Philippine Politics In the Prism of the Peso

``I'm in favor of achievements - degrees and wealth and that sort of thing. Still, those achievements convey formal authority but not always moral authority. The only way to acquire moral authority is through your character and contribution, to live in such a way as to merit the confidence and the trust of other people.”- Stephen Covey

Allergy to Politics and the Focusing Illusion

The most difficult position for one to take today is to be apolitical. To my experience, in almost every discussion which deals with current events seem to require the domestic political equation as an indispensable theme.

Worst, it would appear that our world has been reduced to an argument of tangibles or absolutes (sometimes known as the fallacy of the False Dilemma) - where one’s choice is confined to ONLY black or white, good or evil or pro or against.

Yet, the arguments as we presented last week is one of the abstract phenomenon. It deals with intangibles or theoretical suppositions or even metaphysical concepts- where judgments are mostly based on the perceived values of individuals or are very subjective in nature.

So when words such as “Honesty, Morality, Truth, Altruism, Compassion, Justice etc.” are used and floated in the political sphere, beyond the public’s comprehension these words basically become expediencies or “slogans” meant to achieve a goal. Unfortunately once these are met, we see the cycle repeat over and over again, hence the never ending issue of street politics.

In behavioral finance, such cognitive distortion or bias can be identified as the Focusing Effect or Focusing illusion which is, according to wikipedia.org, ``when people place too much importance on one aspect of an event, causing an error in accurately predicting the utility of a future outcome.” The underlying belief that a personality change in the present leadership will automatically result to national salvation exemplifies this premise. This represent as the “lotto” or "quick fix" mentality. Again, we said the same in 1986 and 2001 only to find ourselves repeating the same mantra.

Yet, without structural reforms in our defective system, which is based on a pork barrel rent seeking “culture” grounded on excessive dependence on government and a dysfunctional market system controlled by politicians and their associates, all this beliefs are likely to signify another illusion-as in the past, we are likely to see the same dynamics in the future (even under new leadership).

The Abstraction of Action Speaks Louder

Abstraction, seen in the present day developments in our local financial markets, can be related to one’s perception of reality.

Because of the onslaught of controversies encompassing media space, the atmosphere depicted is of a country teetering on a verge of chaos. Thus, we are told that the Philippines as having been mired in a deep crisis which requires “urgent solution to a desperate situation”. This reverberating clamor for “change” has today become a fashionable social theme. Unfortunately, this fad has yet to reach a “critical mass” or to the same level of political fervor that has successfully ousted incumbents in the past.

Nonetheless, as a market observer, we are aware of the distinction between what is bruited about in the media-conventional thinking and how the market responds to what is the perceived as the risk environment.

The normal or conventional behavior is; the general public is unlikely to invest in a marketplace whose environment is perceived as highly risky. For example in 2002-3, hardly any local investor wanted to even talk about investments in the Philippine Stock Exchange following its deep cyclical funk because it was perceived as “highly risky”. This signifies extreme levels of risk aversion, yet, the public’s “Focusing Effect” led them to miscalculate and miss out the greatest buying opportunity which marked the secular bottom of the Phisix for this cycle.

If I ask you to invest in the sub-Saharan African states, would you? How about in the previously war torn areas of Mindanao? The most likely response would be a NO, especially if one is not acquainted with the area or is not from the area. Because people tend to operate merely on impressions, the conventional perception of such risk environment is likely to be based on negative reports depicting anarchy or violence.

But can a perceived high risk environment receive ample investments? Yes, perhaps depending on the social mood and or on the risk appetites of investors. So when social mood is optimistic or rather risk appetite is more tolerant regardless of the stream of bad news, then markets may not exactly reflect today’s headline sentiments and vice versa. In other words, ACTION speaks LOUDER than words! Financial markets may translate to votes of actual money placements by the investing public than mere “verbal” sentiment.

The Weakest Link: The Phisix

The Phisix today seems most susceptible to the present political drama than in any part of the current cycle (since 2003) because foreign money which had underpinned the run up of the entire cycle has now turned to negative (since the late semester of 2007).

In contrast, the local participants apparently have traded places with their foreign counterparts, whereby the former have been providing the backbone to the Phisix during the recent market turmoil as the former drivers exited.

Yes, as you well know, external developments have dragged foreign sentiment away from local equities which is most likely due to the ongoing liquidation dynamics as a result to the implosion of the house of cards built from highly leveraged mortgage securities and other derivatives papers in the US and in some other parts of the world.

Since many institutions had been caught holding into these papers with unrecognized value, raising funds meant selling of the most liquid holdings of their portfolio, hence the contagion effect (selling across the globe). Some financial institutions and lenders have been estimated to shrink capital assets by about $2 trillion (Greg Ip- WSJ).

Aside, this also mean adjustments in the economic and asset valuation expectations from the perceived impact of a meaningful downshift from the US economy as an offshoot to the tightening credit environment- where the same estimates say that about 1.5% percentage points would be knocked off the US economy- brought upon by the ongoing global credit crisis and the contraction of leveraged securities markets.

So with hiatus of foreign money serving as principal support for the Phisix, this leaves local participants as its major drivers. True enough, we have seen SOME impact of the political drama manifest in the Phisix as shown in Figure 1.

Figure 1: stockcharts.com: Phisix “Decouples” on Political Drama

The vertical line represents the “short-term” bottom from which Emerging market Economies (lowest pane), the US S&P 500 (above pane) and the Dow Jones ex-Japan index (behind-center window) has indicated partial recoveries or consolidation. On the other hand, over a similar timeframe, the Phisix has missed the recovery train and remained sluggish. Hence, the Phisix has partially "decoupled" from world markets which implies clues of negative impact from domestic politics.

Notably, in spite of this the net foreign selling has been greatly reduced and in fact these turned positive last week, as our market belatedly recovered (see circle).

Of course, hefty fall by the major benchmarks in the US markets last Friday are likely to exacerbate the negative conditions in the Phisix at the outset of this week.

So yes, admittedly over the short period the lack of foreign support has exposed the Phisix to some degree of political risks.

The Peso As The Strongest Measure of Sentiment

But, this is not entirely the same tune we hear if measured relative to our currency.

The Philippine Peso is likely to be a more accurate pulse of investor sentiment since they reflect capital flows across asset classes within our domain, aside from other factors such as remittances or trade surpluses or deficits.

Figure 2: Philippine Peso: No Crisis so Far

As a reminder, net selling in the Phisix does not automatically reflect capital exodus as it may imply asset shifts (from stocks to bonds or short-term cds).

Figure 2 shows of the historical significance of political tensions to the Peso. Tremors from major scandals, which rocked the political landscape in the Estrada Impeachment to the culmination of the People Power 2001, caused a significant drop in the US dollar-Philippine Peso exchange rate (see red arrow leftmost side).

Following the Estrada ouster in 2001, the Peso appreciated over a short period but resumed its long-term downward path.

It is the same story in 2005. The Peso which has greatly lagged the region relative to currency appreciation found itself attempting to firm up during early 2005 [as explained at What Media Didn’t Tell About the Peso]. However, as the HELLO GARCI scandal erupted- where almost the same intensity for the quest of “truth” was advocated-the Peso lost its upside momentum and consequently fell back to the 56 level (middle red arrow).

Meanwhile, the Phisix lagged the world by trading sideways then. It must not be forgotten that operating underneath the dynamics of 2003 to 2007 had been sizable foreign portfolio flows. Such that even during the outbreak of the Garci Scandal, foreign funds accounted for “net buying” even at greatly reduced scale.

Essentially, the public’s impulse of scampering for cover in response to the political scandals has been demonstrated by a loss of value of the Peso relative to the US dollar-where political anxieties has even overwhelmed foreign money flows. Or simply said the resident public exited the Philippine Peso on political antsy and sought the US dollar as safehaven.

Today we see almost the same extent of political drama but under a different set of circumstances. Yet as opposed to the past - the Peso is seen breaking into NEW highs…in fact is in a fresh EIGHT year high! Nonetheless, this comes in the light of a streak of net foreign selling in the Phisix since the advent of 2008!

This development thus leads us to several intriguing questions:

1. If the Public is seen selling from the perceived “crisis” then who is on the other side of the trade…buying? This is a big curiosity. Yet, market reaction does not suggest of high volatility or wild gyrations (just look at the chart) to indicate strains of “panic” or “fear”, accompanied by a “forcible” containment (yet!).

2. Has the public been immune to the political risks such that all the brouhaha for change could possibly translate to an “All bark no bite” scenario?

The fragmented elite, many of whom have joined the caravan to the supposed “path of enlightenment”, seem to have been jaded by the political stress as they appear to remain calmly invested! There has been NO substantial evidence of panic selling from locals in the Phisix or in the Peso. In fact, the main support in the Phisix has been from the local participants since the July 2007 credit crisis exploded or even since the start of the year! Can we deduce their actions as merely rhetoric in a political sense?

3. Has the negative real rates impelled the local investors to turn a blindeye to political risks (despite the social chatters) given the opportunity cost of holding US dollar assets? The thinking goes, “I’d like to flee but where to go? The US dollar keeps falling! Besides, inflation is eating up my peso.” (Still this does not represent a sign of panic…since they’re still thinking!)

4. Or how about this naughty thought of mine…could it be that some political entities been “manipulating” public sentiment to do a “poop and scoop” or spread bad news in order to buy assets in the hope that they fall?

With Philippine trade account registering a deficit for 2007 of $5.04 billion (forbes.com), this leaves remittances and portfolio flows as possible major contenders for the vitality of the Peso.

Yes, remittances have remained strong- as they had been during the Estrada impeachment to the People power 2001 and during the 2005 outbreak of Garci Scandal…yet the Peso fell! But it would seem dubious if they signified as the sole variable responsible for the levitated state of the Peso.

This most likely posits that the combined forces of unseen portfolio flows, the “no panic” attitude (yet) among local investors (instead of capital flight maybe a capital repatriation!) compounded by continuing of remittances may have buoyed the Peso. (Of course, this has shadowed the region's performance).

Foreign Money Are Not Zombie Investors!

It is also awkward or a cockamamie to suggest that foreign money is inured to political risks.

Figure 3: Bloomberg: Thailand’s SETI

While there are still substantial signs of copious liquidity in the world’s financial system, the market tensions evident in the global credit markets as well as in the structured finance securities and derivatives markets spilling over to global equities signify traces of discriminatory flows of liquidity. Ostensibly, these “surpluses” have been flowing into the commodity markets. Hence, the attendant risk taking posture by international fund managers are likely to be more discerning than during the previous pre-July 2007 Credit crisis era.

Yet, even then, political risks did matter. When the military successfully unseated the incumbent Thaksin Government of Thailand via a coup d'état, a financial market carnage ensued in September 2006 as seen in Thailand’s premier benchmark, the SETI, in Figure 3 courtesy of Bloomberg.

This was further exacerbated when Thailand’s central bank instituted capital controls from which they have partially reversed following a fierce backlash from investors. Incidentally, Thai’s Central Bank has reportedly been scheduled to lift all controls this week (Reuters).

So, foreign investors are not zombie buyers who acquire assets regardless of risks. Since they are profit oriented enterprises (unless they are Sovereign Wealth Funds SWFs), their positions are based on estimates of a risk-reward tradeoff.

Likewise, foreign money have not been acquiring assets out of political considerations; again unlike central banks who continue to amass US dollar instruments (mostly agencies today) despite the steep losses of the US dollar or like select Sovereign Wealth Funds (e.g. China’s CIC or SAFE). So it would be a huge mistake to presume foreign money flows as entirely impervious to political risks.

Encore: Believing In Six Impossible Things Before Breakfast

All this goes to show that words can be different from actions. One can say a mouthful of things yet act on the contrary. Politicians are the ultimate practitioners of this, they are devout followers to Napoleon Bonaparte’s advice, ``If you want to be a success in the world, promise everything and deliver nothing.”

Such abstract disparities have been equally conspicuous under today’s setting; reality according to the Philippine financial markets is starkly different from the reality as limned by the media, the politicians and their followers.

In a perspective, yes there is a crisis- but this has been limited to the political spectrum, the media space, and to social circles.

No, there is no crisis (yet) in the financial sphere or the economic front as signified by performances of the Peso or other financial markets; for whatever reasons possibly higher risk tolerance, negative real yields or buoyant social mood.

To argue otherwise is to see our reasons BLINDED by extreme fixation on politics. Besides, the generalization that Philippines in a crisis falls under a logical fallacy- the fallacy of composition, which is, according to wikipedia.org, the inference of ``something is true of the whole from the fact that it is true of some part of the whole (or even of every proper part).” As you can see, sensationalism will bring us nowhere.

To paraphrase Mr. Warren Buffett in his latest Berkshire annual letter, many of those suggesting for a crisis seems to direct descendants of the queen in Alice in Wonderland, who said: “Why, sometimes I’ve believed as many as six impossible things before breakfast.”

So until we see this “crisis” rear its ugly head possibly through further deterioration in the political arena which may diffuse into the real economy and most likely felt first in the markets, like the global depression tales, they belong to the genre of horror movies.