Has The Phisix Entered An Initial Bottoming Out Phase?

``Asset managers without long-term lock-ups (or with impatient clientele) are surely more likely to be asset gatherers—appealing to the poorer judgment of their clients who want instant returns and low volatility. Those asset managers are no different than politicians—winning votes with popular short-term promises at the expense of long-term consequences. Politicians figure the next guy will be left holding the bag and have to deal with the mess. Short-term money managers, figure their clients will.” –Josh Wolfe, Forbes Nanotech, Timeless Space & the Mismeasure of Risk

It’s been quite a while since we’ve dealt with the stock market.

Nonetheless, as seen from my little social world, it seems that the present market activities have shifted the emotional reactions by market participants from one of inquisitiveness (in search for explanations) to one of deafening silence. In just over six months amidst a stinging 25% loss from the market’s peak, enthusiasm in the marketplace has remarkably suffered from a scathful drubbing. Viewed from the market’s psychological cycle, could this account for a transition from the denial stage to submission phase so soon?

The marketplace is a dynamic environment fluidly responding to permanently changing conditions. That’s what makes it so challenging. Yet, most participants seem to believe that this endeavor assumes like a game of dice throws; with limited variables at play that renders a quantified outcome. Instead, for us, the prospects of the risk return outcomes in the financial markets could be assessed from mostly a combination of market action (sentiment, cycles and technical indicators), and importantly fundamentals.

Sentiment Measures: Accumulation By Long Investors A Positive Signal

In my previous article Phisix: “Fear Is A Foe Of The Faddist, But The Friend Of The Fundamentalist”, we elaborated on several market internal measures to gauge investor sentiment where in particular we dealt with the Daily trades, which for me, serves as the best measure for speculative activities. See figure 1.Figure 1 PSE Daily Trades: From Speculators to Long Buyers

Daily trades incorporate the daily transactions of ALL market participants, i.e. from scalpers to punters to traders to investors be it from local or foreign participants.

Here we noted that since the Phisix segued into the advance phase in 2003 and more than doubled in price value (1,000 to 2,200), daily trades has mostly drifted from somewhere between 2,500 to 5,000- where we assumed the average as somewhere around 3,000 to 4,000 a day but interspersed with intermittent anomalies.

In short, the growth in the Phisix during the 2003-2006 cycle could be construed as coming from limited punts and mostly from fundamental accumulation and thus has not been indicative of a bubble in progression.

This is important to understand because secular inflection points or major cyclical long term trend reversals almost entirely emanate from “bursting bubbles” in the world of central bank money, where asset classes are inflated by monetary policy induced credit or leverage driven speculative excesses which eventually either collapse under its own weight or from policies meant to curtail its pernicious repercussions to the real or main economy.

It was only during the last quarter of 2005 where daily trades consistently trended higher, which incidentally coincided with the firming of the Peso, from which we surmised the strength of the Peso as having possibly drawn in more participation from the locals and consequently the increased episode of speculation.

Yet as the US mortgage and credit bubble imploded and spread globally and into the Philippine Stock Exchange, the subsequent loss has, as expectedly, reduced interests of market participants (mostly punters) who were caught with losing positions or have found stock market investing as an unworthy alternative or importantly where present losses have stricken fear into the hearts of the investing public with its recent volatility and with the social bearing consequences from the recency bias-meaning the impact of the herding/bandwagon effect (“with everybody losing, why should I dabble with stocks?”).

This is what I wrote then, ``This leads us to deduce that once the 3,000 level per day is met, the Phisix could mark a BOTTOMING OUT since fundamental based buyers are likely to dominate the Phisix investing space!”

Put differently, the present figures as shown in the daily trades chart reveal that the chapter of speculative froth has closed with the exogenous triggered meltdown.

Figure 2: PSE: Diminishing Peso Volume on Reduced Volatility

But this also means that the “reversion to the mean” by the daily trades suggests that in the CONTEXT OF SENTIMENT the Phisix could now be in the INITIAL PROCESS of carving out A BOTTOM.

Coupled with the STILL ELEVATED NUMBER of daily issues traded (another measure of sentiment), a meaningful decline in the Peso volume of cumulative daily transactions to the 2006 levels (see red line in figure 2) on inchoate signs of declining volatility in the face of the unblemished Phisix’s long term trend, the diminished activities of punters could be read altogether with the other developments in a positive light. So in the dimension of the market action in the PSE, we could be actually seeing signs of the Phisix “bottoming out”.

As a REMINDER, when we say potential bottoming, it either means an extended process of base building or consolidation or a slow recovery (usually a U shaped chart) because it takes awhile or more time to reestablish the confidence lost from the recent traumatic encounters.

Moreover, we shouldn’t expect a similar pace of outperformance as the previous years (not yet for the meantime anyway) or a V-shaped recovery since the risk environment abroad still manifests some indications of persistent credit tensions. Besides, any V-shaped recovery could mark another Bull Trap as discussed in “Missing Rallies or Catching A Falling Knife?”.

The important point to understand in a bottoming out process is that the downside risks are seen subsiding compared to its upside potentials, or that the odds of further market weakness seems to be declining compared to the odds of future gains, although it may take sometime to accomplish the latter. In other words, on an investment standpoint, gradual accumulation is likely to be a better option today than selling.

Further Confirmation Required

Figure 3: stockcharts.com: Global Benchmarks are Recovering

Could the Phisix go lower from here? Absolutely. But most likely it will attempt to find a base using the recent lows (2,772) as a yardstick. To go beyond it means all our bets are off.

This also implies that the Phisix needs to be further buttressed by MORE TECHNICAL ACTION to underpin such cyclical transitions, matched by DURABILITY from possible renewed pressures from EXTERNAL INFLUENCES or AN EXTERNALLY LED RECOVERY see figure 3, which is most likely the case today.

Utilizing global benchmarks, signs of “decoupling” has still not been palpable, but surprise surprise…global markets appear to be recovering even in the face of an onslaught of bad news…persistent credit crisis, more signs of US economic slowdown, declining corporate earnings in developed countries, surging consumer prices worldwide, soaring oil, food and other commodities.

Major benchmarks as the US S & P 500 (center window), the Dow Jones World Index (top most pane), emerging markets (window below center) and Asia Dow Jones ex-Japan (bottom pane) have made substantial recoveries.

Emerging markets appear to be leading the recovery front with a possible breakout attempt over the coming sessions on the back of record breaking commodity prices… yes, Crude Oil at an astounding US $117 a barrel!

We see very strong performances from key emerging bourses as Brazil and Mexico (both attempting to breakout to record highs),South Africa (at record highs) and Russia (likewise nearing record highs).

On the other hand, China’s previous sizzling performance (jumped sixfold in over 2 years) has suddenly blown cold deflating by 41% year to date and by 49% from its October pinnacle, it is my guess that China’s performance could probably mimic Saudi’s Tadawul Index which also exploded sixfold during the bubble years of 2004-2006 and eventually gave back 65% of its gains. Today the Taduwul index has been in consolidation since late 2007 and up by over 35% from the recent troughs.

Figure 4 stockcharts.com perf charts: Phisix Underperforms!

Yet, the Phisix continues to lag major bourses as shown in figure 4 courtesy of stockcharts.com which shows the performances of the major benchmarks along with the Philippine benchmark since the global markets broke down in October of 2007.

Emerging markets have recovered most of their losses and is down by only about 5% compared to Dow Jones world index -10%, Dow Jones Asia Pacific ex-Japan -14% and the S & P 500 -11% while the Phisix is down 19.5% hardly distant from its recent lows.

This lagging performance could be traced to the uncertainties surrounding the potential impact of the recent rice crisis to risks of social upheaval and to the risks of the deterioration of the country’s fiscal position, which I think is (one) overstated, (two) a temporary phenomenon and lastly a self-inflicted predicament as the local authorities have themselves been responsible for painting this “crisis” impression turbocharged by a sensationalist media (diversionary political ploy perhaps?).

Deeper Negative Real Rates As Potential Impetus

Finally, I read an article where the IMF recommended to Philippine monetary authorities to further cut rates amidst the present environment in the expectations that inflation pressures will taper and the US dollar will recover which should temper oil and commodity prices.

Figure 5: US Global Investors: US Money and Global Money To The Sky!

I think the IMF projection is too optimistic. One, contrary to my expectations of a stronger dollar early this year, the US dollar index has remained soft. Two, the global credit and US economic woes are likely to linger with more forthcoming “socialization” programs. This implies further pressure on the US dollar. In short, a US dollar recovery in the second half is unclear. Third, a revival of US economic growth in the second semester is also uncertain. Fourth, the pumping of money by global governments (see figure 5 by US global investors) has less been able to bridge the capital vacuum required to rebuild confidence in the US financial system. Instead, the money intermediated into the global financial system are being channeled or “finding a home” into commodities and basic goods, thus higher consumer prices or as tagged by media “inflation”.

At present rate, consumer prices are rising faster than what is expected by authorities, thus at the prevailing clip, rising consumer prices could eclipse present borrowing and lending pegs, aside from the coupon rates across the yield curve by our sovereign debt papers. Plainly put, the purchasing power of the Peso continues to erode as the prices of consumer goods soar.

And when the public doubts the viability of the purchasing power of the currency, it loses its function of “store of value” which means the public may actively “hoard” goods, financial assets as stocks or tangible assets as real estate as a substitute “store of value”.

If our authorities will comply with the IMF or maintain the present interest rate fixings, then it is promoting a negative real rate environment. Such environment essentially penalizes savers and encourages speculation and hoarding. The irony here is that government sets the policy, but “arrests” people who would simply be responding to the incentives set forth by the designated regulatory climate.

On the other hand, if authorities increase rates, given the continuing plight of the US dollar, they may attract speculative capital from overseas given the window of interest rate arbitrage which may lead to increased pressures for domestic money growth and again higher “inflation”. Damned if you, damned if you don’t.

Maybe stock markets abroad have been recovering not because of improving fundamentals but rather from the second wave of tsunami of excess money flooding the global monetary system. As Fritz Machlup wrote, "... continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply."