Inflation The Bogeyman; An Asian Liquidity Crunch?

``Interventionism generates economic nationalism, and economic nationalism generates bellicosity. If men and commodities are prevented from crossing the borderlines, why should not the armies try to pave the way for them?”-Ludwig von Mises

Last week we opined that the unexpected hawkish statement from European Central Bank’s Jean Claude Trichet may have negatively impacted markets as huge short positions were unwound which led to the largest single day jump in oil prices ever since the futures market contract begun.

This week’s heavy lashing of mostly the Asian markets could be an extension of last week’s maelstrom. While we can’t deny that the bogeyman, as hyped by media, had been rising inflation, as Asian bonds had been severely hemorrhaged, aside from the precipitate fall in most Asian currencies, there is a deep skepticism on our part if inflation was indeed the culprit.

As an inflation or crisis hedge, inexplicably gold is steeply down for the week (-2.8%) tracing the decline of the US dollar index heavyweight counterpart the Euro (-2.48%). On the other hand, gold’s nemesis, the US dollar index soared 2.42% and strengthened sizably against all the currencies in the basket. In other words, as global investors fled the bond and equity markets only the US dollar took the role of a safehaven status.

Figure 6: stockcharts.com: Inflation Bogey?

Figure 6 shows how global equity markets turned the corner as the US dollar pivoted higher. The Dow world (center red line), Dow Jones Asia ex Japan and Emerging Markets index all in a simultaneous downturn as the US dollar (center-behind) vaulted higher.

Next, only Asian markets took the brunt of most of the losses, followed by some equity benchmarks of Eastern Europe. While a big majority of global indices suffered losses this week, the emerging markets of Africa and Latin America with inflation rates known higher than Asia similarly fell but to a lesser degree! Is the market suggesting that Africa is a better option than Asia?

Some MENA bourses have even traded at RECORD levels despite soaring inflation rates such as Tunisia, Oman (11.56% inflation March), Qatar (14.75%-March) and Bahrain! Of course, one can’t argue that this outperformance is about oil revenues, since many of the major oil exporters are far from the record highs, e.g. Saudi Arabia and Kuwait.

Table 1: Jim Jubak: Inflation From Asia: The Next Crisis

It’s odd that many analysts (including institutional analysts) use the recent past performance to explain causality and make projections into the future. Put differently, just because Asian markets have cratered while headline news screams INFLATION, the market performance has been explained as being plagued by inflation. And that the next global crisis should befall in Asia!

This exactly what George Soros calls as the reflexivity theory, a two way feed back loop which grapples investors into shaping expectations and outcomes. As the above example it is cognitive function where outcomes shape expectations.

Figure 7 from stockcharts.com: Performance of Asian bourses

We can test the validity of this inflation-sell Asia hysteria thesis: If the degree of inflation linearly determines the performance of the equity benchmark, then a similar ranking of inflation should be reflected in the equity benchmark performance. In other words, the nation with the least inflation should outperform and vice versa.

Figure 7 courtesy of stockcharts.com shows that the worst losers to be China (-45.59%), the Phisix (-29.37%) and India (-25.78%). Of course India and the Philippines have the one the worst inflation data. But ironically, the country with the highest inflation rate, Indonesia at 10.4% see table 1 courtesy of MSN’s Jim Jubak, outperforms even Malaysia at 3% with the least inflation rate!

As you can see a single observation can disprove or invalidate a general assumption. That is why we would have to be careful in making generalizations.

Figure 8 stockcharts.com: Dow Jones Asia/Pacific Industry Year On Year Performance

It’s the same argument we can suggest with the Phisix.

As you can see in figure 8 under the Dow Jones Asia/Pacific industry context, the oil and gas sector, basic materials and telecoms have outperformed the general market since the bear market struck in 2007.

In fact, even after the recent selloffs, they remain in positive territory. Again as we have repeatedly argued, since inflation is a loss of the currency’s purchasing power against energy, commodities and food, then issues supporting these themes should benefit from the relative price adjustments.

Theoretically in a high “goods and services inflation” environment, since people’s incomes are limited then spending patterns tend to shift towards the basics/necessities or on perceived safehaven instruments.

And the performance as shown above seems to validate our view. Aside from oil and gas, basic materials and telecoms signifying the outperformers, the healthcare, consumer goods and utilities make up the next best performers although they are in negative territory.

Yet the recent carnage in Asia seems to heavily impact all the sectors or have been across the board. Again this is unlikely to be representative of an inflation induced selloff. As a bogeyman yes, but not as a genuine cause.

On the contrary, the patterns of activities resemble the initial outburst of selling pressures in July and October, which means liquidity prompted pressures but whose epicenter this time seems to be in Asia.

Instead, the other potential cause could be a China driven selloff whose staggering losses reached over 13% for the week!

If both of these turn out to be false negatives then it should be unearthed soon.

As for the Phisix, except for the mines which has accounted for the least losses, these Asian sectoral trends haven’t been similarly reflected. To the contrary, the region’s worst performer, the Financials, is the Phisix second best performer.

Likewise, we believe that the Philippine benchmark’s lagging performance have been due to intense politicking compounded with the dreary external sentiment. The biggest losses have been suffered by the Lopez group who is now in engaged in a legal tussle with the administration.

In the Fil-Am friendship day celebration the Philippine Supreme Court justice added to the latest outbreak of nationalistic sentiment by taking on “economic colonizers” something we will deal with possibly in the future.

As we learned from Louis Vincent Gave, aside from bubbles, bear markets can be induced by governments. To quote Mr. Gave, ``The bear market created by governments usually because one or several of what we have called in our research The FIVE Cardinal sins- protectionism, tax increases, monetary policy mistakes, regulatory overkill or war.”

The mounting nationalistic undertones are definitely signs of increasing protectionism. We hope that those in the leadership or those who are aspiring to do so will use economic commonsense than simply succumb to well meaning popular sentiment freedom themed prose but whose walls they propose to erect would lead to the unintended consequence of long term economic bondage. We never seem to learn from the past.