Exogenous Risks Amidst A Milestone Phisix High

``It is a mistake to try to look too far ahead. The chain of destiny can only be grasped one link at a time.”-Winston Churchill

As expected, the porous events unfolding abroad finally permeated to our own market as the Phisix blasted away from its May high hurdle to establish a 7-year landmark! Exciting right? This means that the July 5, 1999 high of 2,632 and its respective close of 2,621 is merely a breath away from last Friday’s close! A breach of this threshold level suggests that the Phisix would take at aim at its next goal of 3,447.6 (reached last February 3^rd 1997), its ALL-TIME high!

Figure 1: Stockcharts.com: Phisix Charges to a 7 year high!

As Figure 1 courtesy of stockcharts.com shows, the Phisix now appears to be headed for the resistance level of its current channel (two blue lines) estimated at 2,670-75. Present momentum could push it towards these levels before a retreat ensues. But remember, I wouldn’t put so much emphasis on the Phisix alone, as I have previously noted, activities in Wall Street appears to be directing the flow dynamics of the world financial markets, inclusive of world equities or the Phisix. In a financial world with increasingly seamless borders, a singular focus on domestic analysis as drivers for the local market is a grave mis-analysis.

This outperformance of the Phisix, up an astounding 2.35% for the week, was surprisingly second only to Pakistan’s Karachi 100, which had a scorching 5.87% advance. Of course, this has been a worldwide phenomenon. World equity markets or even emerging market bonds have been on fire lately.

If you ask me anew, what all these “optimism” is all about? My repeated succinct reply as enunciated in my previous outlook is that all these have been mainly liquidity driven (expectations for loose money environment or room for further leveraging or veiled inflation channeled via asset prices).

Today’s financial world has been at the core of world economies, especially that of OECD economies or of the industrialized world. The financial markets have greatly outdistanced in magnitude the real value of the exchange of goods and services. Credit markets have grown itself a size with the help of technology, to engender innovative “financial intermediation” products enabling investors to shore up speculative positions compared to real investments. Again, the praxeological (``individuals engage in conscious action towards chosen goals”-Murray Rothbard) impulse...the stretch for yields!

Massive productivity growth coupled with weak real investments has led to outsized global current account imbalances which at the same time fueled worldwide asset speculations. In fact, one of the peculiar outgrowth of today’s financial structure has been that of “savings” or “surpluses” (Bernanke) from Emerging market economies “financing” the industrialized world. To say differently, believe the unbelievable...the Poor have been funding the Rich! Talk about inequalities or absurdities!

Now since the world is highly dependent on “wealth effects” from the world’s major consuming nations, it is but natural to revolve around on loose money/financial conditions to buttress further leveraging in an ever growing reliance for asset-based economies in the industrialized world. Hence the so-called spin on “low inflation expectations” which are nothing more than camouflaged excuses or alibis for maintaining the status quo or pining for the perpetuation of conditions conducive for more leverage. Give an inebriate more alcohol or an addict more of the substance!

Moreover, in a world of diminishing returns and intense competition, greater leverage is necessitated to accentuate yields. Last week, I quoted IMF’s Rajan who simply validated our standpoint that liquidity drivers have not been dependent on the traditional banking sector. He notes that “80% of value added is found outside the banking sector”, where non-bank activities has been “increasingly central” to economic activities and not to its traditional role of “passive holder of assets”. Thereby, several analysts focusing on bank aggregates as measure of world liquidity have been bewildered if not stupefied by the baton turnover from stocks to real estate and now back to equities. Yet, this is what has been occurring, in the US, to quote favorite analyst Doug Noland, ``The sharp slowdown in home sales activity is offset by more aggressive home equity, credit card, and small business lending. Almost across the board, commercial lending volumes are strong.” Inflation manifestations have been rotating.

Nonetheless, the greater the leverage, the higher the risks! But who is to say the music should stop (not me!), when the going even gets better! More dosage please?

Let me cite you an example of what non-traditional non-bank liquidity to the ever-increasing levered world means, from Randall Forsyth of Barron’s, ``Credit default swaps allow investors in risky assets to, in effect, buy insurance against something bad happening, just as a homeowner transfers the risk to an insurance company writing the homeowner's policy. But flood insurance has not reduced the chance of a hurricane. Indeed, flood insurance has increased the chance of a hurricane hitting a populated area by letting people build houses at the shore, seemingly without risk. In the same way, credit derivatives don't eliminate credit risk but arguably facilitate it. In so doing, the risk to the entire system has increased.” As somebody else or some other party takes on these transferred risks, risk taking appetite becomes even more proliferate or expansive. People or the investing public become less risk averse and gravitate to even illiquid stakes, which becomes a question of growing “Moral Hazard”?

Allow me another pertinent quote from IMF’s Raghuram G. Rajan (emphasis mine), ``The problem when the world has excess desired savings relative to investment, and when central banks are accommodative, is that it is awash in liquidity. Many investment managers can enter the business of liquidity provision, and even as they take ever more illiquid positions, they compete away the returns from doing so. The point is that current benign conditions engender "illiquidity seeking" behavior. But they could have worse effects.”

Figure 2: Daily Wealth/Stockcharts.com: Where is the Fear?

And in the circumstances of a highly levered world, risk taking via more margin or borrowed bets becomes increasingly systemic!

Borrowing the memorable words of Nixon’s economic adviser Herb Stein, ``if something's unsustainable, it tends to stop”. Oh yes, it will one day. As to the timing, this is greatly beyond my ken or anyone else.

Now to balance your ecstatic outlook, figure 2 shows that US equity markets showing signs of pervasive confidence...the public getting lax and showing signs of more complacency!

Back to the Phisix, this next chart has been a favorite of mine (see Figure 3), I’ve been showing this since 2002 (Recall, Index Trading Edition?) and more importantly this cyclical chart has performed “Luckily” in my favor, thus far, even as the consensus had been stridently cynical then.

Figure 3: Phisix 20-year chart: Working towards a full-cycle?

In conversation with some market participants, to my surprise I figured that only a few have been seemingly aware that the Phisix is only about 25% shy of its record HISTORICAL high of 3,447 in 1997.

Let me reiterate, if I am right about the secular phase for our domestic market, which is supposedly operating in an environment under an advancing or (drum roll please) bullmarket phase, then the 1997 high would eventually be taken out in a cinch.

I may not be sure of the timeframe simply because I am not your Madame Auring (a famed local seer). I can’t read the minds of the investing public overnight, but certainly can use tools or indicators to measure it....(read my lips!) O.V.E.R.T.I.M.E. Time distinctions vary a great deal relative to risks-return analysis, example the shorter the time frame the greater the risks.

However, it is important to note that it is the characteristic of bullmarkets to replace previously established highs with FRESH record highs. That is why I’ve repeatedly said to you that at least 10,000 Phisix is a possibility in the future. No, I didn’t pick the figure from the sky...the rising Peso, restructuring of regional investment, trade and financial flows, growing evidence of increasing financial integration with our neighbors, demographic trends, et.al...as LONG-TERM fundamental drivers behind such target.

But enough of cheerleading, there is no shortage of immodest Panglossians in today’s perky atmosphere. We must continue to guard against complacency. Nonetheless, in my view, the epigram of William James (1842-1910), US pragmatist philosopher captures overconfidence at work, ``A great many people think they are thinking when they are merely rearranging their prejudices.”