Foreign Money Governs PSE; Value Investing Amidst Fear

``The farther backward you can look, the farther forward you are likely to see." Winston Churchill

The PSE Playing Field

Retail investors according to the PSE registered only a scant 430,681 accounts for Filipino investors in 2007. This signifies less than 1% of the total population, something we talked about as early as 2004. Yet, of the total, only 103,412 have been active or involved in a trade in a year, which represents a grotesquely small figure even considering the run up over the past 4 years.

Of course, the PSE didn’t include those indirectly involved in the trade, which should have accounted for mutual funds and trusts funds offered by banking institutions such as Unit Investment Trust Funds (UITF) or by Life insurance companies such as Index Funds.

Even so, this implies that a reasonable ball park figure should account to some 1% of the population which means the Philippines remains one of the least exposed to the capital markets, which is one reason the Philippines remain poor.

Capital markets, as we have so frequently stated, function as an alternative source of financing next to banking.

Aside, they operate like money- they serve as a platform for conducting exchanges of financial instruments (medium of exchange), they are avenues for valuation and liquidity generation (unit of account) and are repository of assets (store of value), thus contribute to the mobilization of savings, the channeling of investments and help determine consumption patterns.

For instance, when an economy grows with an attendant rise in corporate profitability, if these companies are predominantly not publicly listed, then corporate profits contributes less to the consumption patterns because they don’t pay dividends or offer capital appreciation to a wider scope of ownership but the profits stay within the companies that generate or produce them.

However in countries with mature and deep capital markets, when profits rise, stock prices and dividends also tend to rise. Shareholders can easily sell or use their stockholdings as collateral to finance consumption or for reinvestment. They may also choose to use value added dividends to do the same. In essence, capital markets allows for a wider option for individuals or enterprises to access capital increase savings and investment returns or to even act as a hedge to an investment (for sophisticated markets).

Unfortunately most of the participants misunderstand this and sordidly treats the capital markets as some sort of an alternative avenue for gambling or a casino.

Of course, this is abetted by the woeful quality of information dissemination by the key participants themselves who engage the public into a short term perspective or to the allure or promise of easy money with a dearth of understanding between the tradeoff of risk and returns or of cost and benefits.

Half Full or Half Empty?

Overall there are two dimensions that can be gleaned from this-

One there is a commodious growth for the capital markets over the long term, especially if Asian markets will continue to outperform the world or converge with developed countries in terms of scalability, depth and sophistication.

As an example, despite the global credit crisis and stock market infirmities in the region, Asian merger and acquisitions continue to proliferate and outperform the world, this from the Financial Times (Sundeep Tucker),

``The aggregate value of announced cross-border deals between Asia-Pacific companies has totalled $54bn in the year to date, according to figures from Dealogic, the data provider. This compares to $25.7bn during the corresponding period last year.

``Bankers report that deals currently in the pipeline should mean 2008 will be a record year for intra-Asian deals, eclipsing last year's mark of $76.2bn. The value of intra-Asian deals has risen steadily since 2004, when combined deal activity totalled $35.2bn…

``Regional consolidation has been led by outbound Chinese investment into the financial services and resource sectors. There has also been strong cross-border activity across south-east Asia.

``Bankers attribute the growth in Asian M&A to strong economic growth, increasing scale and financial capabilities of the region's corporations and rising confidence among senior management ranks to execute overseas deals.” (underscore mine)

Second, presently given the size and breadth of domestic investor’s participation, they seem serve as subaltern to foreign money. Although of course, we have noted that local participants have occasionally functioned as the alternative cushion to the market especially during the recent foreign driven selling, the dominance of foreign money is the explicit reason why our performance has been closely tied with activities abroad.

Yet, with a general negative sentiment (initially due to forced liquidation abroad for capital raising purposes) towards equity markets which resulted to a net foreign selling here, politicking has compounded on the domestic arena which persisted to weigh on the market, this time with local participants largely contributing to the selloff.

Of course, the idea that recoupling due to the gathering storm of deflationary forces or from the inflation contagion as the reason why global stock markets are being sold down the sewer can easily be rebuffed.

In my recent post Recoupling and Inflation Doesn’t Explain Everything…, we showed how bourses of some countries have defied gravity (uncannily some in Africa!) and continue to drift at record highs.

The point is that markets can act distinctly from the general observation for one reason or another.

Asia’s Leverage of More Policy Options

As for Asia, we think that the region’s Central Banks have more policy options compared to its counterparts in Europe or in the US which should allow Asian markets to recover rapidly.

Like us, University of California Berkeley Professor Barry Eichengreen believes that aggressively raising rates should be an instrument to consider,

To quote Prof. Eichengreen (RGE Asian),

``These negative interest rates and their artificial stimulus to consumption and investment are also why we haven’t seen more of a slowdown in Asia – why we haven’t seen more recoupling. But now that Asian central banks are being forced to tighten, we will see more evidence of their economies slowing down. Asian currencies will appreciate against both the dollar and the euro. Although the Fed and the ECB may raise rates as well, both inflation and growth are weaker than in Asia, so they will have reason to respond more moderately…

``Fortunately, there is another instrument for sustaining demand in these circumstances, namely fiscal policy. Higher interest rates will push up the exchange rate and damp down inflation. Tax cuts and increases in public spending on locally-produced goods will limit the contraction of aggregate demand. Insofar as these fiscal actions stimulate the demand for locally-produced goods, they will push up the exchange rate still further, which will moderate the rise in import prices and further contain inflationary pressure.” (highlight mine)

This means that public investments on infrastructure, as an example, may help offset (by lowering cost of transactions) any decline in the economic growth arising from the costs of higher interest rates. Besides, being a major commodity producer, expediting investments within or related to this field could help rebalance our economy aside from boosting foreign exchange revenues.

Yet, higher interest rates could induce for a firmer peso and could lure foreign money back to the Philippines and into local assets.

Remember, if you are concerned that local money will be diverted away from equities, just refer to the data from PSE and realize that foreign money and not local investors have been the key drivers of the financial markets (for the time being until perhaps certain higher levels of the Phisix would be attained).

Value Investing Amidst Fear

Figure 8 Phisix: Quarterly Chart

Yes, the bearmarkets (see figure 8) of the past whether as a countercycle of a bullmarket or during the main bearmarket cycle have shown the Phisix to have lost 50-60% before recovering.

While of course we can’t discount this to reoccur, we doubt this premise simply because the past conditions do not represent the same as today as we laboriously argued in Phisix: No Bubble! Time for Greed Amidst Fear.

Anyway as a matter of technicals, a 50% retracement should imply the Phisix at 2,450, otherwise if the market should fall further then a 61.8% retracement should imply the Phisix at 2,100.

But as Michael Maubossin of Legg Mason wrote in The Failure of Arbitrage, ``Trend followers, as emotion riders, are not concerned with price-to-value discrepancies. Price alone indicates whether a momentum investor is right or wrong. So while trend followers care only about price, value investors care about the discrepancy between price and value. The distinction in the perceived source of edge in the strategies is crucial because it implies very different roles in the market ecosystem.”

So at this point the investing perspective shifts from that of momentum (fear) to that of Value.