Jesse Livermore was Right, A Rising Tide Lifts Most Boats!

``Democracy, Communism, and Modern Portfolio Theory all rest on the same claptrap - that The People are geniuses and saints. All the theories agree - there is no higher source of wisdom, virtue, or pricing than the will of the heaving masses. If the voters want to do something foolish, who can tell them not to?” –Bill Bonner, Daily Reckoning

WE face arduous challenges in trying to communicate our long term views relative to the short-term expectations of the public.

As we have described in numerous times, the average investor have the natural inclinations to look for simplified explanations on the market’s action rather than understanding the underlying structural dynamics beneath its moves.

While we attempt to identify present trends as part of the long term cycle, the average investor desires to be told of media-hugging sensationalized activities as drivers of the markets or prices of securities.

The legendary trader Jesse Livermore had been absolutely right; the average investors don’t want to know whether it is a bull or bear market, they only want to be told of what they want or need to hear. And media alongside with mainstream analysis feeds on these popular “ad hoc” explanations, which are mainly “event” prompted.

Because sound scrutiny does not appeal, intuition based rationalization becomes the fundamental basis for decision making. It is of no wonder why most investors are bound to lose when the market cycle turns, as it has always been. Again the invaluable words of Mr. Livermore, ``The stock market never really changes that much. What happened before will happen again and again and again."

For instance, we persistently hear of arguments that our local markets are MICRO fundamental driven. Said differently, securities are believed to be priced according to its corporate fundamentals, i.e. cash flows, sales, earnings, dividends, enterprise value and etc.

And because it is supposedly micro fundamentally driven, the implied assumption is that the success in stock selection becomes a function of ability or talent. This reminds us of the behavioral finance school which identifies the common follies of investors called as the “cognitive biases” or in this case, specifically the attribution bias or the tendency to attribute success to one’s skills and failures to randomness.

We have long argued that aside from being macro or globalization propelled, because of the juvenile state of our stock market, the Philippine Stock Exchange have been mostly impelled by momentum trades by local investors over the broad market rather than valuation based investing; hence, the “rising tide lifts all boats” dynamics have even been more pronounced. In matured or developed markets, I would wholeheartedly agree that fundamental drivers are important contributors to the market’s direction, but not locally.

Why? The lack of local investor breadth has been one elemental foible. Yet where local investors have been actively engaged, they have been mostly guided by momentum driven or voguish explications from sell side analysts, whose economic interests are far divergent from the investor’s goals. To our experience, this lack of sophistication and comprehension of the financial market dynamics applies to even local institutions.

Second, there is also the issue of the paucity of publicly listed companies and the lack of more sophisticated trading instruments. The universe of publicly listed companies in the PSE is only about 260, which is far below our neighbors with Vietnam fast catching up on us with 109 listed companies from 30 companies at the start of 2006.

Figure 1: Number of Issues traded shows a “Rising Tide Lifts All Boats”

As shown in Figure 1, the booming Phisix translates to the rising incidences of number of issues traded. The accelerating trend of issues traded from a limited bandwidth depicts of the diffusion of issues gaining the attention from investors as the market advances.

In addition, where the stock market functions as claims on future cash flows, we see some issues frenetically being bidded up, whose fundamentals are backed by nothing but “stories”.

On some accounts, if one realizes the supposed actualization of cash flows from the purported plans, they would probably occur (if they materialize at all) at the peak of the market’s cycle. And astonishingly yet, these issues have greatly outperformed the market by a mile!

Evidently, the investing public has become less discriminatory and more daring with regards to imbuing risk appetite. This simply shows how the gullible public would ACT on justifying their actions using any pretext to eagerly join the bullish bandwagon.

Another, over the broader market, from the start of the year, the Phisix has gained by 15.4% as of Friday’s close. Nevertheless, advancing issues outnumber declining issues by a daily average of 59 relative to 52, respectively.

Lastly, sliced and diced based on the sectoral index performance, as shown in Figure 2, we prominently see the arguments in favor of a “Rising Tide lifts all Boats” dynamics.

Figure 2: PSE sectoral Performance: “Rising Tide Lifts All Boats”

The Manulife and Sunlife weighted All index (violet line), the Commercial Industrial (Pink line), Holdings (Red), Property (Blue), Services (Orange) and the Mining Index (Green line) are seen in conjunction headed higher, as the Phisix breaks into a new high.

Two important notes, since Manulife (unchanged year to date) and Sunlife (+2.2%) has barely budged from the start of the year, the rising trend of the “All” index markedly exhibits of a broad market advance.

Second, the mining index has as previously identified broken above its crucial resistance levels (another bullseye for us!).

While it is true that several market cap heavyweights are key components to these disparate indices, there have been rotations within each benchmark to offset the stalled activities of the others.

In effect, Mr. Livermore was quite accurate with his assertions that the inclinations of a cyclical market is for broad market moves. Let me repeat, issues may not move simultaneously (except on parabolic stages) but may undergo rotation by the sector or by the units within the sector.

Of course, there have been some exceptions to the rule, where some issues continue to lag. However these exceptions could be construed as symptoms of greenness or immaturity of the advancing phase of our secular bull market which represents a very bullish long term signal.

Again all these evidences contravene the arguments that our markets have been micro “valuation based” boosted but rather lends credence to our contention that global inflationary bias has psychologically pushed investors into bidding up asset prices of emerging markets, as in the PSE, with a “reflexivity loop” of the “prevailing bias” of the markets influencing economic fundamentals.