Phisix and Global Markets: A Momentum Play In the Face of Adversity

``The moment we want to believe something, we suddenly see all the arguments for it, and become blind to the arguments against it."-George Bernard Shaw

We had earlier contended that the market would react with temporal influence from the recent unfortunate Glorietta 2 incident. Unluckily we have not been accorded the opportunity to witness its solitary effect, since a big drop in the US markets preceded a bloodbath in global markets, particularly reflected in Asia, this week. Succinctly put, the 3.98% drop of the Phisix last Monday was seen from the reflections of the Glorietta 2 blasts and most importantly, a ripple from the US markets. It is the latter that has likely impacted the Phisix more than the sordid Makati incident.

Anyway, global markets recovered strongly from Monday but our Phisix ended the week down by .91%. The Philippine benchmark greatly lagged its highly spirited neighbors, such as Indonesia (up 2.37%), Thailand (+2.14%), Malaysia (+2.06%) and Korea (+2.94%) this week, where we cannot yet rule out the potential impact of the last Friday’s incident, as shown in Figure 1. Although, since the authorities have leaned towards the accident angle, media have correspondingly shifted away from the issue to focus on ex-President Joseph Estrada’s pardon which has similarly dissipated analysts attribution of Glorietta 2 incident to market actions.

Figure 1: Stockcharts.com: Buoyant ASEAN indices

What can be factually observed was that foreign selling had stepped up for the second straight week to the tune of Php 2.561 billion, its highest scale since the week which ended in March 2 of this year. Another, the share of foreign participation has been below 50% of the aggregate Peso trading volume for the third consecutive week or about 45% this week. Notably, all these suggest that local investors have taken the drivers seat.

Now since local investors are likely to be politically infatuated than their foreign contemporaries based on the PSE’s previous experiences, then it would be sensible to argue that if the Glorietta blasts had a negative impact then such could have negatively affected the trading activity patterns of local investors, which doesn’t seem so.

Nevertheless, foreign selling has been seen even prior to last Friday, although they doubled from last week. So while these data suggests that the recent activities could have little connection from last Friday’s adverse Makati incident, it remains to be seen if present operatives will continue.

Bullish Premise: Buoyant Region, Halloween Indicator and Strong Asian Currencies

Given that the US markets have closed strongly last Friday, together with upbeat sentiments in ASEAN markets, also seen in Figure 1 where Indonesia ($IDDOW-highest pane below Phisix) appears working for another breakout, Malaysia ($MYDOW-lowest pane) recently brokeout, and Thailand ($SETI-middle pane) at resistance levels, we are inclined to view that the present optimistic momentum could likely continue for the Phisix (main window) barring any shocks.

Further with the Peso at Php 44.06 against the US dollar, a SEVEN year high, where if the recent firming short-term Phisix-Peso correlation should hold, this should augur well anew for the Philippine equity assets.Figure 2: chartoftheday.com: Halloween Indicator

Next, if we take the potential direction from the US markets, the inspirational leaders of global equities, seasonal strength could likely be a force that may support momentum, as shown in Figure 2, where the November to April cycle has been historically favorable for investors. This should likewise support the US presidential cycle which could translate to a positive yearend.

Bearish Premise: Rising Risk Aversion, Worsening US Housing Recession, Narrowing Market Breadth

Nonetheless, we cannot write off the risks which persist to becloud the US economy and its financial markets aside from questioning the health of the global credit system as risk aversion has not been the same as prior to the July Credit Crunch.

The highly reputed independent BCA Research, shown in Figure 3, while maintaining a bullish stance remains equally cautious…

Figure 3: BCA Research Risk Aversion Returns

From BCA Research (emphasis mine), ``Renewed concerns emanating from weakness in U.S. housing, further turmoil in the financial sector and credit markets have sparked a broad-based selling of financial assets. Over the past couple of days, implied volatilities have moved higher, carry trades have begun to unwind, stock indexes across the globe have taken a haircut and government bond markets have rallied. While further downside is probable in the near term, a bear market in risky assets is unlikely: The global economic backdrop remains decent despite a weak U.S. economy, and further monetary easing will be provided. Investors should continue to bet on reflation, but also to expect heightened volatility and a further narrowing in breadth of the advance to persist heading forward, particularly in the U.S.”

And speaking of narrowing market breadth, since the US markets have been strongly up due advances in the overseas levered technology sector, analyst Mish Shedlock points out that the chunk of these advances came from only three stocks see figure 4…

``Of the 400 NASDAQ points we're up this year, 206 came from three stocks. Apple (AAPL): 127, Research in Motion (RIMM): 47, Google (GOOG): 31”

Figure 4: stockcharts.com: Narrowing Market Breadth?

A narrowing market breadth refers to growing divergences in the general market where the advances of an index have been mostly due to select issues. Such deteriorating breadth could be indicative of a maturing bullmarket or could even presage a top.

Nevertheless Mr. Shedlock notes of the high P/E ratios from which the investors have priced in for the recent market leaders: “Google (GOOG): 55.91, Research in Motion (RIMM): 81.39, Apple (AAPL): 52.57”

Reflation Trades And Policy Steroids

Better still, global markets have presently been elevated from expectations of “reflation trades”, where as we had repeatedly pointed out (market on steroids or Dr. Jeckll and Mr. Hyde), each time the financial market undergoes some volatility, chatters of policy actions by central banks have cushioned and stirred up a buying frenzy in the equity markets.

Nonetheless such reflation trades have been quite visible with the record breaking week for the global financial markets as reflected in a record low US dollar, all time high for oil prices and 27-year gold prices! See figure 4.

Figure 4: stockcharts.com: Evidences of Reflation trades

The Euro heavy US dollar trade (upper pane) weighted index continues to decline on expectations that Fed instituted monetary policies will be effected in support of the asset markets while gold (upper pane below main window) and oil (main window) have risen on the account of fundamental demand supply disequilibrium aside from the deterioration of the US dollar.

In addition, the continued strength of emerging markets appears to have been backstopped by rising commodity prices as the Reuters-CRB Index (lower window).

We think that the markets have been manifestly underestimating the potential threats posed by the continued degeneration of US real estate industry to its economy as well as to the global credit markets, which has not fully recovered.

Recently the Bank of England said that its financial system is vulnerable to another shock which threatens to spillover to its economy, from the Timesonline (highlight mine),

``Britain’s financial system is vulnerable to new shocks in the wake of its most severe challenge for decades, and banks and authorities must learn the lessons of the crisis, the Bank of England says today.

``In its first detailed analysis of the squeeze that has engulfed credit markets since the summer, the Bank says that financial institutions have become more fragile and that the availability of credit may tighten. In turn, it sounds a warning that tighter lending conditions could spell serious fallout for the economy, with sub-prime borrowers and highly-leveraged companies particularly exposed.

Similarly the IMF recently warned of the heightened risks of a Global slowdown, from Allafrica.com (highlight mine),

``World economic growth is expected to slow next year, with recent turbulence in financial markets triggered by the fallout from the US subprime mortgage market clouding prospects," the IMF said in the October 2007 World Economic Outlook.

``Risks to the outlook, however, are firmly on the downside, cantred around the concern that financial market strains could deepen and trigger a more pronounced global slowdown. Thus, the immediate focus of policymakers is to restore more normal financial market conditions and safeguard the expansion," the report adds

While remaining long term bullish on Asian equities we think that there is a real risk where volatility could pop out from nowhere and spoil the fun over the interim. Staying completely out seems to be a poor option, unless one believes that the world will undergo a depression spasm. Instead, selective positioning based on one’s risk profile should be considered. Nonetheless, as the markets remain heavily on policy steroids, we will play by the momentum and manage risk accordingly.