Politicking Weighs On Phisix, Inflation Problems Have Been Policy Induced

``For far too long, we have accepted the idea that government can and should take care of us. But that is not what a free society is all about. When government gives us something, it does two bad things. First it takes it from someone else; second, it causes dependency on government. A wealthy country can do this for long periods of time, but eventually the process collapses. Freedom is always sacrificed and eventually the victims rebel. As needs grow, the producers are unable or unwilling to provide the goods the government demands. Wealth then hides or escapes, going underground or overseas, prompting even more government intrusion to stop the exodus from the system. This only compounds the problem.” Congressman Ron Paul Challenge to America: A Current Assessment of Our Republic

The Phisix has been bedraggled by administration led politicking which has led to its recent rout (down 3.1% over the week). Yet, the efforts by the mainstream media have been to affix the culpability to inflation which recently rose to a 9 year high. This mindless penchant to attribute false causes has been misleading the public compounded by blabbermouth experts.

Attribution To Inflation Woes Don’t Add UP!

As we argued in my recent post, Phisix Breakdown: Politics Not Inflation Related, goods and services inflation means the loss of purchasing power by the domestic currency to mostly fuel and food (which is what the news report says). Alternatively, this means that rising fuel and food prices have been getting a far larger share of expenses out of household or business budgets from which comes at the expense of non-fuel and non-food items. In short, spending on food and fuel crowds out other items. This is called relative price adjustments.

So in the perspective of relative prices applied to the equity markets, share prices of energy issues should benefit from the expectations of rising share of fuel expenditures and so with food related firms at the expense of other issues if “inflation” is the concern. Relative to the performance of energy companies, except for Petron Corporation, which amazingly soared by 17.65%, the rest of issues slumped such as Aboitiz Power (-3.57% w-o-w), Aboitiz Equity Ventures (-1.39%), PNOC EDC (-5.36%), First Gen (-1.43%), First Philippine Holdings (-3.03%) and Meralco (-4.07%)! So the so called inflation woes don’t add up.

Yet, inflation figures reported in the news reckon of past performance-particularly of last May. This means markets acting as a forward discounting mechanism should have discounted the past and read into the future.

If in the past (say last month or in May which read on the April figures) the market believes food and fuel inflation will continue to impact spending patterns in the future (which is today) then share prices of these issues would have likewise adjusted. This means at this point, shares of energy and food issues should be on an uptrend. But this isn’t the case.

And when the same deduction will be applied tomorrow or if once again the energy group is extrapolated to reflect on the continuing adjustments of consumption patterns then they should be expected to trend higher. This means prospective higher prices for energy issues!

But have we been seeing such dynamics? The reality is energy issues have either been consolidating (AEV, PCOR, AP and FGEN) or seem headed for the sewer (Meralco, FPH and EDC). Again, this inflation themed anguish doesn’t rhyme at all.

So why have energy issues (or the Phisix in general) been collapsing in the face of spending pattern adjustments arising from higher costs of fuel and food?

Because foreigners have been selling the Phisix! This week, foreign money has sold the most (Php 1.273 billion) since end of April. Coincidentally, the bulk or 68% of the foreign selling came at the time when the joint foreign chamber of commerce was being excoriated by our sanctimonious politicians.

A foreign chamber of commerce is a business organization representative of foreign owned enterprises in the Philippines. The benefits or costs accrued by their companies are transmitted to their countries which may induce or reduce incentives for future capital investments locally. Hence, any negative projection imparted by our leaders or by our political economy will negatively impact our image which may lead to foreign capital efflux aside from inhibiting future capital investments-our future jobs and taxes. So it becomes a paradox to brag about our “sovereignty”, especially under today’s “globalization” or increasing trends of cooperation and integration, when we can’t produce for ourselves enough capital to make enough jobs for our countrymen.

Besides, if as a foreigner you are invested in the country, having come to the realization that your equity ownership is at risk from political intervention, will you not sell and pull out? The answer is pretty obvious. Hence, the political risk arising from the administration’s continued assault on the private sector has been impairing the country’s attractiveness as a business destination. In effect, we have been shooting ourselves in the foot anew. We just hope and pray that sanity will be restored to our leadership.

Finally, the cause and effect between inflation and equities doesn’t necessarily have a linear correlation as we have always argued. To see an example, let us base it on recent global events-Kenya’s massive rise in its inflation data was equally met with a strong response in its stock market as shown in my post Kenya’s Mixed Message: Soaring Inflation Rates and Rising Stock Market.

Of course, Kenya is unlike Zimbabwe whose currency has practically collapsed down 84% since May and whose inflation rates is said to have vaulted to 1.8 MILLION PERCENT in May (Reuters). Of course, Zimbabwe’s hyperinflationary refuge has been its stock markets where its industrial index is up 261.15% in just ONE week while its mining index is also up 379.23% in just THREE days (allafrica.com)! In these we find that equity investments can become the corollary store of value when trust over a currency loses its foundation.

Yet, if there is any little trace of inflation based positioning in our domestic markets, well Figure 3 tells it best…

Figure 3 PSE data: Philippine Mining Index Diverges From the Phisix!

The Philippine Mining index (red line) has greatly outperformed the Phisix up 2.68% amidst the harrowing decline of the Phisix (black candle) over the week.

If inflation is defined as a loss of purchasing power against hard assets then naturally, resource based issues are likely to outperform under a massively devaluing currency reserve standard of the world, the US dollar.

Besides, since the Mining industry is the administration’s baby, (hopefully they won’t change minds), it is likely that there will be continued rotation towards such resource based sectors.

Figure 4 stockcharts.com: Resource based Assets Survive the US onslaught

And it’s not just here.

The major US benchmarks fell by about 3% last Friday, as the US dollar crumbled, to which some have associated the market’s reaction to the surprising stance by European Central Bank Jean Claude Trichet indicating the possibility of raising interest rates in July.

This unexpected declaration by Mr. Trichet allegedly prompted for a forced massive short covering across the Euro and commodities-particularly the oil benchmark which jumped by 8% the biggest increase since oil futures started trading in 1983 (NYT), aside from liquidation sales in the broad equity for margin calls. On the other hand, commodity related international stocks fell at a much subdued clip while mining and oil bellwethers in the US jumped (see figure 4)!

The Dow Jones Latin American Index (main window) slipped by 1.9% but still trades at near its recent highs, while the Dow Jones US mining index (pane below main window) shot to fresh record heights amidst the market turmoil.

Meanwhile, the Dow Jones Oil and Gas Services (middle pane) similarly leapt, as the Dow Jones Gold index (lowest pane) pivoted higher following the recent doldrums which has basically reflected the price action of gold.

As you would observe, except for the US Gold mining index which we think would follow suit higher, all three indices have been moving to the upside despite the increased volatility in the main US markets of late. This is “inflation” at its finest. In short, the loose correlation with the general market makes commodity based investments very attractive diversifiers.

Politically Induced Policy Measures Assures Of Prolonged Inflation Pains

All these market signals indicates too that the commodity and the “goods and services” inflation pressures being generated by the massive imbalances imposed upon by collective governments in skewing the global marketplace will continue to persist and risks even exacerbating. It is unhealthy to discount the possibility of a US dollar crisis.

In fact, our local politicos and the administration’s actions will likely compound on their dilemma with a slew of unintended consequences arising from their growing hostility towards the market instead of utilizing them for efficient allocation.

To give you an example the recent land conversion ban of agricultural properties ensures of the rising values of real estate which will likewise be reflected on rising rental prices as the supply of non-agricultural properties gets restricted in the face of growing urbanization and expanding population growth.

Figure 5: ADB’s Hyon H Son: Has Inflation Hurt the Poor?

As shown in Figure 5 courtesy of Hyon H. Son of ADB, rental comprises the largest of the non food expenditures for the Philippine poor and also for the non-poor.

So essentially, our government is simply shifting from one form of “popular” burden to another form of “unpopular” burden which eventually will get us slammed overtime anyway. Of course, the trick here is to understand how to cash in from the opportunities presented by the government’s populist impulsive driven policy gaffes.

Government’s Time For Self Introspection

And like all trends, commodities and good and services inflation doesn’t move in a straight line.

And as we also expected, inflationary pressures abroad has filtered to the domestic scene and will continue to do so until perhaps a global stagflationary recession occurs or a policy induced slowdown (tightening) by key Central Banks or nations collectively drop policy distorting measures (quite an impossibility).

Yes, another fulfilled expectations too is our (Bangko Sentral ng Pilipinas) BSP’s tepid response to rising “inflation” by increasing its headline borrowing and lending rates by a measly 25 basis points.

The unfortunate part is that increasing policy rates will do little good because-ONE, our inflation is basically imported, as University of Columbia’s Joseph Stiglitz recently wrote against inflation targeting, ``Inflation in these countries is, for the most part, imported . Raising interest rates won’t have much impact on the international price of grains or fuel. Indeed, given the size of the US economy, a slowdown there might conceivably have a far bigger effect on global prices than a slowdown in any developing country, which suggests that, from a global perspective, US interest rates, not those in developing countries, should be raised” and-SECOND, raising rates on baby steps doesn’t remove the accommodativeness of the Philippine monetary landscape.

Come to think of it even after raising rates, the margin of our inflation index has been growing wider compared to 1) the country’s economic growth rate or 2) the nominal rates set by the central bank or 3) the yields of our treasury bills, which means like many other central banks around the world, the BSP seems to be fostering an “inflation friendly” negative real rate environment, again another policy induced problem.

Of course not to mention that March money supply growth rate is nearly double or 9.6% of the recent economic growth clip-another prospective contributor to domestic inflation.

So essentially the problem with our government is that they have been looking for scapegoats at the wrong places and have been caviling on the private sector’s contribution to our economic woes, when in fact, it is time for them to do some self-introspection.