Sectoral Performance In US, China And The Philippines

``[Asia is] a very different dynamic compared with the rest of the world. Most banking systems in Asia are flush with liquidity as they have a surplus of deposits over lending. So if [corporates] have in the past financed in the international bond markets, when it comes to refinancing they can turn to the local market alternatives because plenty of banks are still willing to lend”- Jason Rogers, a credit analyst at Barclays Capital Asia-Pacific corporate bonds surge

In bubble cycles, the object of a speculative bubble, after a bust, normally takes years to recover.

To cite a few, the Philippine Phisix following the 1997 Asian Crisis episode hasn’t fully recovered even 12 years after, Japan’s Nikkei 225 and its property sector remains in doldrums following the bust in 1990 (that’s 19 years!), and the technology centered dot,com bust during the new millennium in the US has left the Nasdaq miles away from its peak, 9 years ago.

The recent bubble cycle phenomenon evolved around the US real estate sector which had been funded by the financial industry. In short, these two sectors-financials and real estate accounted for as the epicenter of the bubble cycle crisis. So given the nature of bubble cycles, I originally expected the same dynamics to unfold.

The fundamental reason for this is due to the market clearing process or the process of liquidating clusters of malinvestments acquired during the bubble.

And since bubble blowing or the “boom” phase is a process underpinned by policies that is cultured by the markets over time, the liquidation or the “bust” phase likewise employs the same time consuming process but in reverse.

But I guess this dynamic doesn’t seem to be the case today or put differently, this time looks different.

Why?

Because US money managers have largely been overweighting the financial sector, see Figure 5.

Figure 5: Bespoke Invest: Institutional Sector Weightings

According to Bespoke Invest, ``money managers collectively have 18.5% of their long portfolios in the Financial sector, which is the highest weighting for any sector. Technology ranks second at 16.8%, followed by Health Care (12.9%), Energy (12%), and Industrials (10.3%).

``The second chart compares these weightings with the sector weightings of the S&P 500. As shown, institutions are overweight the Financial sector the most and underweight Consumer Staples the most.”

Obviously, the enormous backstop provided for by the US government to the US financial sector has circumvented the natural process of liquidations from fully occurring.

Hence, the intriguing outperformance led by the money managers piling into a sector under the government “umbrella” to seek profits or “economic rent”.

Yet, despite such outperformance, government intrusion to the industry will likely result to more systemic distortions.

To quote Professor Mario Rizzo in a recent paper ``These are agents whose discretionary behavior, insulated from the normal discipline of profit and loss, can significantly affect the course of economic effects. Thus, discretionary behavior on the part of monetary authorities (the Fed), fiscal policy makers (Congress or the Executive), or even in some cases private monopolists, can increase uncertainty faced by most economic agents (“small players”). They will have to pay more attention to trying to guess the perhaps idiosyncratic behavior of the big players. Economic variables will become contaminated with big-player influence. It will become more difficult to extract knowledge of fundamentals from actual market prices.”

Again, pricing signals are becoming less efficient due to government intervention (more difficult to extract knowledge of fundamentals from actual market prices) and is likely to heighten systemic risks (can increase uncertainty faced by most economic agents) arising from the asymmetric behavior of the industry participants shaped by regulators (insulated from the normal discipline of profit and loss).

In combination with the toxic assets stacked in the bank balance sheets, I would remain a skeptic over US financials.

Interesting Parallels In China And The US, Possible Opportunities

It is interesting to see how some parallels can be gleaned from the institutional interest in US stocks and in China’s recent sectoral performance.

While Financials, Materials, Consumer Cyclicals, Energy and Industrial outperformed the S & P 500, in China, Energy, Materials, Financials, Technology and Industrials constituted the top 5 during the latest run on a year to date basis, see figure 6.

Figure 6: Bespoke Invest: China’s Sectoral Performance

In other words, except for Consumer Cyclicals in the US and Technology sector in China, there seems to be some common interests from respective domestic investors-energy, materials, financials and industrials.

In the Philippines, the top 3 sectors have been Mining and Oil, Industrial (energy) and holding companies, whereas financials and services (telecoms) have been laggards.

Except for the financials, basically we see the same pattern playing out.

More interesting insights from Bespoke Invest, ``Sector performance in China paints an interesting picture. In typical selloffs, sectors that lead the rally see the steepest declines, while laggards in the rally tend to outperform. In this selloff, however, this trend is much less evident. The chart below shows the average performance of Chinese stocks by sector during the rally and since the peak on 8/4. While Energy led the rally and has seen the sharpest decline, in other sectors the relationship has been much less evident. For example, Utilities and Telecom Services were in the bottom four in terms of performance during the rally, but during the decline they have also been among the weakest sectors with the second and third worst performance.” (emphasis added)

Given the degree of corrections, it appears that China’s financials are on the way to outperform but could still play second fiddle to Energy.

So while I would remain a skeptic over US financials, it’s a different story for China and for Asia.

Nonetheless if we follow Dennis Gartman’s 7^th rule of his 22 trading rules, ``Sell markets that show the greatest weakness, and buy those that show the greatest strength. Metaphorically, when bearish, throw your rocks into the wettest paper sack, for they break most readily. In bull markets, we need to ride upon the strongest winds... they shall carry us higher than shall lesser ones”, then this would imply that energy, materials and financials could be the best performing sectors over the coming years and could be the most conducive place to be in to achieve ALPHA.

That’s also because China has aggressively been bidding up global resource and energy stocks, for reasons we cited in China's Strategic Resource Accumulation Continues.

Finally, this brings up a possible “window of opportunity” arbitrage for the Philippine markets. Since the local financials have severely lagged the recent rally and IF the same US-China patterns would play out sometime in the future, then positioning on financials on market weakness looks likely a feasible trade.

In addition, the underperformance of the telecom sector which has patently diverged with technology issues has piqued my interest and could be a point of discussion for another day.

10 US Energy Facts

From American Institute for Economic Research

1 New York State per capita energy consumption is among the lowest in the nation due in part to its widely used mass transportation systems.

2 California imports more electricity from other states than any other state.

3 Iowa is the largest producer of ethanol in the United State and is a leading state in electricity generation from wind turbines.

4 Montana is one of the top hydroelectric power producers in the United States.

5 Colorado’s oil shale deposits hold an estimated 1 trillion barrels of oil—nearly as much oil as the entire world’s proven oil reserves. However, oil production from those deposits remains speculative.

6 Florida is a leading producer of oranges, and researchers are attempting to derive ethanol from citrus peel waste.

7 North Carolina is one of the top nuclear power producers in the United States.

8 Oregon is one of the nation’s leading generators of hydroelectric power, which accounts for more than one-half of state electricity generation.

9 The Henry Hub in Louisiana is the largest centralized point for natural gas spot and futures trading in the United States, providing access to major markets throughout the country.

10 The Powder River Basin, most of which lies in northeastern Wyoming, is the largest coal-producing region in the nation, accounting for approximately 40 percent of all coal mined in the United States.

Market Talk on Select Philippine Energy issues: Refinancing Woes or Available Bias?

Recently because of the poor performance of some locally listed energy issues, we were asked of the opinion of why this has been so and if we agreed with a study of a domestic broker on the notion that the recent share price decline have been prompted by 1) the question of having to raise money in today's environment given the scale of the company's refinancing requirements and 2) the falling value of the equity collateral of its recently acquired subsidiary which mandates the said company to raise funds to cover such deficit.  

Some FACTS first:

1.    These issues have been on a downtrend since October last year, which basically reflects overall market decline. 

2.    Since the advent of the credit crisis, foreign selling has dominated the selling side 

Our observations:

One, the study has been ambiguous in the order of causality: have the decline of share values in the said issues been "causing" debt refinancing problem, or has debt refinancing woes "caused" the losses in its share prices? 

Two, given the "facts" above, we really doubt if the declining trend had been all about debt refinancing. The Phisix bear market has been due to net foreign selling which has been a broadmarket affair since the credit crisis surfaced. And as we have been saying it is the deleveraging dynamic that has been the vicious knot that ties the miseries of global markets. The debt refinancing issue has only been recently raised.  

On our end, the thesis of "debt refinancing woes" could be based on sheer speculation than of genuine concerns.

Three, while there has indeed been some spillover of the credit woes to Asia, this hasn't totally sucked liquidity out enough to squeeze the Asian or Emerging Market sovereign or corporate debt markets. 

According to Christian Monitor: "Dutch bank ING has calculated that $111 billion worth of emerging market bonds must be refinanced during the next year. But credit is tight. That's raising doubts about whether corporate borrowers will be able to refinance their loans.

"I don't think we'll see a sovereign debt default problem," when a country can't repay its loans, says Mr. Das. The focus will instead be on banks and "companies that have been major issuers into the credit bubble."

"He says, "Russia, Kazakhstan, and Ukraine had a number of banks issuing debt. They haven't all lost access [to credit], but if even Gazprom is having to pay higher [interest rate] spreads [on loans], you can be sure that the weaker names will continue to have a much harder time getting bond deals done.""

Another, it seems the loan market in Asian remains vibrant, click on FinanceAsia article.

Fourth, the underlying business models of these companies generate immense cash flows. Thus, the problem won't necessarily be about the access to debt but instead to the cost of debt.  This means the high cost of financing (assuming the tight credit environment) risks taking a bite out of the company's earnings or bottom line.

Having said so this bring us to perspective of the company's solvency; will the "high" cost of debt refinancing render the company insolvent? Unlikely in my view.  And since the problem is NOT one of INSOLVENCY, thus, the controversy over the company's refinancing could be seen as "rationalization" (looking for excuses to justify present market action) or Available Bias (the use of current events to explain market actions). We think that the company will easily find a lending window given its generally feasible business model.

Fifth if the company is faced with any risk, it could emanate from the political front (populist policies), as the owners of the said companies have been seen as political foes.

All told we adhere to Edwin Lefevre's advise (truism), "In a bear market all stocks go down and in a bull market they all go up...I speak in a general sense."  

A Government Cardinal Sin That Results To A Bear Market? War!

What is one of the government prompted cardinal sins that results to a bear market? The answer is War! We have dealt with this in our past article, Phisix: Learning From the Lessons of Financial History.

So now it appears we have a LIVE unfolding showcase: Russian assets have been collapsing since the military conflict with Georgia erupted!

Courtesy of Danske Bank

From Lars Christensen and Lars Rasmussen of Danske Bank (highlight mine),

``Russia’s financial markets remain under pressure today following the news. Performance has been negative in FX, fixed income and equity markets, and among derivatives. The Russian rouble (RUB) at one point weakened more than 1.3% against its dual currency basket (45% EUR and 55% USD) to trade around 30.10. The Russian central bank (CBR) has since stepped in to support the currency. The RUB basket currently ranges between 29.70-29.90, a few percentage points weaker than last week.

``Meanwhile, Russian share indexes have hit their lowest levels for almost two years. Russia's benchmark RTS stock index fell more than 4% this morning, to its lowest level since November 2006, although it has rebounded somewhat in the last couple of hours. Overall, Russian equities are down more than 30% from their peak in mid-May.

``Going forward, the Russian markets will remain under pressure for as long as there is no move towards a resolution of the conflict. In addition, further falls in oil prices could add to the downward pressure on Russian assets. Caution is thus clearly warranted in the Russian financial markets.”

Additional observation…

From the New York Times,

``Mr. Saakashivili, the Georgian president, said Russia’s oil riches and desire to assert economic leverage over Europe and the West had emboldened Kremlin country to attack. Georgia is a transit country for oil and natural gas exports from the former Soviet Union that threatens Russia’s near monopoly.

“They need control of energy routes,” Mr. Saakashvili said. “They need sea ports. They need transportation infrastructure. And primarily, they want to get rid of us. ”

Hmmmm. It seems to sound more like a conflict premised on commodity geopolitics!

Tidal Power As Alternative Energy

Biofuels, Wind or solar power are the popularly known alternative energy.

What is least known is the recent commercialization of tidal power or tidal energy-(wikipedia) “form of hydropower that converts the energy of tides into electricity or other useful forms of power.”

A schematic of how tidal power runs looks like this…

from technologystudent.com

What we’d like to emphasis is-innovation is a natural product of the markets- where rising energy prices has opened the avenues for (substitutes) alternative energy sourced from mother earth.

You can read about the entire article of the first commercial tidal power system in Northern Island here.

courtesy of technologyreview

A short excerpt…

``The world's first commercial tidal-power system has been connected to the National Grid in Northern Ireland. Built by the British tidal-energy company Marine Current Technologies (MCT), the 1.2-megawatt system consists of two submerged turbines that are harvesting energy from Strangford Lough's tidal currents. The company expects that once the system, called SeaGen, is fully operational, it will be able to provide electricity to approximately one thousand homes.

``The system is currently being tested and has briefly generated 150 kilowatts of power into the grid. But it has also damaged one of its rotors due to a failure in the control system when the rotor began turning too fast. Although the problem was a minor setback, the unit is not expected to start running continuously and at full capacity until November, says Peter Fraenkel, the technical director at MCT.

``The technology works like a wind turbine, but instead of wind, the turbines are driven by the flow of tidal currents. It offers a significant advantage over wind because currents are predictable, says James Taylor, the general manager of environmental planning and monitoring at Nova Scotia Power, a company that also has plans for a one-megawatt tidal-power project. "Wind is intermittent and, because of that, is much more difficult and expensive to integrate in a power system," he says.

Phisix: Too Much of Horror Movies

``In the sky, there is no distinction of east and west; people create distinctions out of their own minds and then believe them to be true." – Buddha

Local investors have been spooked by either inflation figures or elevated oil prices or both. The Phisix lost another 3.94% over the week to increase its year to date losses of 34.58%. From the Phisix peak in October 2007, the present bear market has accrued losses of about 39%.

Despite the net foreign selling this week, which was mostly due to the special block sales of San Miguel shares, board transactions reveal of a marginal net foreign buying. Again the rather slightly bearish bias to neutral outlook by foreign participants indicates of the locals at the driver’s seat.

The recent activities suggest that local participants continues indiscriminately sell the market in the assumption that the apocalypse is around the corner. This is a peculiarity though; retail investors hardly seem to know how to absorb losses which makes us suspect the ongoing selling pressures could possibly come from redemptions from indirect participants (e.g. bank UITFs, or Index funds or mutual funds).

Well we have been arguing that inflationary environments does not equate to financial Armageddon, there are industries that have been seen to benefit from the present environment see figure 7.

Figure 7 PIMCO: Winners and Losers

Pimco’s Mark Kiesel says that their company remains weighted in certain sectors (highlight mine), ``The energy, materials and metals and mining sectors remain areas we continue to favor in our credit selection process. In the case of energy, fundamentals tend to improve as price levels rise because higher inflationary periods typically result in strong top-line revenue growth for energy companies where demand is relatively inelastic. The industrialization of the emerging markets has led to significantly stronger demand growth for energy and put pressure on already tight resource supplies. Not surprisingly, gross margins for energy companies have expanded over the past several years as revenue has grown faster than costs.”

Why? See figure 7 again courtesy of PIMCO…

Figure 8: PIMCO: Who Has Pricing Power?

So inelastic demand, commodity pricing pass through, revenues growing faster than rising costs makes the aforementioned industries attractive.

Why have the local participants been selling? Because they’ve watched too much of horror movies.

The Politicking the Philippine Energy Sector

This is my reply to a foreign client on the state of the Philippine Energy (edited/revised version) and how government actions have been impacting the financial markets. I think it deserves a wider audience…

How can the Philippines attract investments when government is making the joint foreign chambers and the private sector a scapegoat for our problem? How does one attract investments when we have been threatening capitalists?

We supposedly have an Energy Policy (EPIRA) which was meant to deal with Napocor's problem by selling its assets and the liberalization of industry to attract investments.

Now intervention via "patriotism" is threatening to stall if not alter the entire process. Yet there is NO template for a viable alternative scheme! The recent proposals are nothing but patchy stop gap measures!

The administration have been passing the buck to private ownership by accusing them of overcharging the populace because of "greed"/similar to windfall profit tax on oil companies in the US.

On the first place, the "take or pay" provisions of which has been the bitter point of argument is a carryover from the Ramos Regime, where in due haste to resolve the daily 8-hour brownouts, Former President Fidel Ramos executed contracts unduly in favor of IPPs. In short, the policy mistakes of Ramos regime is the object of GMAs ire but directed to the IPPs and distribution utilities. Who signed or implemented this in the first place?

Look at the administration’s present proposals (Businessworld):

“The Finance chief said the task force had agreed to recommend:

-asking distribution utilities to absorb the value-added tax (VAT) on system losses;

-a review of the cap on systems losses to lessen the burden for consumers;

-that state-owned National Power Corp. (Napocor) offer flat rates of P4.11/kWh to Manila Electric Co. (Meralco); and

-ensuring that local government units (LGUs) allocate part of their tax share for lifeline subsidies…

- Renegotiate existing government contracts with IPPs."

It basically highlights TWO features:

one-SUBSIDIES by Napocor and LGUs and

two-asks that private companies (distribution utilities and IPPs) ABSORB Losses! Huh? Our government officials now seemingly think that the role of private institutions is similar to that of public institutions-to provide subsidies to consumers? If the private sector losses money will they be subsidized by taxpayer money??? Hellloooo???

Yet the true story is that NO MATTER what the administration does with such past contracts, it won't solve our energy predicament. It won't lower prices over the long run. Such actions WILL ONLY RESTRICT SUPPLIES! It will only create friction with the investors who will eventually refrain from investing, leading to A REPEAT of the Ramos era Brownouts and the repeat of the entire vicious cycle of supplication when we become desperate. It seems that we have not learned from our past.

Our government has failed miserably in its attempt to centrally plan the industry at a humongous cost of estimated $7.2 billion Napocor debts!

You see, the entire episode is nothing but a Public Relations stunt. And I believe the administration is aware of this and is likely to be a tactically designed political action for unstated political reasons.

In essence, the attempt to prove to the poor that the administration is "doing something", will mean RESTRICTING supply or HIGHER PRICES and or ROLLING BROWNOUTS in the future. Pretending to do something today means WORSENING OUR SITUATION TOMORROW.

Yet the administration knows that taxpayers cannot afford to shoulder any nationalization or continued subsidies of the industry because the Philippines is hobbled by debts, which ironically the industry have contributed immensely. Not to mention that this means higher taxes tomorrow in an already onerous tax regime. Besides, hostility towards foreign principals also means REDUCING ACCESS TO CAPITAL even in the international markets. So if you don’t get financing and restrict supply, what happens next? HIGHER Energy Prices or HIGHER Taxes!

So yes, the Philippines have abundant endemic non electric energy sources (think geothermal-we are second or third in the world in terms of reserves). But no, trying to win the votes or sentiment of the public by creating scapegoats and squeezing profits of energy companies will even do as more harm than good.

So investments are at risks and supply will be a future problem. Politicking which is all about the short term means more poverty and hardship for us.

The lesson here is that government intervention always distorts the distribution process of efficient resource allocation and aggravates the situation than help solves it. Even the privatization of US Senate dining services basically proves how markets function more efficiently than government actions.”

Politicking Weighs On Phisix, Inflation Problems Have Been Policy Induced

``For far too long, we have accepted the idea that government can and should take care of us. But that is not what a free society is all about. When government gives us something, it does two bad things. First it takes it from someone else; second, it causes dependency on government. A wealthy country can do this for long periods of time, but eventually the process collapses. Freedom is always sacrificed and eventually the victims rebel. As needs grow, the producers are unable or unwilling to provide the goods the government demands. Wealth then hides or escapes, going underground or overseas, prompting even more government intrusion to stop the exodus from the system. This only compounds the problem.” Congressman Ron Paul Challenge to America: A Current Assessment of Our Republic

The Phisix has been bedraggled by administration led politicking which has led to its recent rout (down 3.1% over the week). Yet, the efforts by the mainstream media have been to affix the culpability to inflation which recently rose to a 9 year high. This mindless penchant to attribute false causes has been misleading the public compounded by blabbermouth experts.

Attribution To Inflation Woes Don’t Add UP!

As we argued in my recent post, Phisix Breakdown: Politics Not Inflation Related, goods and services inflation means the loss of purchasing power by the domestic currency to mostly fuel and food (which is what the news report says). Alternatively, this means that rising fuel and food prices have been getting a far larger share of expenses out of household or business budgets from which comes at the expense of non-fuel and non-food items. In short, spending on food and fuel crowds out other items. This is called relative price adjustments.

So in the perspective of relative prices applied to the equity markets, share prices of energy issues should benefit from the expectations of rising share of fuel expenditures and so with food related firms at the expense of other issues if “inflation” is the concern. Relative to the performance of energy companies, except for Petron Corporation, which amazingly soared by 17.65%, the rest of issues slumped such as Aboitiz Power (-3.57% w-o-w), Aboitiz Equity Ventures (-1.39%), PNOC EDC (-5.36%), First Gen (-1.43%), First Philippine Holdings (-3.03%) and Meralco (-4.07%)! So the so called inflation woes don’t add up.

Yet, inflation figures reported in the news reckon of past performance-particularly of last May. This means markets acting as a forward discounting mechanism should have discounted the past and read into the future.

If in the past (say last month or in May which read on the April figures) the market believes food and fuel inflation will continue to impact spending patterns in the future (which is today) then share prices of these issues would have likewise adjusted. This means at this point, shares of energy and food issues should be on an uptrend. But this isn’t the case.

And when the same deduction will be applied tomorrow or if once again the energy group is extrapolated to reflect on the continuing adjustments of consumption patterns then they should be expected to trend higher. This means prospective higher prices for energy issues!

But have we been seeing such dynamics? The reality is energy issues have either been consolidating (AEV, PCOR, AP and FGEN) or seem headed for the sewer (Meralco, FPH and EDC). Again, this inflation themed anguish doesn’t rhyme at all.

So why have energy issues (or the Phisix in general) been collapsing in the face of spending pattern adjustments arising from higher costs of fuel and food?

Because foreigners have been selling the Phisix! This week, foreign money has sold the most (Php 1.273 billion) since end of April. Coincidentally, the bulk or 68% of the foreign selling came at the time when the joint foreign chamber of commerce was being excoriated by our sanctimonious politicians.

A foreign chamber of commerce is a business organization representative of foreign owned enterprises in the Philippines. The benefits or costs accrued by their companies are transmitted to their countries which may induce or reduce incentives for future capital investments locally. Hence, any negative projection imparted by our leaders or by our political economy will negatively impact our image which may lead to foreign capital efflux aside from inhibiting future capital investments-our future jobs and taxes. So it becomes a paradox to brag about our “sovereignty”, especially under today’s “globalization” or increasing trends of cooperation and integration, when we can’t produce for ourselves enough capital to make enough jobs for our countrymen.

Besides, if as a foreigner you are invested in the country, having come to the realization that your equity ownership is at risk from political intervention, will you not sell and pull out? The answer is pretty obvious. Hence, the political risk arising from the administration’s continued assault on the private sector has been impairing the country’s attractiveness as a business destination. In effect, we have been shooting ourselves in the foot anew. We just hope and pray that sanity will be restored to our leadership.

Finally, the cause and effect between inflation and equities doesn’t necessarily have a linear correlation as we have always argued. To see an example, let us base it on recent global events-Kenya’s massive rise in its inflation data was equally met with a strong response in its stock market as shown in my post Kenya’s Mixed Message: Soaring Inflation Rates and Rising Stock Market.

Of course, Kenya is unlike Zimbabwe whose currency has practically collapsed down 84% since May and whose inflation rates is said to have vaulted to 1.8 MILLION PERCENT in May (Reuters). Of course, Zimbabwe’s hyperinflationary refuge has been its stock markets where its industrial index is up 261.15% in just ONE week while its mining index is also up 379.23% in just THREE days (allafrica.com)! In these we find that equity investments can become the corollary store of value when trust over a currency loses its foundation.

Yet, if there is any little trace of inflation based positioning in our domestic markets, well Figure 3 tells it best…

Figure 3 PSE data: Philippine Mining Index Diverges From the Phisix!

The Philippine Mining index (red line) has greatly outperformed the Phisix up 2.68% amidst the harrowing decline of the Phisix (black candle) over the week.

If inflation is defined as a loss of purchasing power against hard assets then naturally, resource based issues are likely to outperform under a massively devaluing currency reserve standard of the world, the US dollar.

Besides, since the Mining industry is the administration’s baby, (hopefully they won’t change minds), it is likely that there will be continued rotation towards such resource based sectors.

Figure 4 stockcharts.com: Resource based Assets Survive the US onslaught

And it’s not just here.

The major US benchmarks fell by about 3% last Friday, as the US dollar crumbled, to which some have associated the market’s reaction to the surprising stance by European Central Bank Jean Claude Trichet indicating the possibility of raising interest rates in July.

This unexpected declaration by Mr. Trichet allegedly prompted for a forced massive short covering across the Euro and commodities-particularly the oil benchmark which jumped by 8% the biggest increase since oil futures started trading in 1983 (NYT), aside from liquidation sales in the broad equity for margin calls. On the other hand, commodity related international stocks fell at a much subdued clip while mining and oil bellwethers in the US jumped (see figure 4)!

The Dow Jones Latin American Index (main window) slipped by 1.9% but still trades at near its recent highs, while the Dow Jones US mining index (pane below main window) shot to fresh record heights amidst the market turmoil.

Meanwhile, the Dow Jones Oil and Gas Services (middle pane) similarly leapt, as the Dow Jones Gold index (lowest pane) pivoted higher following the recent doldrums which has basically reflected the price action of gold.

As you would observe, except for the US Gold mining index which we think would follow suit higher, all three indices have been moving to the upside despite the increased volatility in the main US markets of late. This is “inflation” at its finest. In short, the loose correlation with the general market makes commodity based investments very attractive diversifiers.

Politically Induced Policy Measures Assures Of Prolonged Inflation Pains

All these market signals indicates too that the commodity and the “goods and services” inflation pressures being generated by the massive imbalances imposed upon by collective governments in skewing the global marketplace will continue to persist and risks even exacerbating. It is unhealthy to discount the possibility of a US dollar crisis.

In fact, our local politicos and the administration’s actions will likely compound on their dilemma with a slew of unintended consequences arising from their growing hostility towards the market instead of utilizing them for efficient allocation.

To give you an example the recent land conversion ban of agricultural properties ensures of the rising values of real estate which will likewise be reflected on rising rental prices as the supply of non-agricultural properties gets restricted in the face of growing urbanization and expanding population growth.

Figure 5: ADB’s Hyon H Son: Has Inflation Hurt the Poor?

As shown in Figure 5 courtesy of Hyon H. Son of ADB, rental comprises the largest of the non food expenditures for the Philippine poor and also for the non-poor.

So essentially, our government is simply shifting from one form of “popular” burden to another form of “unpopular” burden which eventually will get us slammed overtime anyway. Of course, the trick here is to understand how to cash in from the opportunities presented by the government’s populist impulsive driven policy gaffes.

Government’s Time For Self Introspection

And like all trends, commodities and good and services inflation doesn’t move in a straight line.

And as we also expected, inflationary pressures abroad has filtered to the domestic scene and will continue to do so until perhaps a global stagflationary recession occurs or a policy induced slowdown (tightening) by key Central Banks or nations collectively drop policy distorting measures (quite an impossibility).

Yes, another fulfilled expectations too is our (Bangko Sentral ng Pilipinas) BSP’s tepid response to rising “inflation” by increasing its headline borrowing and lending rates by a measly 25 basis points.

The unfortunate part is that increasing policy rates will do little good because-ONE, our inflation is basically imported, as University of Columbia’s Joseph Stiglitz recently wrote against inflation targeting, ``Inflation in these countries is, for the most part, imported . Raising interest rates won’t have much impact on the international price of grains or fuel. Indeed, given the size of the US economy, a slowdown there might conceivably have a far bigger effect on global prices than a slowdown in any developing country, which suggests that, from a global perspective, US interest rates, not those in developing countries, should be raised” and-SECOND, raising rates on baby steps doesn’t remove the accommodativeness of the Philippine monetary landscape.

Come to think of it even after raising rates, the margin of our inflation index has been growing wider compared to 1) the country’s economic growth rate or 2) the nominal rates set by the central bank or 3) the yields of our treasury bills, which means like many other central banks around the world, the BSP seems to be fostering an “inflation friendly” negative real rate environment, again another policy induced problem.

Of course not to mention that March money supply growth rate is nearly double or 9.6% of the recent economic growth clip-another prospective contributor to domestic inflation.

So essentially the problem with our government is that they have been looking for scapegoats at the wrong places and have been caviling on the private sector’s contribution to our economic woes, when in fact, it is time for them to do some self-introspection.

Phisix: Plagued By Domestic Politics

``The interventionist doctrinaires and their followers explain all these undesired consequences [of government intervention] as the unavoidable features of capitalism. As they see it, it is precisely these disasters that clearly demonstrate the necessity of intensifying interventionism. The failures of the interventionist policies do not in the least impair the popularity of the implied doctrine. They are so interpreted as to strengthen, not to lessen, the prestige of these teachings. As a vicious economic theory cannot be simply refuted by historical experience, the interventionist propagandists have been able to go on in spite of all the havoc they have spread."-Ludwig von Mises, Human Action

One of the risks we mentioned in today’s marketplace, aside from external recessionary environment, is domestic political risk.

Considering that foreign money has not been much of a driver of late, the Phisix has been subjected to mainly domestic sentiment, which has gyrated from the flux of events dominated by politics as the inopportune MERALCO affair.

Political Grandstanding Amidst Global Inflation

While external markets have mainly recovered from the other week’s selloff (see figure 4), the Phisix closed .77% lower over the week weighed by the seeming “tightening of the noose” by government officials on the marketplace as seen in the sordid Meralco imbroglio aside from the “free texting” and Banking industry’s forex deals.

Figure 4: stockcharts.com: Phisix versus the World

As we have repeatedly noted, the rising prices of consumer goods and services have spurred officials to do “something” in the face of public pressure if not as a deflection from controversial issues surrounding the administration. Essentially officials have vented the blame on public utilities for such dilemma.

Our public officials have not been forthright though; in an interview over an international business network we even hear the chief of our central bank claim that “inflation pressures” arose from “supply shocks”. This isn’t exactly the picture.

Like the rice crisis, these supposed “shocks” have been exacerbated by knee jerk political reactions (e.g. restriction of exports by surplus food producers or panic buying from the Philippines abroad) than the genuine causality. To date, since the rice crisis emerged, there has been no indication of a rice crisis for the commercial rice, but in the past-on NFA or government subsidized rice level. What was featured as a nationwide crisis in media was certainly true for some areas but not all.

Figure 5 ino.com: July Rough Rice

Of course, since many governments have now regained their composures and tempered their trading curbs aside from supply side responses to high prices in terms of more harvests (Bloomberg), rice prices have moderated (see figure 5)—for now.

With a sharp correction in major commodity prices this week, it is likely that goods and services inflation will probably have a “reprieve” in the coming weeks or months. But it is highly unlikely that these inflationary trends will meaningfully subside given the penchant for governments to “socialize” under the present landscape.

However, the fact is every part of the world today has been experiencing “goods and services” inflation, even among developed countries suffering from a credit squeeze due to the recent housing industry bubble bust. This means that goods and services inflation has basically been IMPORTED and not simply due to a domestic/global “supply” shock. Rising demand from emerging markets as China and India represents similarly a “demand” shock.

What policymakers have eluded to say is that monetary (monetary pegs, negative interest rates, bridge liquidity provisions for the credit affected financial sectors in the developed worlds, currency debasement or “competitive devaluation” programs in emerging markets) and fiscal policies (subsidies, high taxes and tariffs, trading curbs, non-transparency, nationalization, et. al.) have severely distorted the functions of price discovery, price transparency, pricing efficiency as allocators of resources in the marketplace, pushed a tsunami of money into the financial system, which has been finding a refuge at hard assets, where others superficially interpret as “market fundamentalism”, a.k.a. speculation.

Yet because most people don’t understand what is truly going on, for simplification purposes, somebody or some entity would have to take the blame.

This means that the first line of assault would be on the public utility providers, where “profits” are scrutinized and condemned as “unjust” and contributing to “inequality” and “poverty” thus requiring redistribution. Bolivia is an example of this recent movement, as it recently nationalized energy and telecom companies. Could we be smelling the same pattern here?

The popular notion is, if you squeeze public utility operators of profits or “nationalize” them, prices of basic services will go down. Baloney. Yes, this will happen over the short period of time. You can party for as long as the booze will last, but not when it gets depleted.

The basics is that the government can only afford to “subsidize” for as long as the revenues it gets is enough to compensate for this, which is the same as saying picking from taxpaying (productive) Pedro and doling out to non-taxpaying (non-productive) Juan. The problem is that the source of looting is limited while the demand for financing is unlimited.

The key question now is “Can a country’s productive sector permanently sustain a non productive sector?” The obvious answer is no. Eventually the country which undertakes heavy socialization or welfare programs will pay for the political mountebank when it enters into a financial crisis or sees its standard of living decline.

That’s why politics is always about short term convenience at the expense of the long term pain. The fundamental problem is that the public is easily directed away from the true causes.

A Snippet on Meralco’s Controversies

Energy issues have been taking the brunt with monopoly distributor Meralco down 3.91% over the week (down 25% from the week ending May 2^nd), aside from First Philippine Holdings (14% w-o-w) and Petron (10.53%-it’s a wonder if foreign investors are now anticipating a political spillover to this issue).

Fortunately enough, the strong performances in Friday ended the week positive for telecom issues and banking issues (led by Banco De Oro up 7.45% and Union Bank up 11.11%-could some prospective deals be brewing between them?).

As for Meralco we have not scrutinized on the nitty-gritty of the ongoing controversy but have construed the recent developments as possibly emanating from the following motivations:

One, a political retribution or a ruse to engage a vocal supporter of a well entrenched political adversary or

Two, an attempt to sidetrack the controversies surrounding the recent government scandals by redirecting the public attention to “goods and services” inflation by effectively focusing on utility providers as culprits, or

Three, a possible economic opportunity for certain interests group to wrest the management in order to benefit from the ongoing changes under the Electric Power Industry Reform Act (EPIRA) in the power sector. As a distribution monopoly, grabbing hold of this strategic network by any of the power producers ensures of a captive market.

Lastly, a combination of any of the three.

What are the major points of contention we can observe of in the corporate dispute:

-Take or Pay provision, a derivative of the 1993 Electric Power Crisis Act of the Ramos Regime which is the source of the wrangling over the charging of system losses.

-Royalty taxes and VAT charges

-alleged conflict of interest from cross ownership

So essentially you have a technical LEGAL spat over a government monopoly franchise operating under an intensely regulated industry.

Since the Lopezes have not been cordial or in good graces with the administration, the present environment of rising good and services inflation makes them susceptible targets for politicking.

But of course, other tangential concerns have brought upon by left leaning groups as;

-Subsidies
-market abuses from operators
-regulatory capture or regulators overwhelmed by those regulated
-corruption
-high rates required to sell Napocor assets
-“high prices breed inefficiency”

…our unsolicited comments;

-subsidies-see above
-market abuses (because of the monopoly), corruption and regulatory capture (the latter two are intertwined-regulators get controlled because they can be bought) are principally offshoots to overregulation. They represent the symptoms and not the cause.
-high prices in itself do not “breed” inefficiency but reflects on demand and supply even if they have been contorted with misaligned or skewed policies (e.g. high taxes) or lousy management. Simply said, high prices are the result of accrued inefficiencies. High prices DO NOT create, breed or foster inefficiencies; policies do. You put the horse before cart, and not the other way around.
-high rates needed to sell NPC assets accounts for a slippery slope argument. Investors invest because of the attractiveness of returns relative to risks not because of high prices. High prices do not guarantee returns. It’s the net margins or the ROI that counts!

Yes while a new management maybe able to trim down rates to achieve so called “efficiency” (which is highly doubtful), the fact that our problems is basically one of “imported inflation” ensures that over the long term energy prices will continue to rise unless:

One- demand destruction overtakes the global economy via ‘stagflation’ or

Two- alternative energy or unconventional energy sources will be able to generate sufficient economies of scale to overhaul the energy dynamics of the global transport and energy consumption infrastructure.

Three-policies will be undertaken to remove excess liquidity in the global financial system (meaning a policy induced recession)

Next, for the local energy sector, I’d like to give the EPIRA a chance to be fully implemented compared to a centralized energy policy since 1972 (Presidential Decree 40 - “Establishing Basic Policies For The Electric Power Industry”), where Napocor’s unwieldy P 600 billion debt should be enough lesson for us.

Risks of Owning Public Utilities

Figure 6: PSE: Industrials Taking the Heat

Of course, the major risk of owning “sensitive” public utilities today is that political powers will probably use them as scapegoats to pass populist policies which should be detrimental to the industry or to the society. The least is to harass them for publicity purposes as we might be probably witnessing today.

Figure 6 shows how the PSE Industrials have been buffeted by political volatility (aside from the recent bearmarket pressures) and is seen in a continued downdraft, where Meralco (26% of the Index) and other energy and public utilities are benchmarked. Overall the Industrials have been a sizeable drag to the “recovering” Phisix.

Besides, the risks of nationalization or instituting price caps or government takeover are enough reasons to dissuade foreign investors from owning these issues, even if it were just mere rhetoric. The problem is that it could be seen as an attempted assault on private ownership rights which tarnishes our credibility and takes sometime to restore.

Of course we don’t discount that there is a possibility that all these could also signify tactical moves of a facelift poop and scoop operation where investors flee from anxiety while giving entry opportunities for those fostering such scenario.

But on the contrary, we also understand that a declining Phisix isn’t a good reflection for the administration (especially if world markets begin to markedly advance) which habitually likes to take credit or bask in the glory of its past successes.

This means that if the Phisix will lag the world because of continued politicking, the meddling into these industries might suddenly or surprisingly fade! But this is being hopeful.

Important Disclosure:

This is not to say that you should own or not own public utilities shares. Instead, this is to evaluate on the risks of owning public utility shares given today’s “inflation” driven politicized environment. It represents risks or opportunities to gain from such risks. This is a market critically dependent on the path of government action.

Besides, not all of the public utilities share the same or equal measure of risks.

Writer owns shares of First Gen (FGEN).