Why An Increasingly Asset Friendly Environment Should Benefit The Phisix

``There is only one cure for terminal paralysis: you absolutely must have a battle plan for reinvestment and stick to it.”- Jeremy Grantham Reinvesting When Terrified

The risk environment seems to be tilting towards an increasingly cash hostile-asset friendly environment from which the local stock market would likely benefit from.

Here are six reasons why:

1. Extremely Depressed Mainstream Sentiment.

After a 55% drop in the Phisix from its peak in October of 2008, the public still sees the equity market as highly “risky” in the “traditional” economic sense (more below).

You can just see this overwhelming dire sentiment in news headlines or TV news shows or from the viewpoints of media’s favorite talking heads. This runs starkly opposite to the dominant sentiment when the Philippine benchmark was at 3,800 when there was a cheery consensus (except for us).

In other words, overtly depressed mainstream sentiment (or sentiment extremities) conveys of nascent signs of a possible inflection point.

2. Creative Destruction

After a staggering $50 trillion loss of global financial assets from which one fifth or $9.6 trillion has been ascribed by the Asian Development Bank to Asia (msnbc.com), a recognition of global recession and the collapse in global trade, investment and financing or deglobalization, such colossal downsizing of financial assets and the massive retrenchment in the global macroeconomic structure, for us, signifies as “creative destruction” which may have reached a near culmination of the process in many parts of the world. Possibly with the exception of the US and parts of Europe.

3. Perspective Shift from the Macro to Micro environment

Despite the latest globalization trends, since the world isn’t “entirely” integrated, where much of the external linkages have been only from the aspects of labor (remittances), trade, finance and investments, the significant market attention on the macroeconomic framework during this adverse adjustment period is likely to shift weight towards to the micro landscape [see Fruits From Creative Destruction: An Asian and Emerging Market Decoupling?], thereby possibly leading to more signs of “divergences” or “decoupling”.

4. Policy Incentives Are Directed Towards Aggressive Risk Taking

Of course, we have to admit that the healing process from today’s major drastic economic shakeup will translate to a time consuming effort or that resource or capital reallocation essentially takes quite a time.

But this doesn’t mean markets can’t progress especially when global policymakers have been working feverishly to impel incentives favorable to risk taking.

One, global central bankers have been squeezing down interest rates nearly to zero…

From Morgan Stanley’s Joachim Fels and Manoj Pradhan (bold highlights mine) ``. Within the G10, official interest rates are virtually zero in the US (0-0.25%) and Japan (0.1%) and just 0.5% in the UK, Canada and Switzerland.

``In the euro area, the refi rate still stands at 1.5% after last week’s cut, but the effective overnight interest rate (EONIA) between banks trades close to the 0.5% floor set by the ECB’s deposit rate. Thus, the GDP-weighted G10 policy rate now has a zero handle. The weighted G10 policy rate is likely to drop further as we expect more rate cuts in the euro area, Japan, Australia, New Zealand, Sweden, Norway and Switzerland in the next few days, weeks or months.”

Next, they’ve also been monetizing debt or printing money…

Again from Fels and Pradhan ``several major central banks including the Fed, the ECB, the Bank of Japan and the Bank of England are engaged in various forms of quantitative easing, which has led to an explosion of excess reserves held by banks with these central banks. The explosion of bank reserves has pumped up the monetary base – consisting of cash in circulation plus bank reserves held at the central bank – in these four countries, as we have illustrated. In the US, the monetary base has more than doubled over the past year, while it is up by 40% in the euro area and 30% in the UK over the same period. The monetary base is also called ‘high-powered’ money, because our fractional reserve banking system allows banks to create many times the dollar amount of deposits from the monetary base through lending to, or acquiring assets from, non-banks.”

It is not much different here in the Philippines see figure 1.

Figure 1: Danske Emerging Market Briefer: Philippine Negative Interest Rates

At least in terms of the interest rate regime, the Philippine overnight borrowing rate has been fixed presently below the (CPI) inflation level by the Bangko Sentral ng Pilipinas (BSP), which makes the domestic interest rate environment essentially negative- net losses for savings compels the public to stretch for yields, which makes the marketplace conducive for speculation.

Furthermore, since the Philippine economy has negligible exposure to leverage, where the underlying risks from the evolving crisis has so far been “marginal” and limited to the external nexus, policies have been mainly directed at the interest rate and fiscal “safety nets”. In other words, no Quantitative Easing required, which should be a strong case for the Peso.

Table 1: IMF: Distribution Share of Global Stimulus Package

Finally global governments have been applying huge-but according to IMF and other ‘Keynesian’ economists-inadequate-doses of fiscal stimulus programs (see table 1) in an attempt to offset growing slack in the global economy.

Figure 2: Ivyglobal: Size of Global Bond Market

With over 75% of the global debt markets, see figure 2, held by the overleveraged economies in the US and Europe, this means that these coordinated measures appears to have been also targeted at “reducing the real debt levels” mostly held by the private sector.

So to rephrase, despite the repeated promulgated goals by global governments to induce “normalization” of credit flows by various ways to replace lost ‘demand’ mostly via government spending, the combined actions of lowering of interest rates, coordinated “various forms of quantitative easing” and massive infusion of fiscal stimulus can also be construed as inflating away debt levels.

What does this imply?

The gradual metastasizing of the risk environment from one characterized by economic recession to one where global currency values are being deliberately debased seems to be intensifying. This increases the opportunity costs of holding cash. And the effects are likely to be felt first in parts of the global asset markets. But there isn’t going to be a revival of the securitization-financial structured-shadow finance markets, the source of the bubble bust though.

5. Signs of Improving Trends in the Marketplace.

We may have begun to witness signs of selective recovery in several asset markets.

There has been significant progress in the technical pictures of primary commodity markets such as oil, copper, gold and the Reuters-CRB index or in the general commodity markets. Importantly the advances in the commodity markets have equally been reflected on Baltic Dry index, a cargo freight weighted index, and several key credit markets.

Moreover, there was an explosive upside action in most of the global equity markets last week.

Figure 3 stockcharts.com: Oversold Bounce

While this huge bounce appears to have been mainly a function of severely oversold conditions, see figure 3, it is important to note that Emerging markets (EEM), at the topmost window, have led the bounce earlier relative to major markets in Asia (DJP2-ex-Japan), European (Stoxx 50) and the US S&P 500.

From the technical perspective since the US S&P 500 have widely departed from its 50-day moving averages, hence, like an overextended rubber, snapped back vigorously.

We are skeptical yet of the US and key European markets as having hit the milestone “bottom”. Material progress in the technical picture, which requires some additional time to reveal on its maturity, plus signs of some economic improvement could serve as key indicators for a turnaround. Besides, the mayhem in the financial sector hasn’t been resolved. But for now, these markets appear to be working off overstretched conditions.

Nonetheless, the oversold bounce, which could probably last 1-2 months, could likely help boost general market sentiment even temporarily. And the progress in general sentiment could function as the necessary fulcrum for an extended and substantial improvement of the technical picture of the relative outperformers, mostly found among Emerging Market bourses, enough to cushion them into the next possible wave of decline.

For instance, the Philippine Phisix, which appears to be in a bottoming process, could be jolted out of its consolidation phase and segue into the early stage of the advance phase of its market cycle.

It could possibly do a Taiwan, whose key bellwether the Taiex index, a surprising outperformer, which appears to have broken out of the consolidation phase on the back of a fantastic 3-week run, even prior to last week’s general recovery in the global equity markets. The Taiex is up by about 17% from its lows last November and is up 6.6% over the year with the gist of gains coming from last week’s 5.24% romp.

6. Phisix: Learning From Market Cycles

In our July 2008 edition, the Phisix: Learning From the Lessons of Financial History, we identified the scalability of the typical bear market cycle for the Philippines.

Since the activities of today’s domestic bear market cycle reflects on principally the global contagion effects from last October deleveraging or “forcible selling” process more than economically prompted, we seem to have accurately read the dynamics where an easing of foreign based deleveraging motion will cease to hemorrhage asset values in the Philippine markets.

And indeed as the share of foreign trade has contracted and where net foreign selling has materially diminished, [see Phisix: Braving The Global Storm So Far], the Phisix appears to have been in consolidation or appears to have been reinforcing this bottom formation dynamics for about 5 months now.

Besides, with the Phisix having to touch losses of 55% late last year, it is has nearly reached its conventional bear market range of retracement of 60-66%. To consider, this bear market hasn’t been “internally” (domestic or regional) generated but instead from contamination overseas. Hence, its recovery will likely be fortified on signs of the more participation from the region’s bourses and from signs of improvements in the national economies in the region.

Together with some developments in the corporate world, the windows for risk taking either for the long term or for the short-term outlook seem to have opened. It is time to take advantage of it by nibbling on the market either by trading or taking long positions or both.