Markets Abhor A Vacuum: Philippine Bonds and Peso Sees Daylight

``I’ve been dealing with these big mathematical models of forecasting the economy…I’ve been in the forecasting business for 50 years…I’m no better than I ever was, and nobody else is. Forecasting 50 years ago was as good or as bad as it is today. And the reason is that human nature hasn’t changed. We can’t improve ourselves.” Alan Greenspan

In the light of the recent global market volatility, we previously dealt with how the present actions in the marketplace impacted the Philippine asset classes. While the consensus in the investing community have now gravitated towards the “reconvergence” theme, covering Philippines assets, we noted how bonds and the Peso have deviated from the previous patterns where past global volatility resulted to a carnage in all domestic asset classes. Such perspective can be seen either as an anomaly or perhaps as an inchoate sign of divergence.

Barely has our ink dried commenting on such aberration and we found another test to our hypothesis. Just as the Philippine credit ratings were upgraded by Moody’s a week ago, the Philippines surprisingly went into a $500 million bond offering early this week, which astonishingly was avidly grabbed by investors.

``The government’s $500 million sovereign offering was more than eight times oversubscribed at the top end of its initial price guidance as investors bought into the country's rosier economic outlook. (highlight mine)” (Inquirer.net)

If this had been a stock market IPO, then the outsized demand could have perhaps resulted to a vigorous jump in its listing price. But of course bonds and stocks are distinct animals.

FinanceAsia labeled the Philippines as “masters of timing” for being able to take advantage of the timeliness of its offering (offering ahead of the US FOMC meeting, seizing the recent upgrade momentum) and for having squeezed out a good deal of short positions.

Nonetheless, much of the demand came from Asia and domestic investors (of the 44% allocated to Asia, 20% were subscribed by locals).

David Lai, portfolio manager at Aberdeen Asset Management observed (highlight mine) ``It reflects that liquidity in the market is still strong, it’s just that people don’t want to risk their money in markets that are this volatile. Right now, they want safer bets, not risky issuers, even if these do pay a high return. Therefore a Philippines sovereign is just the ticket, given the country's improved fundamentals, the modest issue size and strong support from onshore investors.” (FinanceAsia)

Philippine bonds as a safety bet? Who would have thought of this a few years back? Not especially with the politically obsessed populace. But today locals are clearly part of the anchor to Philippine assets. Here George Soros’ Reflexivity theory is clearly at work, market prices have reshaped the public’s perception of fundamentals.

Another interesting comment quoted by FinanceAsia (highlight mine)``This transaction shows that investors, despite their nervousness, are able to consider emerging market sovereigns rationally since this asset class has exhibited low correlation to the rest of the credit markets," says a market observer. "But it won't impact the $20 billion-worth of deals currently in the pipeline, waiting to come to market."

And this has not been an isolated event; earlier Indonesia and state-run Korea Development Bank likewise went into the bond market and successfully raised $3 billion last January. From the Philippine Daily Inquirer, ``Indonesia's $2-billion two-tranche bond issue early this month was about three to four times oversubscribed, traders said. (highlight mine)”

Meanwhile, the global credit market crisis has not deterred the Philippine Peso from reestablishing a new milestone high. The Philippine Peso closed at Php 40.50 a fresh 7 and a half year high (abroad it even closed at 40.325). Again this is not an insulated event as prices of regional currencies have responded to the recent actions of the US Federal Reserve.

``All 10 of the most-actively traded Asian currencies outside of Japan rose versus the U.S. currency in the week after the Fed lowered its benchmark rate to 3 percent and signaled it's ready to reduce it further to spur U.S. growth. Thailand's baht strengthened beyond 33 to the dollar in onshore trading for the first time since August 1997. (highlight mine)” (Bloomberg)

Moreover, even as gloom and doom analysts dominate the webspace today, as you probably read in newspapers the Philippine economy vaulted to its highest economic growth in 31 years at a time where concerns of a US recession are expected to drag global economies with it.

From the Economist, ``Despite the dark clouds gathering over the global economy, the Philippines has put in its best economic performance in over three decades. New data show that the economy grew by 7.4% year on year in the fourth quarter of 2007, as strong domestic demand and services growth more than offset weak exports. The fourth-quarter result brought full-year real GDP growth in 2007 to a 31-year high of 7.3%. The domestic economy's prospects will remain bright in 2008, although a sharp slowdown in the US, the Philippines' largest export market, will prevent GDP growth from maintaining quite such a rapid pace as last year.”

True enough economic data are lagging indicators, and for us do not serve as key movers of the financial markets. Nonetheless, we concede that in a world of globalization of trade and finances, the conditions in the US will have SOME impact to different countries but on a varying scale.

For the Philippines, the transmission channel will probably be through trade (export and imports are equally about 40% of GDP) as noted above and remittances (52% of total are from US). But other variables such as domestic demand (private consumption accounts for 70% of GDP) can also have a material impact.

The point is if economies operate on complex and diversified moving parts in the face of perpetually changing conditions, then analysis based on straightforward classroom assumptions are likely to be misguided.

Yet, as to how external conditions could affect domestic demand remains unclear. Again from the Economist, ``the key question for the Philippines is whether domestic demand can continue to support growth if a US recession hits exports hard.”

Bottom line: Amidst the credit contraction in the US and some other parts of the world, liquidity appears to remain abundant in Asia and in the Philippines, such that Philippine bonds and the Peso seem impervious to the recent bouts of volatility and in fact got recently bid up. Either this signifies an anomaly that would adjust in the face of more external pressures (from the US) or this represents seminal sign of emergent decoupling--remains to be seen. If the latter emerges, then this should spillover to the equity markets.

Besides, markets like nature abhor a vacuum. As global central banks printing presses churn out paper and digital money, especially under today’s conditions to arrest signs of budding deflation haunting some major economies, they are likely to fill up on some assets markets and or filter into consumer prices.