devalued its currency for the fifth time in nine years, a move that may undermine support for ailing President Hugo Chavez and his allies ahead of possible elections later this year.

South America’s biggest oil producer may have to call elections if Chavez, who hasn’t been seen for two months after undergoing cancer surgery in Cuba, dies or steps down. He ordered his government to weaken the exchange rate by 32 percent to 6.3 bolivars per dollar starting Feb. 13, Finance Minister Jorge Giordani told reporters yesterday in Caracas.

A spending spree that almost tripled the fiscal deficit last year helped Chavez, 58, win a third six-year term. The devaluation can help narrow the budget deficit by increasing the amount of bolivars the government receives from oil exports. Yet the move also threatens to accelerate annual inflation that reached 22 percent in January.

So the Chavez led Venezuela’s government finally admits to what black markets have been exposing all along: The imminence of shortages of foreign currency (US dollar) and an insatiable and profligate government financed by money printing engineered to buy votes.

Importantly, the above dynamics has been leading to real and not statistical inflation.

Proof? More from the same article: (bold mine)

Annual inflation accelerated to 22.2 percent in January, the fastest pace in eight months, led by a jump in food prices. Prices climbed 3.3 percent in January after rising 3.5 percent in December.

In the unregulated market, the bolivar weakened 6 percent yesterday to 19.53 bolivars per dollar, according to Lechuga Verde, a website that tracks the rate. Venezuelans use the unregulated credit market because the central bank doesn’t supply enough dollars at the official rates to meet demand.

Notice that the estimated price inflation figures has been only 22% (mostly skewed because of price controls and possible manipulations) whereas even considering the recent 32% devaluation, black market rates are way way way distant from the official rates: 19.53 black market versus 6.3 official. Black market rates signify more than twice the official rates.

So black markets are simply saying that real inflation are substantially more than media and official pronouncements. Signs of which are likewise being manifested on the stock market.

Venezuela’s IBVC returned 300% in 2012 in nominal domestic currency terms. As of Friday’s close the index has been up 20% year to date (chart from tradingeconomics.com)

Venezuela’s IBVC’s parabolic moves reverberates with the Zimbabwe’s Industrial Index in 2007, which I earlier posted here. The Zimbabwe bellwether skyrocketed until the climax of her hyperinflation episode in 2008, where consumer prices doubled everyday!!!.

Despite the hallelujahs from the recent devaluation by mainstream experts, Venezuela seems as exhibiting symptoms of the transition towards hyperinflation.

Global Equity Market Performance Update: Philippine Phisix Ranks 6th among the Best

Of the 78 countries in the list of Bespoke Invests’ global equity benchmarks, the Philippine Phisix ranks 6^th among the best performers!

Chart from Bespoke Invest

Venezuela whose economy has been suffering from escalating inflation has taken the top spot…

Chart from Tradingeconomics.com

…but real returns appears to have been eroded by resurgent inflation

A brewing symptom of hyperinflation is when surging rates of inflation drives people into stock markets as with the Weimar or Zimbabwe experience.

chart from goldonomic,com

With only 10 nations posting positive returns (among the 78 or 12%) on a year-to-date basis, the US remains in the top 15 down by only 3% and has outperformed her peers. In contrast 25 nations (or 32%)mostly in the Eurozone are in bear market territory.

Aside from the outperformance of the Phisix, ASEAN bourses have been among the top 15.

Indonesia whose gains have been slightly below the Phisix has ranked 7^th whereas Thailand placed 10^th and Malaysia at 15^th.

I expect the rankings of ASEAN bourses to improve by the yearend.

Mainstream Denials And The Greenshoots of Inflation

``We're going to have a currency crisis, probably this fall or the fall of 2010. It's been building up for a long time. We've had a huge rally in the dollar, and artificial rally in the dollar, so it's time for a currency crisis.”-Jim Rogers Bloomberg

Nobel Laureate Dr. Paul Krugman recently wrote in his widely read column at the New York Times to dismiss of the risks of inflation. He suggested that what has been happening in the marketplace isn’t about inflation, but an attempt by the opposition to dislodge present policies,

``But it’s hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts.” (bold emphasis mine)

Dr. Krugman’s basis for debunking inflation has been 1) most recent data on consumer index and importantly 2) banks haven’t been lending enough since bank reserves remain bloated. Apparently, the popular economist believes that what happens today should be construed as tomorrow’s events.

Yet, Dr. Krugman’s prescription is for the Obama administration to continue with its inflationary path. In other words, the mainstream’s ideology has been epitomized by Dr. Krugman.

And this is the same ideology, which for us has been heightening the risks of intractable inflation, despite the supposed “omniscience” of the Nobel awardee.

As we argued last week in $200 Per Barrel Oil, Here We Come!, inflationary policies will largely cause a spike in oil prices in combination with oil’s structural fundamental imbalances.

Unfortunately Dr. Krugman, who believes in the almighty power of governments as solution to everything, has a skewed understanding of inflation; inflation has been always a political process. Since government actions, such as spending, lending, guaranteeing, protecting, subsidizing etc…, are not determined by the marketplace or by fundamental economic laws of demand and supply, as they are arbitrarily decided upon by policymakers and regulators, then such actions are reckoned as political in nature. Hence, inflation fear mongering isn’t political, Dr. Krugman gets it the other way around, but the use of mandated coercive powers to implement redistributive process is.

Monetary Forces Strengthens Decoupling

Mainstream experts, like Dr. Krugman, have been lost with the sudden rise of stock markets and in the commodity markets as the actions marketplace appears to have been detached from the developments in the real economy. This is because Dr. Krugman has been predicting of a deflationary depression and even wrote a book about it. Lately, Dr. Krugman conceded that “We have averted utter catastrophe.”

As we mentioned in our mid week article, see Monetary Forces Appear To Be Gaining An Upper Hand, these experts have been “rationalizing” on market actions to either affirm or dispute market accounts depending on their inherent biases.

For the bulls, the recent market activities account for as some form of triumph by government policy efforts to resuscitate the global economy or the much ballyhooed “greenshoots”.

For the bears, the widening disconnect with the real economy seems like a surefire indicator of a maturing bear market rally which will ultimately end in tears.

For us, while some signs of economic recovery have indeed been taking place in response to the “shock” (or our Posttraumatic Stress Disorder-PTSD) arising from the near meltdown of the US banking system, due to an institutional bank run which took place late last year, recent developments or market outperformance have been symptomatic of monetary forces asserting dominance over both the marketplace and the economic sphere.

We also beg to differ from the mainstream opinion that the present rising markets is about expanding global risk appetite.

Instead, we see the risk profile as shifting substantially to weigh against US markets more than Emerging Markets or Asia.

Aside from the Bond markets or stock markets (see Figure 4), we note that from the economic growth perspective to policy trajectories (Asia has been adopting policies directed at integration amidst this crisis) to prospective business conditions signs have evinced of “decoupling”.

Figure 4: Bespoke Invest: BRIC outperforms S&P 500

And we are entirely agree with the observation that the ongoing dynamics has been a “shift from the Core to the Periphery”, as analyst Doug Noland in his Credit Bubble Bulletin predicts, ``A robust Core to Periphery Dynamic and the re-emergence of dollar vulnerability are a potent combination. U.S. markets to this point remain sanguine with the prospect of an expanding Federal Reserve balance sheet rectifying any spike in interest rates. But currency markets are no doubt increasingly fixated on our propensity to monetize our massive debt. At some point, increasingly unwieldy flows out of our currency may force the Fed’s hand. The scenario where the Fed is forced to choose between loose monetary policy and currency crisis could be a potential big negative surprise for U.S. markets.” (bold highlight mine)

In short, since the survival of the present paper money system is mainly a measure of confidence or trust in the system, policies that work to undermine these framework risks the extreme ends of either a hyperinflation or deflation.

Another, mainstream deflationists continue to struggle with the fallacies of lack of aggregate demand, US centric global growth model, global surplus capacity, imbalances of current accounts and ‘velocity of money’ all of which are based on the assumption of the neutrality of money.

Debunking Mainstream Fallacies

Inflation doesn’t need demand. This mistakenly assumes that normalization of the credit process depends on the private sector as the sole pathway for inflation.

In the recent Zimbabwe or the 1920s Weimar Germany experience, their governments simply increased liabilities on an exponential scale and simultaneously spent them on the economy and the result was a hyperinflationary depression! No consumer spending required, it had all been government spending!

Today, governments not only in the US but all around the world have been frontloading fiscal expenditures or inflating altogether. Hence the inflationary transmission scheme can’t be compared to Japan in the 90s since this has been a global effort more than a stand alone stint!!!

In addition, as noted above, financing today has apparently taken place outside of the banking system, particularly on the capital markets. Example, financing for junk bonds in Europe has reportedly been brought back to life (Wall Street Journal)!

Thus, global government ‘stimulus’ spending, growth of financing obtained from global capital markets and a semblance of normalization of the banking system risks unleashing outsized or “substantial” inflation, if not the extreme-hyperinflation!

Remember Asia and the emerging markets have the capacity to undertake massive credit expansion since they are both systemically underleveraged relative to OECD economies and have a functional banking system largely unscathed by the recent crisis [see Will Deglobalization Lead To Decoupling?]. Moreover present government policies have likewise been geared towards attaining such goals.

The next problem would be if governments would be able to withdraw or reverse present policies at the right time if benign inflation turns savage!

Moreover, the collapse in global trade late last year was mainly read by the mainstream as a structural loss of the US driven global growth engine. Thereby, without the US consumers it is held, the world was bereft of a buyer for their products. This has been proven to be incorrect.

Apparently, the emergence of barter trades (post October collapse) suggested to us that demand wasn’t impaired but that the problem was in the gridlock in the US banking system which hampered trade financing [see What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis].

And as the world has recovered from this shock, global trades have begun to show indications of significant improvements, and this partly includes the US.

So while it is true that we won’t see volume of trades in the magnitude of the peak of the bubble days and that it would take sometime for the world to adjust to new patterns, recent activities have only confirmed our suspicion that the world hasn’t been dependent solely on the US, as markets everywhere have depicted signs of “decoupling” or divergences.

And if the world isn’t US centric then the rest of the other fallacies which relies on the US as the center of power crumbles along with it, namely surplus capacity, velocity of money or current account imbalances.

Furthermore, since some public personalities such as Pimco’s Bill Gross or former US comptroller General David Walker have raised the likely prospects that the US could lose its AAA credit ratings based on present directions of government policies, some analysts have rushed into the defense stating that the US position is privileged since debt has been underwritten from its own currency and that the US has a larger taxing capacity.

We again beg to differ; if the US continues to debase its currency then it has effectively been implicitly repudiating its debt.

As Henry Hazlitt wrote in From Bretton Woods to Inflation, ``Devaluation is the modern euphemism for debasement of the coinage. It always means repudiation. It means that the promise to pay a certain definite weight of gold has been broken, and that the devaluing government, for its bonds or currency notes, will pay a smaller weight of gold.” Hence, the US risks jeopardizing on its hegemon as the world’s currency reserve standard as it breaks its promises to its creditors.

Money Is Not Neutral

We also agree when experts tell us that the US will endure from significantly higher taxes in order to finance government redistribution programs when nearly two-thirds of the population is close to being bankrupt and that the remaining one third would suffer from a stifling burden of new taxes.

All these imply that the US won’t see any vigorous recovery soon and probably could experience intermittent bouts of economic recessions or weaknesses.

Yet this is also exactly why we should continue to expect accelerated inflation. The mainstream represented by Dr. Krugman, whom has been influential to the present administration, encourages its government to adopt a Dr. Gono “Zimbabwe solution” of money printing away from its miseries. This is because mainstream ideology thinks of money as neutral.

According to Ludwig von Mises in The Non-Neutrality of Money, ``The reasoning of modern marginal utility economics begins from the assumption of a state of pure barter. The mechanism of exchanging commodities and of market transactions is considered on the supposition that direct exchange alone prevails. The economists depict a purely hypothetical entity, a market without indirect exchange, without a medium of exchange, without money. There is no doubt that this method is the only possible one, that the elimination of money is necessary and that we cannot do without this concept of a market with direct exchange only. But we have to realize that it is a hypothetical concept which has no counterpart in reality. The actual market is necessarily a market of indirect exchange and money transactions.”

``From this assumption of a market without money, the fallacious idea of neutral money is derived. The economists were so fond of the tool which this hypothetical concept provided that they overestimated the extent of its applicability. They began to believe that all problems of catallactics could be analyzed by means of this fictitious concept. In accordance with this view, they considered that the main work of economic analysis was the study of direct exchange. After that all that was left was to introduce the monetary terms into the formulas obtained. But this was, in their eyes, a work of only secondary importance, because, as they were convinced, the introduction of monetary terms did not affect the substantial operation of the mechanism they had described. The functioning of the market mechanism as demonstrated by the concept of pure barter was not affected by monetary factors.”

In other words, mainstream economics have analyzed mainly from the context of pure barter trades, or if money is taken into account, they consider its function as medium of exchange only.

This view disregards or dismisses the other function of money as a store of value. Hence, the proclivity by the mainstream, like Dr. Krugman, to suggest of money printing as certified way to juice up an economy.

However for us, money isn’t neutral. It impacts prices relatively, and importantly functions as a store of value (backed by real savings) that has psychological underpinning based on expectations which is being transmitted on real time to the marketplace by virtue of price signal dynamics.

As Henry Hazlitt wrote in What You Should Know About Inflation, ``the value of money varies for basically the same reasons as the value of any commodity. Just as the value of a bushel of wheat depends not only on the total present supply of wheat but on the expected future supply and on the quality of the wheat, so the value of a dollar depends on a similar variety of considerations. The value of money, like the value of goods, is not determined by merely mechanical or physical relationships, but primarily by psychological factors which may often be complicated.”

Surging Food Prices As The Proverbial “Nail In The Coffin”

Well as the mainstream remains firmly in denial, the unfolding price surges continue across stock markets and the commodities sphere.

We will just wait until these significantly percolate into food prices from which should serve as the final “nail in the coffin” see figure 5.

Figure 5: Economist: Food Prices Creeping Up!

In addition to the creeping food prices above, last week saw White Sugar rose to a 3 year high in London and soybeans notched its third weekly gain.

In other words, the broadening of gains seen in commodity prices has now filtered into food. This reinforces our view that monetary forces are becoming “sticky” and that the price inflation has been accelerating.

Since food prices are even more politically sensitive than oil or energy, rising prices will consequently mean a global public outcry that risks political destabilization in some parts of the world. Again this initially will be blamed on “speculators” than on governments, until inflation gets really out of whack.

We expect the 2007 episode to dwarf and function as a prologue to the forthcoming food crisis that could be expected to erupt in several parts of the world as discussed in Four Reasons Why ‘Fear’ In Gold Prices Is A Fallacy.

Finally, the growing incidence of public discontent on high food prices will eventually lead the mainstream ideologues and deflationists to capitulate.

But that would be a great time to talk about deflation.