A “Tipping Point” for the Philippine Capital Markets?

``The highest use of capital is not to make more money, but to make money do more for the betterment of life - Henry Ford

WHEN I came across one of last Sunday’s front page headlines from the Philippine Daily Inquirer entitled ``Why Pinoy savers are turning investors”, it brought a smile on my face for validating what we have LONG anticipated; a concrete testament of the emerging transformation on the psychological acceptability of domestic capital markets investing by the local populace.

Front page headlines reflect on national consciousness such that when the concept of capital markets investing turns topical and gets ingrained into the national level (to reach a proverbial “Tipping Point”), we should expect such trends to further deepen.

In Malcolm Gladwell’s marvelous bestseller the “Tipping Point”, this development could be classified as one of the key “principles of an epidemic”--the “Stickiness Factor” or the longer the idea/disease stays the more it is likely to get propagated.

The inherent strength of ANY capital markets basically lies with its domestic investor base or the so-called “home bias” rather than on foreign portfolio money. Unfortunately, local investors have in the past been geared towards a “US dollar bias” which resulted to the low penetration level of participants (demand side) or our much maligned state of the domestic markets which has been likewise reflected in the state of our national economy. This apparently is changing.

Technicians are wont to believe that they alone capture the directions of the markets by reading the psychological aspects from historical market action. In contrast, by understanding the Misesean standpoint of “Human Action”, where the late great Ludwig von Mises said ``Mans striving after an improvement of the conditions of his existence impels him to action. Action requires planning and the decision which of various plans is the most advantageous”, we asserted that prevailing global dynamics would work for this psychological shift among the local investing mindset.

In particular, we have long argued that our underappreciated, as epitomized by the low penetration level by local investors, and underdeveloped capital markets would mainly benefit from the “global liquidity” driven financial market activities, aside from deepening financial integration or globalization trends, as seen by the current symptoms in the APPRECIATING PESO, RISING PHISIX and RECORD LOW INTEREST RATES. And that such reported “savers turning into investors” signify our own version of “searching for higher yields” syndrome.

In other words, global economic trends have militated on local investor actions, notwithstanding, the activities in the Philippine asset classes in general.

Again we see this development under the rubric of Malcolm Galdwell’s third principle of an epidemic—the Power of Context, external or environmental influences play a far greater role than what we conventionally expect of them.

While the article served to highlight on the du jour accelerating trends, we’d like to make illuminate on some seemingly discrepant views covered.

First, the article quotes an official who says that “markets don’t move in the same direction” where he directly cites stocks and bonds moving inversely, as raison d’ etre for portfolio diversification.

Today’s markets have exhibited that some “textbook” concepts have ostensibly become “inapplicable” to a degree or even perhaps have turned “obsolete”.

Figure 1, from the IMF shows that global financial markets have been increasingly correlated in terms of performances gauged from different dimensions.

Figure 1: IMF (Global Stability Report): Growing Correlation Among Asset Classes and Across Borders

This is something I have shown in the past but would like to repeat to reemphasize on the point of correlation.

On the left panel of the chart is the Correlation of Asset Classes with the main US equity benchmark, the S & P 500, and its corresponding Broad market volatility while on the right panel is the Global Speculative Default rates.

The noteworthy aspect is that bonds or fixed income instruments and most especially commodities have in the past been NEGATIVELY correlated; today we are seeing a radical SHIFT where bonds and EVEN commodities or in fact ALL asset classes have been shown to be POSITIVELY correlated! All of the yellow bars signify positive correlation with that of the S & P 500 (right most yellow bar).

On the other hand, the right panel shows where emerging markets and OECD regions have had historically divergent spreads to reflect on the so-called “risk premia”. Today, such default rates have astonishingly disappeared or have even CONVERGED!!!

Again this is reflective of the prevailing perception of “sustainable” LOW RISKS environment where a country’s currency yield and economic growth factor has apparently taken precedence over other risk variables. In the same dimension we have previously showed that 90-day Philippine treasuries rates lower than its equivalent in the US.

From which again we ask; have investors come to price US treasuries as “riskier” than Philippine contemporaries? Has the emerging market class reflected significant improvement enough to classify its assets as equal or near equal to its developed market equivalent? Or has a new paradigm emerged? Or has this phenomenon simply exhibited a pricing misalignment? The future provides the answer in today’s juncture.

This from the IMF’s Global Stabilization Report (emphasis mine), ``...rising correlations in returns across asset classes have meant that the volatility of the overall market basket has not declined as much as the volatility of its component parts—indeed, by some measures it has increased. Insofar as markets have become overly complacent, they may not yet have priced in this covariance risk, which could lead to the further amplification of any volatility shock. For instance, the recent market sell-off in late February 2007 illustrated how seemingly minor, unrelated developments across markets quickly led to the unwinding of risk positions across a wide range of financial assets.”

In other words, traditional justifications for employing the conventional Portfolio Diversification model would simply be impertinent under present circumstances, where risks as well as rewards have been increasingly shared. So before listening to your financial advisor, who would advocate the traditional models of diversification, ask them of how to go around the risks of intensifying financial assets interlinkages.

The second issue which I wish to deconstruct comes from the statement ``This is the difference between a bank depositor and an investor—depositors can expect guaranteed principal and interest while investors can expect principal risk and yield.”

The implied premise is that bank depositors are “risk free” while investors are exposed to “principal risks”.

While this is TECHNICALLY true, that depositors can expect “guaranteed principal and interest”, the argument does NOT deal with the aspect of the depositor’s equivalent of PURCHASING POWER risks, as natural consequences of inflationary policies. This effectively translates to the risks of the erosion of the purchasing power of the depositor’s principal or an investor’s equivalent of principal risks in spite of guaranteed returns.

In the last issue we have dealt with Zimbabwe from where in 2006 their consumer prices indices have astoundingly soared by over 1,700% a year and yet where similarly its stock market has spectacularly spiked by over 12,000% in spite of an economic standstill (literally speaking).

What this means is that under such hyperinflationary environment, or translated to the currency’s massive loss in purchasing power, has compelled the general public to seek safe haven into the only most liquid asset, i.e. the stock market, which has acted as medium of insurance against the drastic fall in the value of its currency.

Since “guaranteed” fixed income instruments are almost equivalent to cash holdings, the loss of purchasing power translates to a loss in value for the depositor’s principal. While the nominal value of the currency remains, it buys increasingly less amount of goods or services in the marketplace.

Figure 2: Gavekal Research (Brave New World): Building an Efficient Portfolio in Our Brave New World

Put in a different perspective, fixed income instruments do well under disinflationary or deflationary environments as they increase the real value of the underlying currency’s purchasing power, while other assets as tangible assets or commodities normally serve as an insurance against a loss of purchasing power, as well as stocks under “hyperinflationary” mode as in the Zimbabwe or Germany’s 1920s Weimar experience. In the context of risks, even the US dollar which was once the Filipino’s favored asset class has shown of its vulnerability.

In Figure 2 courtesy of Louis Gave of Gavekal Research, the Gavekal team outlines a suggested portfolio allocation under FOUR different economic conditions.

In short, in this mortal world NOTHING is EVER “RISK FREE or GUARANTEED” (except for death and taxes). It is only the degree of risks that differs that which is determined by the nation’s primary economic activity.

Profitability and NOT Vanity Matters

``What feels good or is psychologically appealing is not necessarily profitable.” F.J. Chu

Just A little reminder. Our bullish stance has NOT in anyway been designed to SELL you stocks. If my main economic incentives had been the case, then I would have taken the “micro/corporate” fundamental analysis or “technical” analysis or “insider” route as channels to stoke our reader’s imagination or fire up their adrenalin.

Or I would have utilized my own “call center” version by conducting telephone campaigns instead of this lengthy episodes of writing (where personal phone calls has bigger probabilities for a close--spent nearly 15 years in the field of sales and marketing), or could have opted to work as a full time sell side analyst for a broker who would be willing to pay us enough to cover our basic needs or lastly consider the option to SELL this newsletter service to the public.

Unfortunately, I have deliberately not engaged in such activities as my intent is to specialize in this field of undertaking, which to my mind has vastly enormous potentials (remember bullish non-banking finance?).

Where our actions are a matter of choice, our bullish perspective emanates from our interpretation of market signals operating under our comprehension of the functional dynamics of the Philippine asset classes in relation to the global financial markets as contributing factors in determining absolute returns.

Bluntly said, our view stems from mainly the horizon of a trader-investor and NOT as your typical “sell side” analyst nor as a broker. Although candidly, I am a licensed agent in behalf of a broker, nevertheless, I am NOT paid to be bullish.

This means that divergences in our market outlooks or opinions should not be construed as conflict of interest on my behalf. As we have noted before, differences in economic outlooks, valuation appraisals, technical readings or market opinions or investing/economic/political philosophy pave way for exchanges in the marketplace and are natural and salutary elements of well functioning markets.

Our goal is NOT to be proven vaingloriously right but to be proven humbly PROFITABLE. ``For we are taking pains to do what is right, not only in the eyes of the Lord but also in the eyes of men.”-2 Corinthians 8:21

World Equity Markets on A Bullish Juggernaut, Phisix to Follow?!

``If you board the wrong train, it is no use running along the corridor in the other direction.”- Dietrich Bonhoeffer German theologian

WHILE the domestic stock market appeared to have partially responded to our forecasts of a “global contagion” influenced domestic meltup, this only came after wild swings during last week’s activities.

The Phisix was up 1.17% amidst streaking hot Asian indices as the Peso streaked to a new six year high at Php 47.51 against a US dollar.

The wild swings in our market has been coincidental to an apparently much wilder roller coaster activities in China, whose composite indices fell by over 4% last Thursday but ended the week still with significant gains, the Shenzhen up 5.85% (!!!) and Shanghai 1.87% after an equally strong rebound on Friday.

As we have previously noted, despite the uninspiring or tepid fundamentals, global markets have justified the present loose (inflationary) conditions as beneficial for equities and the rest of the asset classes. This has been greatly aided by the continuing swoon of the US dollar (as measured by the trade weighted index).

And such asset friendly financial market conditions means that in spite of credit (mortgage) growth slowdown seen in the housing sector in the US, there have been signs that more leverage taking activities have shifted to the other sectors.

Let me quote another favorite analyst Mr. Doug Noland of the Credit Bubble Bulletin, ``It appears obvious to me that rampant Credit excess runs unabated. Household debt growth may be moderating, while corporate borrowings are likely expanding at low double-digit rates. But it is the growth in financial sector borrowings that holds the key to liquidity puzzle. The leveraging of existing securities (there’s $45 TN of Credit market debt outstanding) – by hedge funds, in broker/dealer and bank “trading accounts” – is likely a major source of current liquidity excess.”

And such excess liquidity has certainly fired up the US markets to a blast-off stage...

Figure 3: stockcharts.com: US Equity Markets in OVERDRIVE!

We have previously shown how the US Dow Jones Industrials have served to inspire global indices. This time the uptrend has accelerated into a broad market run, as shown in Figure 3, where the S&P 500 (main window), the Nasdaq (highest pane), Russell 2000 (above pane) and Dow Transports (lower pane) have ALL conspired to surge beyond their recently established highs (blue arrows).

Such broad based advance can hardly be deemed as an “isolated” event. And in my view taking a bearish stand against such a vigorous “momentum” would be suicidal for one’s portfolio. Of course, over the short-run the markets may retrace, but given the present pace of advances, the odds are that the emotional impulses will continue to spur prices into a maximum overdrive.

As we have previously presented, the global financial markets have mostly tracked the directions of the US markets.

Last Tuesday, April 17^th the widely followed Canadian independent research outfit BCA Research, came up with their own bullish outlook as emerging markets broke out as shown in Figure 4.

Figure 4: BCA Research: Emerging Market Equities: Breakout!

Notes the BCA Research (emphasis mine), ``...many EM currencies are likely to appreciate further against the U.S. dollar, which will help bring down EM bond yields. In turn, this provides a bullish equity environment. Lower interest rates will further stimulate domestic demand, benefiting domestically oriented sectors and helping encourage P/E multiple expansion. Emerging market banks tend to perform particularly well during times of a falling U.S. dollar, and banks in Asia and Eastern Europe currently appear attractive.”

And such variables COULD HAVE fueled the bourses of our Southeast Asian neighbors to almost simultaneously SET new RECORD highs, as Indonesia, Malaysia and Singapore (except Thailand-still hobbled by political direction on its capital flows), as shown in Figure 5, as well as most of other East Asian neighbors as Taiwan, China, Australia and Korea (Hong Kong and New Zealand at resistance).

Figure 5: With Jakarta Hitting FRESH Record Highs, How Long Before The Phisix Catches Up?

With Indonesia’s Jakarta Composite Index (red candle) on a winning streak into FRESH record highs, the odds are that over the near term (possibly in a week or two), the Phisix (blue line) could likely breach its very own 10-year hurdle following the global juggernaut.

The Economist wrote a dampener following Indonesia’s recent foray to new bullish grounds (emphasis mine), ``Three times since the start of the year it has suffered sharp falls, partly as a result of contagion from problems in other markets (although to be fair, most other Asian markets have suffered similar fates). But Indonesia remains a high-risk market, and it is inherently vulnerable during bouts of global or regional market turbulence. Moreover, the very scale of the JSX Composite Index's gains also makes a corresponding downward correction that much more of a worry. In the 24 months to March, Indonesian equities rose by around 80%, compared with a median of around 45% in ASEAN. Valuations may also be on the high side. The average price-earnings (P/E) ratio of the JSX is currently 20.2, lower than China (22), New Zealand (22.5) and Japan (26.6) but higher than in most other Asian markets. In Singapore the average P/E ratio is 15.3, and in Thailand it is 10.4, although this probably indicates that political instability has lowered valuations.”

Last week, using the Zimbabwe experience we wrote on how monetary processes or inflationary policies can distort market prices and even climb amidst deteriorating economic conditions. And as global asset markets trek higher on grounds of loose money conditions which allows for more inflationary (leverage) undertaking, consumer price inflation continue to manifests itself in varying degrees most notably in Canada (highest in 8 months), China (highest level in more than two years on jump on food prices driving concerns over “exporting inflation”) and the UK (highest in 14 years, which prompted Bank of England governor Mervyn King to write Chancellor Gordon Brown for an explanation).

This makes us likewise recall billionaire philanthropist George Soros’ ``Theory of Reflexivity” where he says that the prevailing bias may impact not just market prices but also the fundamentals, from which becomes a self-fulfilling prophecy and eventually leads to a boom-bust sequence.

While the bears could be right where sometime in the future a liquidity crunch may ensue which could put a grinding halt and possibly reverse the present trends, for the moment market actions have NOT been favorable to undertake positions against the present trend, as the global money machine appears to be working in full throttle.

As always, it pays to consider a contingency plan under potential TAIL EVENTS from which the practical ways would mean risking only the amount one can afford by “position sizing” and by strictly “enforcing your stops”.

When our short term view matches our long term outlook, we tend to become emphatic on our calls.

Remember markets may remain irrational more than we can remain solvent and designing portfolio profitability should always factor in such anomalies.

Global Liquidity Conditions Should Buoy The Phisix

``You can't do well in investments unless you think independently. And the truth is, you're neither right nor wrong because people agree with you. You're right because your facts and your reasoning are right. In the end, that's all that counts. And there wasn't any question about the facts or reasoning being correct.”-Warren Buffett

JUST as I recommended a “Buy” following the conspicuous appearance of a turnaround, the door slammed shut on my face.

Momentarily, yes, the MOMENTUM which I have expected to have carried over seems to have faltered, and that the ticker says that my short term outlook could be wrong.

As student of the financial markets, we are taught to accept and endure mistakes as an integral part of investing, and to avoid from engaging ourselves in defending vanity, as market guru Peter Lynch has taught us, where he says, ``The list of qualities [an investor should have] includes patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit mistakes, and the ability to ignore general panic.”

However, before conceding to such omission, the overriding question is that has the facts CHANGED enough to merit our retreat?

This analyst began his crusade as a technician, long before graduating ourselves into a macro observer. Where in reality the market militates on a diversity of forces, to my mind, rigidly looking at the technical aspects in determining one’s investing decisions has been rather ONE-dimensional, operating in the misplaced assumption that technicals captures the entire breadth of investing psychology. Technicals are preferred tools of brokers whose economic objectives are mostly distinct from investors.

Besides, in the markets, it is not about being right but being profitable that truly counts. In whatever investing style one undertakes, success has been a matter of adhering to discipline.

So far our successes have stemmed from looking at several dimensions, most importantly with respect to macro developments in conjunction with multifarious market signals and market cyclicality over a longer span of time horizon. As you perhaps noticed, we rarely engage in short-term predictions.

With regards to technical aspects, looking at the Phisix today shows some signs of bearishness as revealed by a semblance of “topping” formation of a “Head and Shoulders” pattern. However as mentioned above, we will also assess on the other facets to determine the probability weightings with regards to the market’s outcome over the interim.

We will not belabor the significance of the Phisix’s strong correlation with global equities, in the face of escalating trends of global financial integration as discussed ad nauseam. However, Figure 1 shows that with reference to the developments with MOST global markets, the Phisix appears to have momentarily “DIVERGED” from the general trend.

Figure 1: Stockcharts.com: Divergent Phisix or a BLIP?

When making comparisons against global indices, we use established benchmarks for the purpose of shortening our presentation. It would be exacting and tedious if not downright confusing to show each and every 17 Asian, 18 European and 12 American bourses in one outlook.

For instance, our point is to PROVE that following the “Shanghai Surprise” at the end of February, markets in GENERAL have been recovering, where some indices have even set new record HIGHS.

The Dow Jones World index at the bottom pane and the JP Morgan Fleming Asia Equity at the upper pane has both been treading on record territories aside from depicting conformity with the apparent inspirational “leader”, the Dow Jones Industrial Averages (center line chart), as shown by the blue arrows.

It is noteworthy to emphasize that EACH “undulance” or the peak and troughs from the major to the minor ones appears to have been in CLOSE UNISON. Our question is, if the Phisix has played out a mostly similar rhythm with the rest of global equity bourses since 2003, could this “divergence” last or is it merely a blip?

Now let us examine the recent activities. The holiday-abbreviated Phisix have been the worst performer in a mostly buoyant Asia (down 2.34% over the week). Vietnam (-2.03%) followed next, with Japan (-.69%), New Zealand (-.49%), Bangladesh (-.29%) and Taiwan (-.03%) which showed minor declines, while the rest of the playing field registered SIGNIFICANT GAINS.

Considering that foreign money have DOMINATED trading activities and had been the MAIN CATALYST towards “significantly” most of the Phisix’s advances since 2003 could they be instigators of the present decline?

Foreign money unusually accounted for a LOW of 28.61% of the week’s turnover; this had been due to the humungous special block sales at San Miguel last Friday. And YES while Thursday’s (Php 58.097 million) and Friday’s (Php 10.064 million) declines had been spearheaded by foreign selling, over the week foreign money STILL registered (Php 1.069 billion) of NET foreign INFLOWs. In short, the degree of the outflows had been INCONSEQUENTIAL compared to the degree of the inflows over the week.

Moreover, during Thursday and Friday’s retracements noticeably foreign selling had been concentrated on FEW or SELECT issues, as measured by two successive days of selloff and relative to the respective volume turnover; namely PLDT (-6.25%), MEGAWORLD (-1.37%), RIZAL COMMERCIAL Bank (-9.8%), UNIVERSAL ROBINA (unchanged) and PNOC EDC (unchanged). The rest of the Phisix components have either shown minor outflows or to the contrary of our expectations, INFLOWs amidst the carnage.

Now in the perspective of the broader market, the spread between foreign inflows and the outflows or the “NET inflows” had been the LARGEST since advent of 2007, which includes the depressed sentiment of Thursday (40:29) and Friday (51:25). This certainly is not a convincing sign of a reversal of sentiment by foreign investors, is it?

Moreover, the fact that the Peso climbed to its HIGHEST level since 2001, breaking out from the Php 48 level against the US dollar to close at PHp 47.905 to a USD, implies that more Pesos are being bought relative to the US dollar.

What this simply tells us is that foreign money has NOT initiated last week’s decline but local players.

Figure 2: Studying Elections 2004; Election Jitters suggests a buy?

So our next question would be what has prompted local players to such panic driven selloff?

PERHAPS election day jitters. As the national and local election day approaches, one should expect this major political variable to preponderate over the airspace and nonetheless serve as an excuse or justification by mainstream analysts to explain on the activities of the market.

Figure 2 likewise shows us that learning from the last electoral experience, in 2004, possible election jitters COULD HAVE triggered (we forgot the conditions which lead to this) a short-term decline, from April 28 to May 19^th where the Phisix lost 9% (see blue circle). Yet over the following months Phisix worked to regain all such losses and by September had been trading above its April high. Could it be that local investors today are figuring out the same scenario today?

Yet, as the same experience shows, a knee jerk selloff under a bullish backdrop presents as BUYING opportunities instead of selling on crowd following “sentiment”.

Figure 3: US Dollar driven Phisix

Over the years I’ve repeatedly argued that the Phisix had been mostly driven by the US dollar dynamics.

The Phisix has sizably OUTPERFORMED when the US dollar as measured by the trade weighted index backslides. In Figure 3, it is conspicuously shown that as the US dollar declines (signified by the red trend lines at lower pane), the Phisix rises sharply (red trend lines at center window).

Notice too that when the US dollar staged a substantial rally in 2005 as denoted by the blue trend line, the Phisix has traded mostly sideways, as represented by the blue box.

Well, with the US dollar breaking DOWN from its CRITICAL support level, it could be expected that such added liquidity should serve as support to global asset classes including that of the Phisix and to other Philippine asset classes.

Dr. Ed Yardeni of the Oakwood associates underscores our view of such accommodative stance in favor of global asset classes (emphasis mine), ``...foreign central banks are already increasing their purchases of US Treasuries and Agencies to avert a precipitous drop in the dollar. The growth of FRODOR--foreign official dollar reserves--rose to 20% y/y last week, up from 13.3% late last year, and the highest since January 2005. In other words, the latest bout of dollar weakness is once again causing central banks to pump up the pace of global liquidity, which is why commodity prices are taking off again. Indeed, the CRB raw industrials spot price index is now a whopping 32% above its previous cyclical peak during the global boom of the mid-1990s! The IMF’s data show that non-gold international reserves rose to a record $5.15 trillion in January, more than doubling since the start of the decade. Emerging nations held a record $3.71 trillion in international reserves in January, up 24.8% y/y. International reserves held by industrial countries were unchanged at a record high $1.44 trillion, 6.3% above a year ago.”

So AGAINST a backdrop of combined bearish indications from the technical viewpoint and potential seasonal (remember Wall Street’s longstanding axiom “sell in May and go away”?) weakness to even possibly localized anxiety as the “election jitters”, we should view ANY selling amidst a weakening dollar (on continued premise of global search for yield) as prime conditions for BUYING OPPORTUNITIES.

Of course, anything can happen to the markets over the short-term, but given the strong correlation of the US dollar and the Phisix, as well as the internal dynamics of the Phisix (dominant foreign buying), it is likely that the present divergence may well be a blip.

And it is also important to remind ourselves that ANY risks that are most likely to emerge could EMANATE from exogenous factors, as evidenced by the May 2006 shakeout and the recent February “Shanghai Surprise”. As they may be caused by events in the US, such as withdrawn liquidity from the subprime mortgage fallout or geopolitical policies and reactions thereof (as protectionist measures against China or a military strike on Iran) or a US dollar crash, or possibly (to a lesser degree) in China or other emerging markets (which may cause a domino effect) or unwinding of the of carry trades, however, present day markets appear to have discounted such developments FOR THE MOMENT.

The Significance of the Phisix 3,400

``Investing should be dull. It shouldn't be exciting. Investing should be more like watching paint dry or grass grow. If you want excitement, take $800 and go to Las Vegas.”- Nobel Economist Paul Samuelson

WHEN 3,400 was mentioned as a benchmark, the significance for this is the “concept of round numbers” as propounded by the legendary trader Jesse Livermore (Reminiscences of a Stock Operator), where he says that a round number crossed for the “first time” should likely keep the momentum going further.

In technical lingo, the Phisix has drifted above the 3,400 level from January 31^st to February 5^th in 1997 whereby its watershed level was reached at 3,447.6 on Feb 3, 1997. The other “high” was in January 4^th of 1994 at 3,308.37.

Figure 4: A Breakout of 3,400 Validates the Path to 10,000?

This means to say that it is NOT the first time for the Phisix to reach the 3,400 level. But should it reattempt to do so, it implies that a sustained breach of such threshold level SHOULD SPUR the Phisix to a much significantly higher level.

And MOST IMPORTANTLY, a sustained breakout connotes of the validity of the underlying PRIMARY STAGE of the Phisix bullmarket (nominally based and not inflation adjusted) which I think buttresses our assumption that the Phisix will conservatively reach 10,000 over the present cycle (barring a global depression) see figure 4.

In addition, in a WORLD OF DIMINISHING RETURNS, a Phisix at 3,400 relative to Friday’s close translates to 5.67% return, so absolute threshold levels basically sets your portfolio returns.

Zimbabwe: An Example of Global Inflationary Bias?

``The financial press sometimes criticizes Federal Reserve policy, but the validity of the fiat system itself is never challenged. Both political parties want the Fed to print more money, either to support social spending or military adventurism. Politicians want the printing presses to run faster and create more credit, so that the economy will be healed like magic- or so they believe.”-Congressman Ron Paul of Texas, The Federal Reserve Monopoly over Money

WE have always argued that markets remain irrational (especially over the short-term) more than we can remain solvent. Because I’ve lately quoted Keynes a lot (based on momentum and NOT on Demand management through government intervention), I have been misconstrued to have turned into a Keynesian cheerleader. No, momentum does not equate to cheerleading nor does it signify my tergiversation from our free market principles to the Keynesian philosophical dogma.

Despite the present developments, risks have not abated and in fact as the IMF pointed out in its recent Global Financial Stability Report, they have been enhanced, the Reuters quotes the IMF, ``Global economic conditions have been supportive of a benign financial environment, but underlying risks and conditions have shifted somewhat since ... September 2006, and have the potential to weaken financial stability.”

Yet, we have been ingrained to think or made to believe by textbooks or by mainstream analysts or by the media that stock market performances are reflective of the performances of corporations or of a nation’s GDP growth. Or simply, a country’s economic progression defines its relative returns with regards to stock market investing or is it?

Figure 5: Mises.org: Zimbabwe: Best Performing Stock Market in 2007?

According to John Paul Koning, the Zimbabwe Stock Exchange is shaping out to be the best performing stock index in the world up about 595% year to date, and get this, a whopping 12,000% (TWELVE THOUSAND PERCENT) in over 12 months see figure 5!

Yet, Zimbabwe’s economy has rapidly deteriorated over the years due to policies adopted by its tyrant ruler Pres. Robert Mugabe. The Economist Intelligence Unit shows Zimbabwe’s GDP calculated in Billions of US dollars based on Purchasing Power Parity (PPP) at $25.04 billion in 2002 to $21.13 billion in 2006 or a nominal decline of over 15% over the past 5 years!

The reason Zimbabwe’s stock market has been zooming is due to its hyperinflationary state (Germany’s Weimar 1920s experience relived!). Its degenerative economy and its lack of access to financing have led its incumbent government to undertake excessive money printing in order to preserve its powers.

And excessive production of money has reduced its purchasing power of its currency so great that consumer price index have jumped by an astonishing 1,729% a year! Imagine losing the value of your currency by the day!

Now of course, the lack of opportunities under such hyperinflationary landscape has alternatively made its stock market as the ONLY safehaven from the evaporating value of the country’s currency.

John Paul Koning elaborates (emphasis mine)

``According to Austrian Business Cycle Theory (ABCT), the peak-trough-peak pattern that economies demonstrate is not their natural state, but one created by excess growth in money supply and credit. New money is not simply parachuted to everyone equally and at the same time — it is sluiced into the economy at certain initial “entry points”....

``If, as the Austrian theory states, money enters the economy at certain points, it is likely that a nation's stock market will become a prime beneficiary of any monetary expansion. Fresh money enters the economy first through banks and other financial entities who may invest it in shares, or lend it to others who buy shares. Thus stock prices rise relative to prices of things like food and clothes and will outperform as long as this monetary process is allowed to continue.”

``As prices become more misaligned, basic decision-making abilities of normal Zimbabweans are impaired and the day-to-day functioning of the economy deteriorates. Perversely, all of this has forced the government to issue even more currency to make up for budget shortfalls and to buy support. At last measure, the country's consumer price index was rising (i.e., the purchasing power of currency declining), at a rate of 1,729% a year.”

In other words, contrary to the public’s expectations, monetary process contributes to the conditions of the financial markets and not just changes in GDP.

And it is in this regards where we have frequently commented that the appearance of peculiarities (rampaging asset prices amidst deteriorating fundamentals) in the behavior of the global financial markets may actually reflect such inflationary tendencies...but on a benign scale relative to the Zimbabwe’s experience.

Possible symptoms as price misalignments or distortions, rich valuations, record low yields, low volatilities, record low credit spreads, expanding global imbalances and rampant signs of speculation (private equity, mergers and acquisition and exploding hedge funds) on a backdrop of gradually rising consumer prices indices can be viewed as affectations of such monetary processes to the financial markets in contrast to other preconceived theories as the Global Savings Glut, Lack of Investment or dearth of supply of investible instruments.

So when we declare that momentum favors today asset classes, or otherwise seen as “cheerleading”, our premise originates from the perspective where surging money and credit expansion or simply inflationary manifestations have been MADE conducive for the financial sphere to expand its tentacles behind and in support of today’s structurally asset dependent economies.

In the prescient words of Hyman Minsky, ``An understanding of the American economy requires an understanding of how the financial structure is affected by and affects the behavior of the economy over time. The time path of the economy depends upon the financial structure.”

I guess this should apply not just to the American economy but to the global economy as well.

Flash Outlook: Momentum Favors a Phisix Breakout of 3,400!

Happy Easter!

Let me first tell you that as a matter of priorities my concern hinges on a longer term deposition, it is seldom on my part take on short term forecasting.

However, recent developments over the past week have compelled me to issue this outlook.

Figure 1: US Dollar, Gold and Emerging Markets

As the US dollar (trade weighted index) manifests renewed signs of weakening, Gold and emerging markets have lately been showing signs of rejuvenation.

In fact, as shown in Figure 1, emerging market bourses represented by the iShare Emerging Market indices (red candle) have broken into new heights (lower panel) while gold (black line behind) has seen some resurgence and appears to be on its way to test its resistance level at around the 690-695 area.

What these confluences appear to tell us is that the softening US dollar could be providing for the backstop of liquidity in the global financial markets.

Figure 2: US Global Investors/SGS: Commodity prices recover

Where the performances of emerging market assets have shown strong correlation to commodities, Figure 2 shows of how copper prices, steel and the Baltic freight price Index have recently chimed in to exhibit renewed vigor.

These markets appear to contradict expectations of a global economic slowdown or could they imply “decoupling”? Or is it telling us of another message relative to the purchasing power of the US dollar?

Figure 3: Carry Trade Currencies

Our concern of late has been of the liquidity provided for by the carry trade arbitrage, where the recent spike in the low yielding “funding” currencies has served to curtail “liquidity” in the marketplace which prompted for the recent bout of interrelated market corrections.

Today, the current swoon in the both the Swiss Franc and the Japanese Yen on the backdrop of rallying global assets worldwide suggests to us that the speculative ramp has been set for a possible continuity of in favor of asset upside repricing.

Figure 4: Phisix Peso correlation: Peso Nears breakout, will the Phisix follow suit?

As we have noted in the past, the Peso/USD and the Phisix has shown strong correlations, whereby inflection points have been coincidental (declining Phisix- strengthening USD and vice versa).

At Friday’s close, we see the Peso end at its resistance level relative to the US Dollar as shown in Figure 4. Could we be seeing a breakout of the Peso which should similarly reflect on the Phisix?

At the start of the year, I had neutral to bearish with the Peso and the Phisix considering the market’s cyclicality. I had been expecting a decline at around 2,600-2,800 as a global slowdown unfolds with risks from the US diffusing to the world. That slowdown and cyclical correction appears to have been factored in, in contrast to my expectations, while global markets have taken the next step further.

Yes we are aware that the risks from the US credit markets may yet spread and or liquidity concerns from other aspects as the Carry trend phenomenon or geopolitics may work to forestall the recent advances, however, at the moment, momentum appears to have shifted greatly in favor of the bulls.

So in my view, IF the peso closes below the 48 level, one should expect the PHISIX to bolt out of the 3,400 level SOON.

When asked why the illustrious economist John Maynard Keynes changed his stance on a position his reply was, ``When the facts change, I change my mind. What do you do, sir?”

Do your self a favor, call your broker and execute your trading positions.

Happy Trading!

Observations from ADB’s Development Outlook 2007

``It’s a good idea to operate your life on the assumption that unforeseen circumstances are lurking in the shadows, just around the next bend. Which is why it’s wise to handle your finances with the understanding that Fortune does not carry anyone on her shoulders indefinitely.”- Robert Ringer

One of the amazing observations derived from Asian Development’s Bank’s (ADB) recent development outlook can be found in the chart shown in Figure 1.

Figure 1: ADB: Treasury Bill Rates: Philippine rates LOWER than US Rates!

We have always argued that the strength of the Peso, so as with the advances of Philippine sovereign bonds, and the Phisix have been determined by foreign portfolio flows at the margin.

However, what seems SO incredible with the picture above is that Philippine short term rates have now been LOWER than that of its US counterpart, as if to suggest that US treasuries have now been seen as “riskier” assets than of Philippine sovereign issues.

Or has the world simply chosen to ignore the context of risks in its past signification? Or has the ocean of liquidity jaded the views of global investors? Or has several theories as “savings glut” (as proposed by Ben Bernanke of the US FED), “lack of investments” (Raghuram Rajan of IMF) or “Asset Shortage” or dearth of bond issuance arising from sustained reforms (Stephen Jen, Charles St-Arnaud of Morgan Stanley) been the underlying factors responsible for the present conditions? In short present conditions have been a worldwide phenomenon and are UNPRECEDENTED by sheer scale and magnitude.

This is what ADB has to say (emphasis mine), ``The banking system’s accumulation of net foreign assets fueled liquidity. Broad money (M3) growth has accelerated in the last few years, driven primarily by this accumulation (Figure 2). In 2006, net domestic credit also reversed from a decline in 2005 to contribute 7.8 percentage points to M3 growth, in large measure reflecting a recovery in credits to the private sector. A decline in the risk premium (based on improved fiscal performance), expectation of peso appreciation, accommodative monetary policy, and buoyant liquidity exerted downward pressure on interest rates. The nominal yield on 91-day treasury bills declined below comparable US treasuries in November (Figure 1) for the first time in 25 years.”

Evidently, Philippine asset classes have benefited from the present dynamics.

Figure 2: ADB: Philippine M3: Buoyant Liquidity Driven by Foreign Assets

Figure 2 simply confirms our long held view that the accumulation of net foreign assets has been important drivers of our asset classes and has contributed immensely to the torrential jump in domestic liquidity.

With even more compressed yields, you may continue to expect more of an impetus to the financial asset classes or to domestic investments. In fact, the FINANCIAL sector has registered the biggest jump in gains among the local industries, according to the IMF’s Selected Issues. Again this is in consonance with the evolving global trends, so much so that with the growing sophistication and the deepening of the financial markets brought about by accelerating trends of integration, such developments are most likely to continue.

In contrast to variable thesis posited presented above, global liquidity, in my view, is a result of massive inflationary activities undertaken by both the public and private domains in the financial world in support of the asset classes from which the present economic structures heavily depend upon.

Figure 3 ADB: Net Capital flows to Emerging Markets Nominal US dollar Exchange Rate Index

Figure 3 shows how strong international fund inflows have thus far boosted the equity markets of the Emerging Markets as well as of Asia Pacific’s. And we also see the same dynamics at work which has led to the firming trend of the Asian region’s currencies.

According to ADB’ Prospects for the world economy 2007 and 2008 (emphasis mine), ``Net private capital flows to emerging Asia amounted to $197.3 billion, only slightly down by 3.9% from the previous year, due to slightly smaller foreign direct investment flows. However, with its strong growth outlook, the region continues to be the primary recipient of private equity investment, attracting again more than 60% of net portfolio equity investment flows to emerging market economies in 2006. Relatively low interest rates and benign liquidity conditions in capital markets have kept private credit flows generally buoyant, benefiting emerging Asian borrowers. Credit spreads remained near record lows for emerging market issuers through most of 2006... Expectations for strong growth will continue to underpin the strength of Asian currencies in 2007, as will narrowing interest rate differentials, due to monetary tightening in some countries.”

Finally, when we talk of globalization, we talk of ever growing trends of greater interdependence in terms of trade and the financial markets. We also discussed in the past of the shared risks and benefits of such phenomenon. ADB affirms this view,

``With its share of exports (on a national accounts basis) close to 50% of GDP in 2006, and its dependence on capital inflows, the Philippines is closely tied to the global economy and to sentiments in international financial markets. This is offset somewhat by the seeming independence of remittances to global disturbances, likely reflecting their diversified origins. Low real interest rates and higher fiscal spending on priority projects should also support growth.

``The peso is likely to maintain its strength, supported by foreign exchange inflows from the balance-of-payments surplus. However, to preserve the price competitiveness of exports against the backdrop of slowing external demand and the appreciation of the peso (in real trade-weighted terms), the central bank may again accumulate foreign exchange reserves to stem the pace of currency appreciation. Measures to liberalize foreign exchange outflows to be effective from April 2007 may also relieve some upward pressure on the peso. They include doubling the amounts of foreign exchange that residents can buy to pay for overseas services and investment abroad....

``The main risk to the projections, apart from the extent of the slowdown in external markets, is the potential impact of the Congressional elections in May 2007. The elections need to be transparent and peaceful, and the fiscal and structural reforms kept on track. Steady progress on privatization will be an important signal to investors on the Government’s commitment.

While we share most of the assessment, the risk side is where we part. As we have previously argued, domestic politics appear to have been desensitized from the activities in the financial markets for as long as the IMPACT to the capital flows framework would be negligible. It is more likely that our financial markets be driven more by developments in the region or of the progress in the financial integration, as the recent “Shanghai Surprise-Yen Carry 2” shakeout last February or that of the May 2006 “Yen Carry” shakedown have shown.

Therefore, the object of our vigilance will continue to be directed at external factors more than that of domestic politics.

History Is NOT A CLOSED BOOK: The View from IMF

``We'll tax and tax, spend and spend, elect and elect because the people are too damn dumb to know the difference." -Harry Hopkins, advisor to FDR

Our basic function is to profit from opportunities presented by market asymmetries. This by acting on perceived favorable probabilities presented by themes, be it momentum (technical) or fundamental (growth, value, economic or business cycles etc...). Yet as previously expounded, the marketplace is NO different from the economy as it is CLOSELY linked with the political trends. In the analogy of an Elementary song “Dry Bones”.... ``your toe bone is connected to your foot bone which is connected to your ankle bone which is connected to your leg bone which is connected to your knee bone...”

Yet, in discerning for themes we aim to EXTRICATE signals from noises, since noises could entrap us to false premises and lead to senseless losses.

On the same grounds, when we hear of camouflaged political noises veneered in the context of moral issues such as “Maid Exports” or “Flawed Culture” or “Rapid Population Growth” circulating to influence the mindsets of public, our response is to challenge the “wisdom of conventional thinking” founded on the popular but on highly specious grounds. Our viewpoint comes in the lexicon of “what we see depends on where we stand” framework.

Our recent series of “History is Not A Closed Book” aims to show of how macro dynamics are MASSIVELY TRANSFORMING both the global economic and political landscape, where domestic politics are likely to take the shape under its growing influences rather than the circulating political bunk masquerading as virtuous “moral” ascendancy.

Yes, while we understand that there are risks to such evolution as signs of rising tide of protectionism, where the recently imposed tariffs by US on China’s paper products could be a symptom of a possible snowballing trend in the US (a political and economic hara-kiri in my view) which may serve to impede on the present developments, we think that to some degree technological advances, economic and financial integration and demographic trends will eventually COMPEL the adaptation of political economies that would best fit into today’s rapidly evolving environment.

For instance, the massive productivity growths in emerging market economies have resulted to tremendous impacts to our lives today. While we have been witnessing a trend of decreasing prices in manufactured goods, as a result of expanded capacity, rapid technological advances on the pace of “Moore’s Law” and surplus labor, on the other hand, increasing price pressures on raw materials and commodities, which reflects the strain by rapidly expanding demand on the on the supply side, is an outgrowth mostly from rising per capita income of emerging market economies.

Since most of these countries have benefited from recent globalization trends, chances are that they won’t opt to spoil the party, and would even work further to improve on this preferred avenue for development.

As testament, China, one of the leading forces in today’s seismic shifts, recently undertook a landmark legislation to protect property rights of its constituents. In the same breadth, China will also undertake a programmed expansion of its financial markets to include financial futures contracts and options beginning April 15^th, and as well, plans to establish a sovereign wealth fund or the world’s largest investment company that would manage its excess reserves which has reached over US$ 1 TRILLION.

These measures serve as growing manifestations of the country’s RECOGNITION of allowing market forces to determine the efficiency of resource allocation for the political SURVIVORSHIP of its ruling class. It is a growing realization that unless wealth spreads, the preservation of their power is jeopardized.

I think it will be no different here, unless of course we decide to do the extremes ala Chavez of Venezuela.

While global investments have been on a general decline as a result of the IT bubble implosion but seen with cautious recovery at present, this has NOT been the case in the local arena as investments have been on a steady declining trend far more than our neighbors as shown in figure 4.

Figure 4 IMF: Rising Share of Services sector while Gross Fixed Capital Formation is on a decline.

According to Wikepedia.org, the concept of statistical aggregate of Gross Fixed Capital Formation (GFCF) which is a flow value, is the ``measure of the net new investment by enterprises in the domestic economy in fixed capital assets during an accounting period.” In other words, residents have not partaken into investing domestically, which shows of a declining trend. This has been rightly pointed out by some observers.

However, in contrast to the belief that investments withheld by domestic investors could represent some innate asymmetries, the IMF thinks that present trends could be indications of a transition shift from that of remittances based economy to services based one, also shown above in Figure 4.

According to the IMF (emphasis mine),

``However, the lack of response of investment could also be a transitory phenomenon. Over time, a rise in remittances can cause an endogenous change in consumption-investment decisions. The shifting skill and regional patterns could also have potentially powerful implications for the saving patterns of the dependents in the Philippines who are the end users of these funds. In 1991, nearly 60 percent of families in the Philippines who considered their main income source as coming from abroad came from the bottom two quartiles of the income distribution. By 2003, this share had dropped to just under 18 percent, implying that the share of families in the top two brackets counting income abroad as their main source of income rose from 40 percent to 82 percent. The most likely interpretation of this fact is that the skill set of remitters has shifted exogenously, and there are both “pull” and “push” factors taking higher skilled workers abroad. Given that some 80 percent of families that receive income from abroad as their main source are now middle and high income families, it is much more likely now than in 1991 that the uses for this income go beyond consumption and subsistence, and are put toward saving and investment. This suggests that the lack of a relationship between investment and remittances could indeed be transitory, and that going forward, one may see a pick up in investment in physical capital.”

Figure 5: Gavekal Research: Growing Signs of Massive Capital Investments Boom?

If the IMF thinks that a domestic investment recovery is underway, so did we since last year, as we wrote in Want a Stock Market tip? PGMA’s SONA was a Mouthful, or as early as 2004 [November 29 to December 3, 2004 see Domestic Investment to Help Drive the Phisix?].

Like us, the Gavekal Research team believes that a massive investment boom is imminent in Southeast Asia, where in their recently (February 28^th) issued handbook, Asset Allocation & Economic Research they wrote (emphasis mine),

``One of the key themes of research in 2006 was that Southeast Asia is currently going through a massive capital spending boom (thanks to cheap Chinese machines, higher exchange rates and lower real rates). And everything we look at continues to point towards an unprecedented capital spending boom in ASEAN countries.”

In Figure 5, courtesy of Gavekal Research, the chart of Philippine Imports of Capital Goods shows of a healthy uptrend. This indicates of a reversal from its previous decline following the Asian Crisis. Are we perhaps now witnessing the unfolding of our gradual BOOM scenario?

According to the Gavekal Team, ``As ASEAN starts to spend real money on infrastructure (for example, Mrs. Arroyo just announced a US $20 billion, 4-year infrastructure spending plan for the Philippines), there could be less money making its way to reserves.” Hmmm, sounds familiar?

In a similar plane, we have noted of how the seeds of the infrastructure boom have been sown in India last week, which to the extent reflects the booming Infrastructure theme in Global latitude, and how this should affect the political, economic and investment dimensions.

Now of course, if one would ask WHY the shift to the services industry instead of manufacturing industry? Asian Development Bank (ADB) during their latest development outlook shares with us their insight on the existing malaise of our much maligned industry (emphasis mine),

``In the 1950s, a sophisticated manufacturing sector emerged in the Philippines, supported by protection and a well-developed human capital base (Hill 2003). The problems for manufacturing began subsequently. A combination of factors appear to have played a part, including a period of costly and badly directed interventions, a tendency to focus on protecting rents rather than improving efficiency, poor physical infrastructure, and, to a lesser extent than in India, some problems with labor market regulation. High levels of corruption, disputed property rights and difficulties with contract enforcement have also played their part (ADB 2005). These facets of everyday economic life seem to reflect deeply embedded institutional difficulties including high concentration of wealth and a political system based on patron-client relations (World Bank 2005, p.3).”

So essentially what the ADB in its “Growth Amidst Change” outlook mean is that instead of allowing for market forces to determine the industry’s wellbeing, the country has been engaged in a slew of anti-market forces in forms of policies that cater to protectionism, costly interventions, protection of favored interests (rents), choking regulations, questionable implementations of property rights and contract enforcement.

In short, most politicians and their statist retinues have had a blighted “long-term” record of “saving the country” and in fact, as the ADB shows, have been responsible for compounding our self-inflicted miseries. As Julius Caesar once said, ``All bad precedents begin as justifiable measures.”

Where we always argue that stifling regulations lead to both massive inefficiencies, and imbedded corruption, and where economic opportunities are determined by politicians or by their factotums rather than the market itself (meritocracy; market efficiency determined by efficiency of resource allocation), the result has always been market distortions, little productive savings and investment and the lack of entrepreneurs and or of market opportunities. As been said before, our poverty is a result of dysfunctional and underdeveloped markets.

Here the IMF gives us a list of suggestions for our betterment (emphasis mine),

``Therefore, to move to a decisively stronger growth path, the Philippines needs to prioritize the following areas:

• First, improvements in infrastructure are necessary to support the emerging service sector. For the BPO industry, these include not only continuous upgrading of the technological hardware that has made the Philippines competitive thus far, but also access, in terms of roads and transportation to cities that are new emerging centers for these industries beyond Metro Manila.

• A renewed emphasis on the provision of stronger education, including across engineering and scientific disciplines, are essential if higher value-added overseas jobs, or high value offshore servicing industries are to make the Philippines their home.

• The need for education is further underscored, if the Philippines is to turn its relatively high population growth into a demographic advantage in an “aging” world. Otherwise, sustaining a growing population on income sources that emanate directly or indirectly from abroad with a stagnant set of labor skills could prove untenable.

• Finally, as the demographics of the end-users of income from service sector jobs (domestically and abroad) change, besides education, there is also a need for greater savings out of these incomes, and more productive investments being made using these savings. Absent this, the strong indirect effects from the growth of services which have been seen in other countries may not be realized.”

Except that these proposals come from the IMF itself, have we not dealt with most of these since?

Gavekal, Holy Week and Political Gibberish

My warmest thanks to Mr. Louis Gave and the remarkable GAVEKAL Research team for the compliments; where I was supposedly to purchase their latest publication, “The End is Nigh”, instead got a complimentary set of not one but FOUR books.

It is when the big players whom we’d like to emulate acknowledges our lowly efforts, we feel humbly delighted.

In the observance of Holy Week, our regular outlook will resume on the 15^th of April, although if events warrant, we may post some short insights at my blog.

Finally, heard recently from a newscaster covering the recent hostage taking, “....especially from a country that values most its children.”

Our take: HUH? Isn’t “value” supposedly a subjective word? Our sense of values differs in the context of personal definition. What you value may or may not be the same as mine although in a general sense they could seem or be alike. In the words of Ludwig von Mises, ``All judgments of value are personal and subjective. There are no judgments of value other than those asserting I prefer, I like better, I wish.”

Hence, to arrive at such GENERALIZATION is indeed an outlandish spectacle. One is tempted to ask, on what basis does one derive or attach “VALUE” to merit such assertion; is it because of population growth, educational attainment or educational spending, health, family kinship, cultural ethos or productivity growth or etc. or a combination thereof?

My hunch; statements like this reflect political gibberish on the platform of moralizing from those allegedly are “in the KNOW”. This serves as an example of how the cankers of “toxic noises” pervade media which in turn taint the mindsets of the gullible general public.