Phisix: Back to our Bullish Stance! But Keeping Vigil on the US Dollar Index.

Phisix: Back to our Bullish Stance! But Keeping Vigil on the US Dollar Index.
-US Markets: Presidential Cycle behind Recent Rally?
-BSP Reflates! Locals seen to Add Fuel to Fire
-US Dollar Index Sits At Multi-Year Lows, Risks of Disorderly Unwind Heightens

``Accept the premise that my method is no better than theirs, and yours no better than mine. It doesn’t matter anyway; methodology isn't the primary element of successful trading. The key to success lies in two simple words: money management. There will be losing trades with every methodology. The secret is to have smaller losses on the losing trades and larger relative wins on the winners. To put it another way, "trade picking" ability, while important, is secondary; money management is primary.”- George Kleinman, editor of Commodities Trends, How to Become a Successful Trader

In the past issues we have noted of our interim neutrality stance towards the Phisix stemmed from the ambiguity provided by the dithering US equity markets, which has accounted for the negative factor, relative to the plight of the cascading US dollar, which represented as the positive factor. This push-pull dilemma apparently got resolved this week.

With the US market’s electrifying breakout from its key resistance levels, particularly Dow Jones Industrials (+2.17% week-on-week) and the S&P 500 (+1.48% w-o-w), our main tentativeness have been set aside, as we are LIKELY to see momentum flow tilted in favor of the bulls.

Figure 1: Stockcharts.com: USD-SPX-Phisix correlation

The upper window pane of the chart shows of the US S & P 500 bellwether which recently bolted convincingly out of its resistance level (blue arrow), while the Phisix at the lower panel appears to be levering up for a thrust over the 3,800 zone, although, the Philippine benchmark could back up first to gain enough pivot room for the all important test on the resistance level at 3,822.

US Markets: Presidential Cycle behind Recent Rally?

Amidst the variegated concerns of a deflating housing industry, an equivalent tension over the possibility of a contagion from the subprime mortgages anxieties, and the softening of the US economy, the paradoxical vibrancy seen in the US equity markets could be resonant of the Presidential stock market cycle following next year’s slated US Presidential elections.

The Presidential Stock Market Cycle according to Investopedia.com, ``A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a new U.S. president. According to this theory, after the first year, the market improves until the cycle begins again with the next presidential election.”

Figure 2: Contraryinvestor.com: Script Right on Cue!

In figure 2, courtesy of the contraryinvestor.com, the best returns have been historically found during the third year of the Presidential cycle. And today’s US market performances appear to be right on cue!

To quote contraryinvestor.com (highlight mine), ``What history suggests to us is pretty much crystal clear. In the last half century, there has only been one third year of the Presidential cycle period that has witnessed negative results for the S&P. The average third year cycle performance since 1955 is 18.4%. Again, in the wonderful world of make believe as per "what if this happened in 2007", an 18.4% increase for the S&P in 2007 would mean a target of 1,670. Again, we present all of this completely in the spirit of learning to accept and be at peace with whatever happens in the financial markets, and in the spirit of acknowledging the lessons of history, regardless of our personal outlook or beliefs.”

If we go by the data presented above, then 1,670 as a target for the S&P translates to another 7.5% gain from Friday’s close, considering that on a year-to-date basis the S&P is already about 9.5% higher.

Of course when we talk about statistical average, in simplest form it means that to arrive at an average number requires that about half of the time the S&P has performed above this average and vice-versa.

With the momentum today strongly favoring the bulls following the impressive breakout, our immediate guess is that the index could go higher perhaps until sometime mid-August before a major slowdown or a correction ensues.

Of course, to avoid being literal, no trend goes in a straight line: which also means despite the tendency of US markets to advance there could be one, two day or even a week’s correction interspersed during the coming month or so.

While we aren’t interested in exact figures, what interests us is how the US markets plays out during the last half of the year.

If any corrections especially going into the traditional or seasonal lean months of September-October will be benign or mild then the last quarter could probably see a sturdy bounce to reflect on the Presidential cycle’s usual performance.

If the global market’s correlation to the US markets holds, then the most likely scenario is that world markets including that of our Phisix will continue to strongly outperform.

Anyway all these are just plain conjectures. Statistical patterns or seasonalities are hardly enough reasons why one should be invested.

BSP Reflates! Locals seen to Add Fuel to Fire

As these positive developments unfold, world markets seem to have similarly celebrated the latest shindig.

In all of Asia, only Sri Lanka’s All Share index fell (-2.38%). The biggest gainers were Korea (+5.48% w-o-w), China’s Shanghai Composite (+3.52%), Indonesia’s JKSE (+3.35%), Thailand’s SET (+3.21%), Taiwan’s Taiex (+3.08%), Singapore’s Strait Times (+2.6%) and Hong Kong’s Hang Seng (+2.52%). While the Phisix joined neighboring Malaysia’s KLSE as two of the “lagging advancers” up .72% and .79%, respectively.

While the Phisix registered NET foreign buying, most of these emanated from the highly successful second round offering of the PNOC-Energy Development Corporation (+15.79%).

However, over the broadmarket, excluding special block sales, we observe that foreign money has been Net sellers based on nominal amount (Php 629.5 million), and on the number of issues traded (Net 34 companies encountered outflows this week).

We are unaware if the recent action taken by foreign investors has been related to the recent announcement by the Philippine Central Bank (Bangko Sentral ng Pilipinas or BSP) to recalibrate its monetary tools by suspending tiering system for bank placements and by lowering overnight interbank borrowing and lending (from 7.5 and 9.75% to 6 and 8%, respectively).

Figure 3: NSCB: Declining Philippine Inflation Rate

IT is said that such actions were considered “neutral” and aimed at “preempting inflation” as benchmark oil crude prices (WTIC and Brent) appear to be headed towards the record $80 levels.

However, our reading of this is that BSP acted to REDUCE THE YIELD SPREAD for Philippine assets relative to our neighboring counterparts or relative to our contemporaries in the emerging markets asset class.

In other words, we are predisposed to view BSP’s twin monetary actions with an UNSTATED goal of lessening the INCENTIVES for massive portfolio inflows from overseas investors.

Given today’s INTEREST RATE DRIVEN global capital flows dynamics, the implied effect is to PUT A BRAKE towards the rapid appreciation of the Peso.

In figure 3, the National Statistical Coordination Board (nscb.org.ph) shows of the Philippine inflation rate in sharp decline almost in conjunction with the steep rally of the Philippine Peso vis-à-vis the US dollar in 2005 until the present.

While in most instances, it would be a cognitive folly to attribute a correlation as causally linked, here we can probably say that the rising Peso has perhaps contributed to the decline in inflation rates (as measured in consumer prices).

As previously shown in March 26 to March 30 edition, (see History Is NOT A CLOSED BOOK: The View from IMF-chart provided by Gavekal Research), the rising Peso could have prompted for increasing trends to import capital goods, and this could have translated to lower consumer prices or a greater purchasing power for the Peso. So how bad could a rising Peso be?

Yes, since every action has a consequence and not all consequences will be positive. The rising Peso has to some degree affected our export sector.

However, Morgan Stanley’s Stephen Jen calls this muted effect on the export sector by rising currency levels in Asia as the “Ballast Effect”, where essentially, currency values becomes subordinate relative to the snowballing regionalization trends in the global trading dynamics and a more sophisticated financial markets.

To quote Mr. Jen, ``The notion of declining trade elasticities with respect to exchange rate movements in recent years has been well-documented, particularly for developed countries. What this means is that, with globalization, the export demand curves have steepened, i.e., it now takes bigger price adjustments to induce a unit of change in real trade. Several possible explanations have been proposed by academicians. First, as countries move up the product ladder, products become more differentiated (the ‘heterogeneity’ argument) and therefore less price-sensitive. Second, currency hedging may have retarded the responses in real trade as exchange rates change. Third, global demand (the ‘income effect’) has been so robust recently that the slope of the export demand curve appears steeper, when in fact the export demand curve has ‘shifted to the right’ due to the strong income effect.”

Thus, the BSP has done the unthinkable and unorthodox. But seemingly a lot better approach compared to those advocating the institution of rigid capital controls, as knee jerk reaction to the present trends. Capital controls are most likely to lead us to retrogress economically and financially as markets become heavily distorted by intervention. Recall Thailand’s bungled efforts backfired? Where they ludicrously repealed most of what they have imposed in less than a week!

Moreover, if today’s subdued inflation rate (measured by consumer prices), has been corollary to the rising Peso then in essence, its consequent gains has been more publicly widespread (if the index is to be believed) compared to the propping up of select industries by government intervention at the expense of the society in general.

Putting these into a philosophical dimension allow me to quote the trenchant words of Professor Gary North,

``We all wear two hats: a consumer's hat and a producer's hat. As consumers, we want producers to compete. As producers, we want protection from unfair competition. What is unfair competition? Successful competition.

``People vote with their money as consumers. They often vote in a polling booth as producers. As consumers, they want liberty. As voters, they want controls, or more to the point, control. Control over them. You know. Competitors.

``Spending is about liberation from controls on us. Voting is about the imposition of controls by us.”

The latest action undertaken by the BSP is almost synonymous to the UNSEEN motion to “reflate” the economy.

The lowering of interbank transaction rates effectively reduces rates available to the public across the board. And by the doing so, the public could be spurred to redirect their savings towards more entrepreneurial activities or drive them into the open arms of the domestic stockmarket.

With today’s highly inflationary environment, in terms of surging money and credit growth and intermediation: falling US dollar, bursting-to-the-seams trade and current account surpluses in Asia and oil exporting countries, exploding derivative markets etc…, most conspicuously evident in the global financial marketplace, it is less likely to see a marked constriction of capital flows although the BSP’s move could have SOME effects.

Again we can probably anticipate some intrinsic tradeoffs; a slight decline in foreign money participation but increasingly more local players into the market.

This also implies that as locals join the bandwagon we could probably envisage greater and more volatile activities in the broader market. This means that there could be an increase in the activities in the second and third tier issues, which should also suggest the latter’s outperformance relative to the Phisix.

Perhaps, given the current outlook, positioning a portion of one’s portfolio to speculatives may help increase yields over the immediate term.

US Dollar Index Sits At Multi-Year Lows, Risks of Disorderly Unwind Heightens

The last of the issue of concern is the US dollar.

Figure 4 : NYBOT: Components of the US Dollar Index

Figure 4 is taken from the New York Board of Trade, where the largest component according to its weighted order is the Euro (57.6%), followed by the Japanese Yen (13.6%), British Pound (11.9%), Canadian Dollar (9.1%), Swedish Krona (4.2%) and the Swiss Franc (3.6%).

While a falling US dollar has so far benefited global equity markets, what brings us to worry is that at present the US dollar index closed at a multiyear low.

Because a currency pair is a zero sum game it explains that the plight of the US dollar equals to a record high in the Euro, a 26-high in British Pounds, a 30 year high in the Canadian dollar, 2 ½ year high in the Swedish Krona and interestingly, a indications of significant rallies from “carry trade funding currencies” of the Swiss Franc and the Japanese Yen. In short, the US dollar has weakened almost across the board.

With Iran recently asking Japan to pay in Yen for its oil sales, we risks seeing a furtherance of the decline of the US dollar index, as major exporters

1. Depeg or delink from the US dollar as a currency anchor as Kuwait, or

2. Establish or increase exposure to Sovereign Wealth Funds to augment returns by utilizing surplus or excess forex reserves to diversify into NON-US dollar assets or finally and most importantly,

3. Be required to be paid for export sales of products or services in non US dollar currency.

Effectively all these construe to a weakening demand for the world’s reserve exchange currency.

Foreign central banks portfolios account for about a quarter of the total US treasuries outstanding, with similar degree of significant exposures into other US dollar denominated assets.

With the present decline in the US dollar index, these redound to enormous losses in the price value holdings of these institutions. And added losses could signify a litmus test on the loss taking appetite for these international institutional banks.

So far the US dollar’s decline has been orderly. And the benefits reaped from the global financial markets have been an offshoot to such gradual clip of decline.

However, if anyone from these institutions should undertake the initiative to sell on its holdings to cut losses or for some other reasons beyond our comprehension, such an action could risk a domino-effect panic selling binge that could trigger a US dollar crash, which could easily roil the financial markets and spoil our fun.

I think at such critical times it would be best for one to have sufficient exposures to precious metals in your portfolio, as insurance, especially if a US dollar panic turns into a gold/silver buying spree panic. Oh please if you are contemplating mines as a proxy to metals, only mind those with proven reserves.

Also best be reminded to keep those mental stops active.