``There is room for investors to start celebrating ‘neither too hot nor too cold’ again, when they stop fretting about tightening and before they start worrying about bubbles again…All roads still point to an asset bubble in China, most particularly if the currency’s appreciation continues to be suppressed.”-Christopher Wood, CLSA (Bloomberg)
The recent Fed’s action had not been well taken by Asian markets.
Although Asia’s markets had been up for the week, they have immensely underperformed their regional and emerging market counterparts.
It looks as if Asian markets may have overestimated on the impact of the US discount rate hikes and may equally underestimated the Fed’s future actions.
Figure 4: Stockcharts.com: Discount Rate Troubles?
The fall of Asian markets, including the Philippine Phisix (main window), Japan’s Nikkei (Nikk) and Dow Jones Asia ex-Japan (DJP2) seem to coincide with the Fed’s ‘surprising’ announcement.
Perhaps it maybe just an excuse to retrench or perhaps there could be other factors involved. The week long absence of China’s market, which celebrated her Lunar New Year of the Tiger, may have also been a factor.
Nonetheless, surging commodities prices appears to have turned the tide for the Baltic Dry Index (BDI) an index which tracks shipping prices for dry goods. As for the latter’s sustainability, this has yet to be confirmed over the coming sessions.
Our guess is that if China’s markets have indeed bottomed as we suspect it has [see last week’s A China Bubble Bust Is Unlikely Yet], then the BDI index we suspect will rise in congruence to rising key stockmarkets worldwide.
Since China’s markets has recently shrugged off the recent second round of increase in reserve requirements for her banks, her markets may have begun to digest the “exit” strategies employed by their local central bank.
For us, Asia and emerging markets are likely to be more receptive to the incentives brought about by the steep yield curve to keep asset prices afloat than to developed economies.
So it seems a bizarre reaction that we read from a local official of our domestic central bank, the Bangko Sentral ng Pilipinas, to extol on the Fed’s increase of its discount rate as helping out local policies by “narrowing of the [interest rate] spread”, “this gives us [BSP] additional space before we implement our own exit plan” said BSP Deputy Governor Diwa Guinigundo.
Figure 5: Asian Bonds Online: Steep Yield Curves
Mr. Guinigundo doesn’t seem to realize that local inflation will likely speed ahead of the US given the domestic market’s likelihood to respond better to low interest (see figure 6), the El Nino problem which will likely aggravate the looming shortages of our agricultural produce already hampered by last year’s Typhoon Ketsana nickname Ondoy and Typhoon Parma nickname Pepeng, and compounded by rising oil prices in the global market.
These factors, which weigh heavily on our local CPI, would likely pivot up the domestic interest rates ahead of the US, perhaps as soon as the local elections are concluded in May.
The basic flaw is to read Fed’s policies as oversimplistically linear, as the case is with most of the practicing aggregatists which tend to pick on select variables to highlight on their desired outcome.
We can’t entirely blame Mr. Guinigundo since as one of the leading technocrat for the banking sector, media publicity demands for “simplistic” replies.
By looking at the internal dynamics of the Phisix as potential measure of capital flows, the past two weeks has seen some substantial inflows from foreign funds. These inflows have been coincidental with the dramatic surge of the Phisix following the “Greek and China” myth induced meltdown during the prior weeks.
Yet compared to the 2003-2007 boom, where foreign funds constituted the bulk of the trades, today’s market attribute reveals the opposite local investors dominate trade.
But given the inflationist approach by major economies in dealing with their local predicament, it isn’t far fetched that the “widening” spreads [and “devaluing” foreign currencies] from which our domestic central bankers seems concerned of may come to fruition (see figure 6).
Figure 6: Money Week Asia [UBS]/ Wall Street Journal: Who Wins In A Liquidity Bubble/Private Capital Inflows
And considering the underdeveloped and relatively small state of the Philippine Stock Exchange, a larger than usual foreign inflow can virtually exaggerate returns that could turn the Phisix into a full blown bubble as it had during the 1987-1994 chart (left window).
Phisix 10,000? That should be peanuts compared to the returns then (the Philippines and Indonesia had nearly 1,000% gains while Thailand had 800%. Argentina and Mexico had even an astounding 1,400% gains-all in US dollar terms.)
It isn’t likely that past performance would exactly repeat, but as shown in the right window, foreign capital flows into emerging markets appear to be accelerating anew and they may contribute to enhanced returns based on global policy arbitrages.
And it is also why the IMF has reverted to its interventionist tendencies and has recently prescribed capital controls for emerging markets, ironically aimed at curtailing inflows. This is in sharp contrast to the past where it recommended capital controls to prevent outflows.
Times have indeed changed.
So while many seem to fear for a reprise of 2008, a dynamic which we see as a remote possibility since most of these fears appear to be predicated on Posttraumatic Stress Disorder (PTSD) [see What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?], we see that excess reserves and the inflationist proclivities of developed economies in dealing with their fiscal woes as risking a supersized global inflation or serial bubble blowing in Asia and or in emerging markets.
In short, while many fear a meltdown, I am concerned of a meltup.
Finally, if gold surpasses its resistance at 1,120-1,125, it is likely that global markets will continue moving against a wall of worry or continually move uphill. This ascent will especially be stronger if both the US and China’s markets chimes in.
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