Euro and European Periphery Bonds strength hooked on BoJ’s Abenomics, Reversal Time Coming?

Speaking of carry trades, do you know that BoJ’s ‘Abenomics’ stimulus has fostered the the recent strength of the euro and the latest comeback or reprise of the European peripheral bond’s convergence trade? Part of today's risk ON landscape has been due to this too.

From Bloomberg’s chart of the day: (bold mine)

Euro-area peripheral bonds are hooked on Japan’s monetary stimulus.

The CHART OF THE DAY shows Europe’s peripheral bond rally stalled this month as the yen strengthened versus the euro. Last week the Bank of Japan refrained from adding to the 60 trillion yen ($589 billion) to 70 trillion yen poured into the monetary base each year that has encouraged Japanese investors to put money into higher-yielding European assets.

“Peripheral yield spreads appear vulnerable to a correction following the strong rally and the yen tends to often strengthen on credit risk,” said Anezka Christovova, a foreign-exchange strategist at Credit Suisse Group AG in London. “Japanese portfolio flows usually have an impact. Those flows could now divert elsewhere. We don’t expect any substantial action from the Bank of Japan in coming months and that could also lead the yen to strengthen.”

Japanese investors bought a net 1.41 trillion yen of long-term foreign debt in the week ended May 16, the most since Aug. 9, data from the finance ministry in Tokyo showed on May 22. Flows into Europe may be tempered as yields in Europe’s periphery climb. The average yield spread of 10-year Portuguese, Greek, Spanish and Italian bonds over German bunds has risen 20 basis points this month to 270 basis points, after touching 239 basis points on May 8, the lowest since May 2010, based on closing prices.

New York-based BlackRock Inc., the world’s biggest money manager, said on May 8 it had cut its holdings of Portuguese debt, while Bluebay Asset Management said on May 9 it had seen the majority of spread tightening it was looking for.

This yen euro carry perspective has been shared by my favorite laser focused bubble watcher Credit Bubble Bulletin’s Doug Noland: (bold mine)

Importantly, Draghi’s “ready to do whatever it takes… And believe me, it will be enough” was a direct threat aimed at speculators that had accumulated large bets against European debt and the euro. It’s my view that the Fed and BOJ’s extraordinary measures to devalue the dollar and yen – as the ECB refrained from QE - were instrumental in bolstering the vulnerable euro. And with global central banks supporting the euro coupled with Draghi promising a bond backstop, suddenly European periphery bonds were transformed into an incredible opportunity for speculation - in a world awash in free-flowing speculative finance. Stated differently, the major central banks dictated that the hedge funds and speculators reverse their bearish euro-related bets and instead go leveraged long. This powerful Bubble flourishes to this day.

Aside from ensuring financing flows of government, QEs and ZIRPs have implicitly been meant to suppress “shorts” or bearish bets on the asset markets. In other words, monetary policies have directed to massage market prices by fueling a an asset boom. This is the Bernanke/Yellen-Kuroda-Draghi put in action.

Yet if the BoJ will remain resolute in abstaining from providing further stimulus, then the Yen-Euro carry will reverse and most likely bring back Risk OFF environment. But will the BoJ just take the heat from the Wall Streets of the world?

Also, has the Philippine central bank chief's repeated mentioning of the concerns over foreign "hot money" flows been tacitly referring to this yen-euro carry?

Very interesting times indeed.

George Soros Hedges Portfolio with a Huge Bet Against the S&P 500

From the Businessinsider:

Billionaire George Soros' family office hedge fund, Soros Fund Management, filed its 13F quarterly report with the Securities and Exchange Commission yesterday.

As Marketwatch reporter Barbara Kollmeyer points out, one interesting highlight from Soros' filing is that he bought a bunch of puts on the SPDR S&P 500 ETF in Q2.

It's his biggest holding in the filing.

During the second quarter ended June 30, Soros held 26,157 shares of SPDR S&P 500 and call options on 143,600 shares and put options on 7,802,400 shares in the ETF.

via SEC

In the first quarter ended March 31, Soros held 17,065 shares and puts on 2,618,700 shares of SPDR S&P 500 ETF. 

What's so significant about this move is that puts are used for a downside bet.

It appears that Soros has placed a large bet through S&P 500 puts, basically giving him the right, but not the obligation, to sell them in the future. 

So if the S&P 500, or the ETF which tracks the S&P 500 goes down, Soros will profit handsomely.  

Then again, Soros also bought 66,800 shares of Apple (a major component in the S&P) and he owns a bunch of other stocks.  So buying S&P 500 puts can also act as a hedge. 

Billionaire and market savant George Soros may have indeed hedged his portfolio with a huge bet against the S&P 500 despite having several long positions on many individual stocks.

The action of George Soros reflects on the predicament of investors today. One can hardly take on a purely naked ‘long’ or naked ‘short’ position on the markets.

Being naked 'long' subjects one to the risks of boom-bust cycles from government policies. This I believe represents the Soros- short position

Naked 'short', on the other hand, subjects investors to the anti-shorting policies by governments. Governments has channeled these indirectly through monetary policies (QE and ZIRP) and directly via regulatory bans.

Yes, all these QE-ZIRP stuff have been meant to boost asset prices to keep both the government and their central bank-banking appendages afloat via stealth transfer from society to them or Financial Repression.

So Mr. Soros has long positions in many stocks such as Apple, Google, Johnson and Johnson, JC Penny and etc…

George Soros seems to have emptied his direct gold holdings (signs are that he converted them to physical holdings) but remains heavy on the mines Newmont Mining, Goldcorp and Barrick Gold.

This segment of gold related holdings by MR. Soros reveal of his hedge against government inflationism.

The Soros portfolio exhibits how one should deal with today's highly politicized markets.

Paper ‘Wall Street’ Gold versus Physical ‘Real’ Gold

Casey Research economist Bud Conrad suggests that the recent flash crash in gold may have been engineered.

Can markets really be influenced by big players? Well, was the LIBOR rate accurately reported by huge banks? Have players ever tried to corner markets? The answer to all the above, unfortunately, is yes.

There's an even bigger problem with the legal structure of the futures market: even the segregated funds on deposit can be pilfered by the broker for the brokerage's other obligations. That is what happened to MF Global customers under Mr. Corzine. (I had an account with a predecessor company called Man Financial – the "MF" in the name. I also had an account with Refco, which is now defunct. Fortunately, the daggers did not hit my account, since I was not a holder when the catastrophes occurred.) My take: the futures market is dangerous, and not a place for beginners.

One last note: after the Bankruptcy Act of 2005, the regulations support the brokers, not the investors, when there are questions of legality about losses in individual investment accounts.

The recent actions in the gold markets reveals of the stark difference between paper gold and physical gold markets.

Paper gold markets have essentially been influenced by Wall Street, who in turn are influenced by policymakers such as the FED and central bank cartel, as well as, the governments via regulations and mandates.

In contrast, the physical gold represents real demand and supply which involves the consuming and investing public and real inventories around the world.

So when gold prices suffered a quasi price crash, instead of triggering a wave of selling spree, retail participants rose to the occasion and used such opportunity to accumulate with such ferocity. 

Of course it would be a mistake to view retail buying as non-investments or as non-investors as media commonly portrays. 

Said differently panic selling in Wall Street extrapolated to the inverse scenario—panic buying in the global physical market as shown by the chart from US Global Investors.

In short, the gold flash crash demonstrated the contrasting actions between politically backed financial institutions and of non political influenced individuals.

There has been more accounts of rapid depletion of gold inventories as a result of the flash crash. Premium on physical gold continues to rise, particularly in Asia as of this writing, as a result to supply constraints

Even prior to the flash crash, physical markets kept showing signs of vigorous demand, so the crash shouldn’t have happened, but it did.

This tell us that the parallel universe or patent disparity between gold’s paper markets and the physical markets implies of the anomalous nature with the current pricing dynamics of gold. 

Thus logic supports the idea that there has been an ongoing suppression-manipulation scheme against gold prices or an undeclared war on gold.

And it would also signify a mistake to assert otherwise.  

We don’t really need conspiracy theories, for the simple reason that manipulation of the marketplace has been legitimated and a principal tool used for implementing social policies.

Proof? From Ben Bernanke’s 2010 speech: (bold mine)

Notably, since December 2008, the FOMC has held its target for the federal funds rate in a range of 0 to 25 basis points. Moreover, since March 2009, the Committee has consistently stated its expectation that economic conditions are likely to warrant exceptionally low policy rates for an extended period. Partially in response to FOMC communications, futures markets quotes suggest that investors are not anticipating significant policy tightening by the Federal Reserve for quite some time. Market expectations for continued accommodative policy have in turn helped reduce interest rates on a range of short- and medium-term financial instruments to quite low levels, indeed not far above the zero lower bound on nominal interest rates in many cases.

The FOMC has also acted to improve market functioning and to push longer-term interest rates lower through its large-scale purchases of agency debt, agency mortgage-backed securities (MBS), and longer-term Treasury securities, of which the Federal Reserve currently holds more than $2 trillion.

Or from a recent speech

The expected path of short-term real interest rates is, of course, influenced by monetary policy, both the current stance of policy and market participants' expectations of how policy will evolve. The stance of monetary policy at any given time, in turn, is driven largely by the economic outlook, the risks surrounding that outlook, and at times other factors, such as whether the zero lower bound on nominal interest rates is binding

The above speeches showcases how the FED works to influence the interest rate markets and thereby financial and economic forces. They are direct manipulations on the bond markets and indirect manipulations on other financial instruments.

 

Market manipulation has also been acknowledged by authorities. The New York Fed bragged about how FED policies has boosted US stock markets.  Japan’s finance minister recently said that they have a target for their stock markets.

Governments have also been engaged in banning short sales in both the stock markets and the bond markets to influence prices. Have this not been manipulation?

Here is a recent one.

From the Financial Times

It’s called the law of unintended consequences. Last November, European regulators were fed up with hedge funds using the derivatives market to bet against sovereigns so they imposed a ban on outright speculation.

But fund managers, not being ones to roll over and play nice for regulators, have found other ways to express the same view – this time in a way that analysts warn could increase borrowing costs for the banking sector.

Six months on from the ban on buying naked sovereign CDS protection – where the investor does not own the underlying government bond – it is clear that negative bets against large financials have emerged as a partial replacement.

A CDS, or credit default swap, protects the buyer against the risk of a company or government going into default. The instrument is worth more if the risks of default is perceived to be higher.

Investors are buying protection on European banks on the basis that banks and sovereigns are so intimately linked that any increased risk of a sovereign default will increase the value of a bank CDS in a similar way to a sovereign CDS.

Using organized force or governments to prevent markets from clearing or from revealing their real conditions are manipulations. Government's actions,  thereby, signify as the ultimate perpetrators of insider trading and of picking winners and losers.

So if the stocks and bond markets have been subjected to interventions, or may I say manipulations, directly or indirectly, then why should the gold-commodity markets be any different?

As I recently wrote,

A famous politician once said, You can fool all the people some of the time, and some of the people all the time, but you cannot fool all the people all the time.

The pushback from the gold bear raid as seen in the physical gold market implies that the governments and their apologists cannot fool all the people all the time.

Why Short Selling has been at the Losing End

Short sellers have been at the losing end.

Notes the Economist

THE long-short ratio of global equities, a gauge of market sentiment, is at a five-year high. The ratio, which measures the value of stocks available for short-selling to what is actually on loan, shows longs outnumber shorts by a factor of more than 12, suggesting investors are increasingly bullish. Higher stockmarkets are driving the ratio upwards, as the amount on loan has not changed significantly in the last few years. The appetite for short-selling has been affected by uncertainty over regulation, and by a change of strategy from hedge funds (big short-sellers), which have been less leveraged since the financial crisis. But while the long-short ratio of American and European equities has increased, bears are far from extinct: between 7% and 8% of lendable value is still on loan to short-sellers.

The “appetite for short-selling has been affected by uncertainty over regulation” has been true, but the significance of the role of policies influencing the marketplace seems to have been downplayed.

It must be remembered that markets respond to policies even as many of the current policies has been instituted to affect or influence the markets. 

The fact is that numerous countries have resorted to directly banning of equity and bond short sales despite the questionable efficacy of such measures. 

Inflationism employed by global central banks led by the US Federal Reserve and the European Central Banks have explicitly been targeted to shore up asset prices which means an assault on equity short sellers and bond vigilantes too. 

Bank capital standards have also influenced preferences and the distribution of asset ownerships held by mainstream institutions. 

The US crisis of 2008 reveals that tax and administrative policies had influences to the housing bubble. 

I hardly see any material changes on these.

The point is that current supposed “wealth effect” policies meant to promote asset bubbles signifies as an onslaught against short selling. Or policies have been designed to discriminate against equity short sellers and the bond vigilantes.

The real reason for such policies has hardly about “wealth effect” but to prop up the balance sheets of many insolvent political economic systems (banking-central banking-welfare and warfare state).

Short sellers and bond vigilantes will resurface in the fullness of time.

As a side note: In the Philippines, regulations on short sales have rendered short selling basically impractical. Thus, financial institutions have been incented to see a one directional market: up or a boom. 

Yet reality tells us that policies that shapes a boom will eventually lead to a bust.

War on Short Selling: Price Controls Fail

Prohibition in terms of market transactions or via short selling fails.

From Wall Street Journal’s Real Time Economics Blog

New research supports the notion that instituting temporary short-selling bans during stock market downturns doesn’t do any good.

This might not seem like shocking news to those who believe you have to let market forces play themselves out, even in volatile times, and to those who distinguish between the impact of short selling, the borrowing of shares with the expectation of buying them later at a lower price, and flat-out selling.

Nonetheless, the regulatory bans go on. Just last month, temporary short-selling bans of sorts were put in place in Italy and Spain.

In this latest look at short-selling bans, Federal Reserve Bank of New York economist Hamid Mehran teamed with Robert Battalio and Paul Schultz, both of whom are finance professors at the University of Notre Dame.

Harkening back to the dark days of the financial crisis in the U.S., they studied the two-week ban on short selling of financial stocks that was imposed in 2008 in a futile attempt to stop the massive sector bleeding.

“The 2008 ban on short sales failed to slow the decline in the price of financial stocks; in fact, prices fell markedly…and stabilized once it [the ban] was lifted,” the economists wrote in the latest issue of the New York Fed’s Current Issues in Economics and Finance.

And lest you think this tilting at windmills by banning short sales is a harmless sort of regulatory exercise by perplexed officials in the midst of a crisis, the trio begs to differ.

“If anything, the bans seem to have unwanted effects of raising trading costs, lowering market liquidity and preventing short sellers from rooting out cases of fraud and earnings manipulation,” the economists write.

The real goal of the trading bans is to establish price controls.

Regulators pass the proverbial hot potato (shift the blame) of policy failures or has been scapegoating the markets.

Regulators want to project of “do something” actions, no matter how these would only make the matters worse through “unwanted effects”.

“The regulatory bans go on”, is an example where in the world of politics, doing the same thing over and over and expecting different results has been the convention. That’s because political agents don’t get sanctioned for their decision mistakes which has widespread longer term implications.

On the contrary, regulators use market’s volatility as excuses to curb on people’s property rights, and importantly, to expand their control over the marketplace. This is why the idea that crises may have been premeditated cannot be discounted because political agents see these as “opportunity to do things you think you could not do before”

Political authorities also fantasize about using edicts to banish the natural laws of demand and supply to oblivion. Theories, history and or experience seem to have no relevance in the world of politics.

Importantly the tactical “do something” operations have barely been about the “public goods” but about saving their skins and of their cronies.

Of course, price controls can also come in indirect forms like central bank’s zero bound rates, quantitative easing and the operation twist (manipulation of the yield curve) and or other forms of interventionism (e.g. changing of the rules).

Even the classic Pavlovian mind conditioning communication strategies (signaling channel) employed by political institutions have had distortive effects on the marketplace.

The popular attribution of today’s recovery in the US equity markets looks like a nice example.

From Bloomberg,

The Standard & Poor’s 500 Index (SPX) rose for a sixth day, the longest rally since 2010, amid speculation the Federal Reserve will pursue more stimulus measures. Treasuries rose and commodities fell as Chinese and French data added to signs the global economy is slowing…

“The weaker the data, the higher the likelihood of stimulus from central banks,” said Alan Gayle, a senior strategist at RidgeWorth Capital Management in Richmond, Virginia, which oversees about $47 billion. “The weakness in China is likely to prompt a move there,” he said. “While the Fed has been clear it will do anything to support growth, some people tend to think it’s inevitable.”…

“Whilst markets have recently been rallying on bad news -- in the expectation that it will lead to further stimulus from the central banks -- the deterioration in the fundamentals is becoming a bit harder to ignore,” said Jonathan Sudaria, a trader at Capital Spreads in London. “Traders may be disappointed if their thirst for stimulus isn’t satiated as soon as they expect.”

See bad news is once again good news.

The public’s mindset has continually been impressed upon or manipulated to expect of salvation from political actions.

Central banks of major economies have more than doubled the size of their balance sheets (chart from cumber.com) yet the global debt crisis has not only lingered but has been worsening.

Interventionism through price controls have basically reduced the financial markets into a grand casino, which has tilted to benefit cronies while at the same time has vastly reduced or narrowed people's time orientation.

All these merely validates what the great professor Ludwig von Mises warned, (italics original)

Economics does not say that isolated government interference with the prices of only one commodity or a few commodities is unfair, bad, or unfeasible. It says that such interference produces results contrary to its purpose, that it makes conditions worse, not better, from the point of view of the government and those backing its interference.

At the end of the day, economic reality will expose on the quackery of interventionism.

Explaining Super Mario’s Trifecta

The Buttonwood’s Notebook columnist (Philip Coggan) of the Economist provides a presumable explanation of last week’s rally following ECB Prez Mario Draghi’s pledge to do “Whatever it Takes to Save the Euro”

AN interesting note from the always-perceptive Dhaval Joshi at BCA Research shows that July was a remarkable month. It was the only month in the last 400 in which European stocks, the German 10-year bund and gold rallied by more than 2.5%. Even when Mr Joshi uses a lower 2% hurdle, the last simultaneous rally on this scale was February 1987, and there have been only seven such months in the last 30 years.

Normally, you would expect the conditions for a simultaneous rally to be rare. Inflation would be good for gold and bad for bonds; a recession would be good for bonds and bad for equities and so on.

Super Mario was partly responsible for July's trifecta with his promise to do whatever it takes to save the euro. Equities rallied on the hope that Europe's economy would avoid a catastrophe; gold rallied because the ECB would likely create money; and bunds rallied because the ECB would save all the costs of Spanish rescue from falling on the German taxpayer. or at least that is a plausible explanation, based on the fundamentals. An alternative is that this was a risk-on rally in which investors moved money out of cash and into any likely asset class.

I may add a more important dimension to the above explanation: shorts had been deliberately set up for the ambush

One example: Euro shorts collapsed by 10% in one week and 35% in one month.

Notes the Zero hedge,

And where two months ago, the net short position in the EUR hit an all time record, north of -200K contracts, in the interim this number has contracted by over a third, and as of minutes ago was revealed to be "just" 139K in the week ending July 31, a 10% drop in shorts in one week. Why is this important? Because while short covering rallies have long been yet another narrative to keep shorts on the sidelines, the probability of such an event has declined dramatically now that the bulk of the weak hands have been kicked out, and the net exposure is back to January 2012 levels.

Underneath all the supposed noble sounding rhetoric to save the Euro, interventionism has mostly been about price controls or the manipulation of markets.

Shoot the Messenger: Spain, Italy Ban Short Selling of Equities

When markets expose on the errant ways of the political system, the mechanical reaction by politicians has always been to shoot the messenger.

From the Bloomberg,

Spain and Italy moved to ban short- selling of stocks as prices dropped and the euro traded below its lifetime average against the dollar on concerns about the European Union debt crisis.

Spain’s stock market regulator, the CNMV, said it was banning short selling of all stocks for three months, amid “extreme volatility.” Italy’s Consob said its ban, scheduled to last a week, was introduced on some banking and insurance shares because of the “recent performance of stock markets.”

Today’s bans echoes decisions in August of last year by France, Belgium, Spain and Italy to temporarily ban short selling of financial stocks in an effort to stabilize markets after European banks, including Societe Generale SA (GLE), hit their lowest levels since the credit crisis of 2008…

The Spanish prohibition also covers over-the-counter derivatives, the CNMV said. Market making activities are excluded from its measures.

The underlying hope of politicians has been to reverse the lessons of the famous legend of King Canute who commanded sea waves “to advance no further”. King Canute tried to show “his flattering courtiers” that his power meant “nothing in the face of God's power”

The modern version is that politicians hope that by pinning or diverting the blame on the markets, and through edict or fiat, the basic laws of economics can be overturned.

Spain’s Bolsa de Madrid Index

Dow Jones Italy Stock Index

Note the article says, “Today’s bans echoes decisions in August of last year by France, Belgium, Spain and Italy”, yet both the charts of Spain and Italy, in spite of the last year’s ban, has been trading much much much lower than when the attack against the markets had been implemented.

As I previously wrote,

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

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

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

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

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

Except for #2 which does not seem to apply today as events seem to exhibit accelerating deterioration, everything else seem pertinent

I would further add that such bans are, in reality part of the price control mechanisms employed by desperate and frantic politicians that only aggravates the imbalances of the system.

Doing the same thing over and over again and expecting different results has been the stereotyped reaction by political authorities everywhere. Yet as one can observe, politicians never really learn, which is why we should expect the crisis to worsen. Also, this shows how politics has been mainly about short term fixes and the struggle to preserve of political entitlements. Someone once defined this as “insanity”.

Will the Phisix Divergence Last?

My source of livelihood has almost entirely been from the local stock market, particularly investing, as I am hardly or rarely a short term trader.

Thus, objective and thorough investigations, assessments and analysis have been IMPERATIVE on me. And as part of my investing philosophy, I try to avoid getting married to a position, in as much as assuming the HIGH RISK role of becoming a stock market CHEERLEADER.

Losing money means my family will starve and this is why I cannot afford to lose money. Therefore such punctilious efforts, on my part, to deal with risks represent what have been known as stakeholder’s problem—where my incentives to attain relevant knowledge are prompted by the degree of my stakes in the financial marketplace. Since I depend on the markets thus I have to know the possible risks attendant to my positions.

And this outlook which I share with you, has not only been based on my battle hardened experience, but also from my candid evaluations of the conditions of the risk environment.

I am not here for an egotistical trip as many have been wont to.

Separating Signals from Noise

I have long been an adherent to the wisdom of the legendary trader Jesse Livermore. I have repeatedly been posting one of my favorite Mr. Livemore’s aphorisms here (bold emphasis mine)

I began to realize that the big money must necessarily be in the big swing. Whatever might seem to give a big swing its initial impulse, the fact is that its continuance is not the result of manipulation by pools or artifice by financiers, but depends on underlying conditions. And no matter who opposes it, the swing must inevitably run as far and as fast and as long as the impelling forces determine.

Simply said, profits are to be made based on underlying conditions which drives the general trend, and importantly, serves as the critical source of big swings.

And this is why I give heavy emphasis at the unfolding events based on the big picture. Unlike most practitioners, I am hardly swayed by vacillations from ticker tape activities.

Yet, ticker tape activities and the big picture frequently represent the noise and signal problem

Nassim Nicolas Taleb in his forthcoming book wonderfully explains the psychological impact from noise and signal[1]

we are not made to understand the point, so we overreact emotionally to noise. The best solution is to only look at very large changes in data or conditions, never small ones.

Just as we are not likely to mistake a bear for a stone (but likely to mistake a stone for a bear), it is almost impossible for someone rational with a clear, uninfected mind, one who is not drowning in data, to mistake a vital signal, one that matters for his survival, for noise. Significant signals have a way to reach you. In the tonsillectomies, the best filter would have been to only consider the children who are very ill, those with periodically recurring throat inflammation.

There was even more noise coming from the media and its glorification of the anecdote. Thanks to it, we are living more and more in virtual reality, separated from the real world, a little bit more every day, while realizing it less and less. Consider that every day, 6,200 persons die in the United States, many of preventable causes. But the media only reports the most anecdotal and sensational cases (hurricanes, freak incidents, small plane crashes) giving us a more and more distorted map of real risks. In an ancestral environment, the anecdote, the “interesting” is information; no longer today. Likewise, by presenting us with explanations and theories the media induces an illusion of understanding the world.

And the understanding of events (and risks) on the part of members of the press is so retrospective that they would put the security checks after the plane ride, or what the ancients call post bellum auxilium, send troops after the battle. Owing to domain dependence, we forget the need to check our map of the world against reality. So we are living in a more and more fragile world, while thinking it is more and more understandable.

The bottom line is that many people get confused when working to separate the proverbial wheat from the chaff or when filtering signal from noise. People with lesser stakeholdings are likely to emphasize on the noise which usually signify as “an illusion of understanding the world” and or embrace steeply biased (but unworkable and highly flawed) theories.

The Dopamine Fetish

I would also add that part of the psychological-neuroscience aspect in dealing with markets has been about dopamine neurons.

People’s dopamine neurons, or brain chemicals, gets fired up when rewards attained are GREATER than expected. In contrast, REGRETS are symptoms of depressed dopamine neurons. Thus short term thinking and short term trading have MOSTLY been about the fetish for dopamine trips.

A study on neuroscience suggests that dopamine flows are pervasive during early stages of a ballooning bubble, reflecting desire for profit. However as the bubble peaks, dopamine flows tend to culminate in a cessation just before the market burst[2]

Monetary policies by central banks also whet or induce dopamine powered speculative behaviors[3].

The lesson here is that we should manage our dopamine flows rather than allowing dopamine neurons to dominate the risk-reward tradeoffs that confront our investing decisions. This is basically about Emotional Intelligence (EI)

Let me further add that the technical construct of the Philippine Stock Exchange has been skewed to inculcate upon the public of the upside bias for issues listed on the markets, as well as, the component index.

The rational for this seems to be part of the political designs to exhibit economic booms.

Take shorting. While shorting has been legalized, rigorous procedural and regulatory compliance requirements have made shorting impractical. So we have a facility that has hardly been used.

And since market participants only earn from an UPSIDE price move, thus logically, the dominant entrenched PSYCHOLOGICAL bias would be for the public to yearn for the stock market to go only in one direction—UP.

Next, complimenting the psychological and physiological aspect, monetary policies have also been rewarding speculative activities at the expense of savings and production.

So intensifying speculative activities extrapolates to the herd effect in motion.

Where the basic function of the stock market has been about the cost of buying future income stream relative to insecurities (risk and uncertainty), such functionality has been negated or substituted by rationalizations for price chasing momentum.

Writes Kevin Dowd, Martin Hutchinson, and Gordon Kerr at Cato Forum for monetary policies[4],

Low interest rate policies not only set off a malinvestment cycle but also generate destabilizing asset price bubbles, a key feature of which is the way the policy rewards the bulls in the market (those who gamble on the boom continuing) at the expense of the sober minded bears who keep focused on the fundamentals, instead of allowing the market to reward the latter for their prudence and punish the former for their recklessness. Such intervention destabilizes markets by encouraging herd behavior and discouraging the contrarianism on which market stability ultimately depends. A case in point is the Fed’s low interest rate policy in the late 1990s: this not only stoked the tech boom but was maintained for so long that it wiped out most of the bears, who were proven right but (thanks to the Fed) too late, and whose continued activities would have softened the subsequent crash. The same is happening now but in many more markets (financials, general stocks, Treasuries, junk bonds, and commodities) and on a much grander scale. Such intervention embodies an arbitrariness that is wrong in principle and injects a huge amount of unnecessary uncertainty into the market.

In essence, the inflationary boom psychology has been distorting economic reasoning.

Add to this the leash effects of bailout policies.

The bottom line is that inflation fueled bull markets have become a religion to many.

And advises to undertake prudent positions—based on appraising the risk environment that may adversely affect one’s portfolio—has been seen as sacrilege.

Short Selling Not Recommendable; Contagion Risks

I also do NOT recommend shorting in the Philippines for the following reasons

-the cost to undertake shorts positions have been enormous relative to prospective gains (if a short position is required the best is to do it from overseas)

-a full blown BEAR market for the Philippines has NOT been yet established, although the RISKS from such scenario seem to be STRENGHTENING.

-global regulators have periodically been intervening. The degree of intervention mostly through bailout policies comes with such INTENSITY such that these can TORCH shorts on short notice. A good example has been Europe’s LTRO which singed Euro shorts at the start of the year[5]

-global regulators have innate biases against short sellers. They have done so lately through direct market interventions, such as drastic imposition of shorting bans which forces short covering to investors at a loss. A great example has been the shorting bans on Europe stock markets in mid-2011[6] in the political belief that speculations, and NOT insolvency, have been the fundamental problem that besets the Eurozone. Yet in spite of the bans, European stock markets continue to bleed PROFUSELY. This represents a vivid example of the “illusion of understanding the world” by political agents who always try to shift what has truly been their mistake to the markets.

Lastly I do NOT wish or DESIRE for a bear market.

Because of the limitations to take on hedge positions, bear markets or even phases of consolidation with a downside bias or volatility translates to income drought for me or most market participants (see the structural bull market bias above)

While I am an optimist who believes that the Phisix will reach 10,000 sometime in the future, I am also a REALIST who understands that external forces have a HUGE influence to actions of the local stock markets and that NO trend goes in a straight line.

In suggesting of the countercyclical trend amidst a secular trend I wrote in March[7],

I am not certain whether we will see a repeat of the discontinuities similar to the 1986-1997 bull market cycle or will suffer more than the past cycle before reaching my goal or if the Phisix will proceed to double. What needs to be monitored are drivers of the current trends and the whereabouts of the present boom cycle based on internal and external dynamics.

In short, the PHISIX, despite the secular trend, is VULNERABLE to a CONTAGION risk.

Could this week’s Phisix Divergence Represent an Anomaly?

The local benchmarket, the Phisix, majestically bucked the global stock market carnage last week.

As one would note, the Phisix has not only outperformed the region, the local benchmark basically defied gravity.

China and Malaysia joined the Phisix, as outliers, with hefty gains amidst a sea of red.

Yet such divergences have given the dopamine to Pollyanna trippers the ammunition to declare “bottom” for the market.

I have yet to be convinced.

The gist of the weekly gains or 52% of the Phisix came from Thursday’s activities.

Ironically, the sizable gains occurred in the backdrop of staggering US and global markets.

Media and experts has alluded to reports of sturdy domestic economic growth[8], the hints of a possible upgrade[9] by US rating agency Moody’s on the credit standing of the Philippines and the closure of milestone impeachment trial[10] with a conviction of the accused which favors the administration as reasons for this.

I beg to differ.

I raised this concern on this last Thursday[11]. The Phisix went down to as low as 67 points at the early session, dragged by the selloffs in the US and Europe. But suddenly, aggressive and systematic buying of heavyweights (blue chips) throughout the day pushed the Phisix to close at almost at the peak (76.81) at 73 points. The pendulum swing from loss to gain represented an astounding 2.8%!!!

Buyers seem to have, ironically, been resolutely aggressive to push up prices in an environment of MOSTLY falling stock market prices globally, perhaps in the assumption that local stocks will soon experience a strong surge.

Or is it?

The weekly performance of the heavy cap issues reveals that gains of the Phisix were mostly seen through Ayala Corp (AC), JG Summit (JGS), Banco De Oro (BDO), Metrobank (MBT), SM Investments (SM), International Container (ICT), PLDT (TEL) and Bank of the Philippine Islands (BPI).

The logical part for any buyers under such scenario would be to make use of the dour sentiment to take advantage of price declines to bargain hunt. Yet these have not been the case.

Let me lay out my suspicions.

I do not think that these has been due to general market sentiment, although pushing up the PHISIX index succeeded to give a boost to the general market sentiment.

Thursday closed with a mixed showing between advancers and decliners with the latter having a slight edge. On a weekly basis advancers took a slight lead over decliners showing modest improvement in the market breadth or sentiment.

Second my naughty thoughts suggests that Thursday actions was likely executed to create an impression of economic ‘confidence’. I am not so sure why though. Perhaps to squelch demand for signing waivers for top officials.

Buyers suddenly became price insensitive. The likelihood is that non-market entities may have been responsible for aggressively pushing up Big Caps. I would suspect that these may have been government institutions such as the SSS, GSIS or others.

While it is true that Thursday a net foreign buying, the bulk of these buying can be traced to cross trades at DM Consunji.

Besides, net foreign buying data may not reveal of the real extent of activities that took place. Foreign buying can represent overseas based subsidiaries or branches of locally owned corporate vehicles or tycoons, as well as, foreign based politically allied corporations.

Of course I may be wrong and that there may have been special factors driving up the Phisix.

But if my suspicions are valid then such interventions are likely to produce short term effects.

As example the Bank of Japan’s (BoJ) $13.3 billion[12] interventions DID bring down the Yen for about a month. However the Yen has been regaining lost grounds since. This effectively has neutered tax payer financed interventions. In short $13.3 billion down the drain.

Another question that begs to be asked is WHY the PHSIX alone?

While Malaysia did post hefty weekly gains next to the Phisix, the Malaysia’s benchmark (FBMKLCI:IND, green) has almost missed out the recent bull market. On the other hand, Thailand (SET:IND, orange) and Indonesia (JCI:IND, red) which shared or alternated the lead with the Phisix, since last year, has wilted significantly.

Yet it can be observed that ASEAN’s stock markets have been nearly been moving in nearly synchronous fashion UNTIL the peak in May of this year.

This only means that last week’s gains by the Phisix either represents an ANOMALY or that the Phisix LEADS Asia.

My bet is on the former.

The Decoupling Myth

I have been saying that current environment have been dominated by POLITICAL uncertainty which for the Philippines and ASEAN represents a CONTAGION risk.

If global markets stock markets have been pricing in a bust or the unwinding of malinvestments which is being transmitted to the global economies, then it would dangerous, if not reckless, to presume immunity or “decoupling” where trade and investment linkages of ASEAN economies have been deepening relative to the world.

ASEAN economies have largely been exposed to developments abroad through merchandise trade (exports and imports).

The Philippines merchandise trade represents over 50% of GDP, while Malaysia and Thailand are over 100%.

This means any meaningful economic slowdown in the region or in the world will negatively impact economic growth.

Add to this the potential slowdown effect on remittances and supply chain networks.

The deepening of financial globalization also means the integration of emerging Asia’s capital markets[13] with the world (left chart) and with intra-region (right pane).

In short, the false notion of DECOUPLING will likely melt in the face of a global recession or when a full blown financial crisis, if such phenomenon transpires.

Let me be clear, the conditional term is an IF, while global economies have indeed been slowing down, a global recession or worldwide contagion from euro’s financial crisis has yet to become evident in Asia.

Of course a decoupling COULD happen if there should be massive inflation or even hyperinflation from any of these major economies. However, under the current circumstances this is unlikely to happen.

This means that for those in the belief that the Philippines can decouple from the world, the following chart should be a helpful reminder…

2007-2008 signifies as the contagion based bear market.

Neither has there been an economic recession during the said period nor did earnings fall materially. But the Phisix entered a full blown BEAR Market and lost about 50% peak-to-trough as a result of an exogenously driven financial crisis in 2007-2008.

Of course 2008 is different from today. In fact, today has been worst compared to the 2008 crisis. In 2008 the crisis was limited to the banking, property and mortgage industry. Today the crisis dynamics has shifted to envelop banks AND sovereigns. Not to mention that world wide government debts have surged[14] and that US fiscal deficits have skyrocketed (at $1.327 trillion or 8.2 times larger than 2007[15]).

Yet for those who should insist on decoupling, then I wish you the best of luck.

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[1] Taleb Nassim Nicolas Noise and Signal — Nassim Taleb Farnam Street, May 29, 2012

[2] ChangingMinds.org The Neuroscience of Financial Bubbles

[3] See How US Federal Reserve Policies Stimulates the Public’s Speculative Behavior, May 8, 2012

[4] Dowd Kevin, Hutchinson Martin, and Kerr Gordon The Coming Fiat Money Cataclysm

and the Case for Gold

[5] Marketwatch.com Euro hits 3-month high on LTRO hopes, February 24, 2012

[6] Wall Street Journal, Europe Short Bans Extended, August 26, 2011

[7] See Phisix: The Journey Of A Thousand Miles Begins With A Single Step, March 12, 2012

[8] ABS-CBNnews.com.ph PH eco grows 6.4% in Q1; highest in ASEAN, May 31, 2012

[9] Businessmirror.com.ph Moody’s raises PHL to ‘positive’ May 29, 2012

[10] See The Lessons and Validity of Public Choice Theory Applied to the Chief Justice’s Corona Impeachment, May 29, 2012

[11] See Phisix: Very Impressive Day or Month End Close for May 2012, May 31, 2012

[12] Bloomberg.com Japan Adopts Stealth Intervention As Yen Gains Threaten Exporter Earnings February 7, 2012

[13] ADB ONLINE Asia Capital Markets Monitor August 2011

[14] Zero Hedge, Presenting Dave Rosenberg's Complete Chartporn, June 1, 2012

[15] Weiss Martin Lehman-Type Megashock Looming, Money and Markets May 21, 2012