A Sweet Vindication And Validation As The Phisix Soar To A 25 Month High!

``Pharoah created jobs for us. Moses led us away from those jobs. Even though those jobs helped to complete public infrastructure. Even though they were green jobs, where we used our muscles and our backs instead of fossil fuels. Moses could have been part of the ruling class in Egypt. He chose freedom instead. Those of us who followed Moses also chose freedom. Freedom brings risks. But we preferred the risks of freedom to the security of bondage. Do not confuse government with G-d. Government cannot miraculously provide us with manna--or health care. When we look at government, we should not see G-d. We should see Pharoah. Government-worship is Pharoah-worship. Passover is known as the festival of freedom. To live in the Jerusalem of a free society, we have to leave the Egypt of the reach of government.”-Arnold Kling, If a Libertarian Gave a Sermon for Passover

We have pounded the table for reasons that the mainstream can’t or refuses to see.

For the local experts and media, Philippine equities simply cannot rise supposedly because of election risks[1].

Yet week after week, the momentum, market internals and the Peso has been suggesting an opposite perspective. Denial due to intense obsession over sensationalism and abstractionism seemed to have dislodged rationality from recognizing reality.

Six Impossible Things Before Breakfast

For the foreign mainstream pessimists, this simply can’t be happening.

Rising equities on low sponsorship (in the US), falling bank credit, balance sheet problems of the consumers and the banking system and high unemployment (of bubble afflicted economies), the fiscal woes of Dubai, Greece and the PIIGS, and extended valuations as seen from conventional metrics has been cited as principal reasons equivalent to Lewis Carroll’s “Six Impossible Things Before Breakfast” in Alice In Wonderland.

Yet, as Alice would say, “there is a place called wonderland”, thus, global financial markets continue with their upwards spiral. (see figure 1)

Figure 1: stockcharts.com: “Six Impossible Things Before Breakfast”

Of course, the reason for the apparent realization of such “impossibility” isn’t because wonderland exists, but because many have been fixated over a few variables which appear to be less influential in dictating the course of events.

In behavioural finance, this cognitive bias is called the “focusing effect” or when people place “too much importance on one aspect of an event; causes error in accurately predicting the utility of a future outcome”[2].

As you will note, for the Phisix (main window), the bulls ensured that the resistance at the 3,120-3,125, which has proven to be a significant obstacle, was transgressed with a mighty push, using the actions in the US as catalyst, which generated a noticeably wide gap.

Considering that the gap was backed by substantial volume (volume in pesos jumped 18% this week), one may construe this gap, in technical or chart analysis parlance as a “breakaway gap”.

A breakaway gap, in essence, is a breakout from a trading range or congestion[3].

A breakaway gap implies that the low of the breakout point should hold and serve as critical support. Likewise, this could imply of a beginning of a significant upside move.

Although we are not avid fans of charts, as they are not infallible and are subservient to patterns from past or historical performance, which may or may not unfold, [an example is the 3,120-3,125 level which formed 2 tops that would have indicated of a ‘double top’ bearish formation; however the pattern didn’t pan out]; our view today is that charts have now been in relative consonance with the underlying actions that appear to drive the market. In short, chart actions seem merely validating what we have been saying for sometime.

The Global Reflation Process

If we are correct, then global markets should extend gains over the medium term as the “animal spirits” respond to suppressed low interest rates and a still steep yield curve on a worldwide scale, including the Philippines (see Figure 2).

Figure 2: Asian Development Bank: Steep Yield Curves

The Philippines along with the US has one of the sharpest sloping curve through February 2010, as measured by the spread between the 2 year and the 10 year yields, along with the US, the European Union and Indonesia[4].

Considering the dearth of leverage in the domestic system (as that of Indonesia) compared to the West, the “borrow short invest/lend long” is likely to prompt for significantly more arbitrages and money flows into financial assets (local equities, real estate, bonds and the Peso). And perhaps it is why like Indonesia whose JKSE is up 10% year to date, the Phisix appears to be coming on strongly.

Although since the Phisix scored its eight consecutive week of advances and given the largely overbought conditions, as manifested by the local index’s sharp pullaway from the 50-day moving averages (blue line), a correction should be expected anytime.

Albeit any retracement isn’t likely to be deep and should see the support levels, from the current breakout, to hold. Nevertheless, in bullmarkets overextended upswings may continue.

Besides, given the ongoing “rotational” activities among listed issues, a correction does not likely imply that all issues will go down in synchronicity, but instead what is likely to happen would be a shift in the attention (or crowd favourites) to non-Phisix composite or third tier issues.

In addition, the Phisix, as likewise argued before, has been influenced by external forces, as exhibited by its close correlation with the performance of global equities, more than local issues. And this comes even as local participants dominate the overall market activities.

One would notice that Europe, plagued by the ongoing debt issues of Greece, Portugal and the rest of the PIIGS, appear to be, at first glance, outperforming Asia ($DJP1) and Emerging Markets (EEM) as seen by the performance of the Dow Jones Stoxx 50 ($stox50).

Of course the European Stoxx 50 is up by a measly 1.8% on a year to date basis and has been vastly outclassed by US markets (up over 4%). Incidentally, Asia (inclusive of Japan) is up 5% because it is started the year on a much lower point and has seen a more volatile ride, hence the appearance of lagging performance relative to the Stoxx 50.

In other words, what we are seeing is a global reflation process.

And this has been the core underlying dominant theme in the markets today, which has significantly been overlooked and underestimated by the mainstream pessimists.

Liquidity Seepage, Inflation Ahoy!

And where have most of the analytical loopholes by the pessimists can be found?

In the transmission effects of the collective zero bound interest rates, the lagged effects of yield curves, the idiosyncrasy of “habits” of every society[5], the impact from concerted fiscal policies or “automatic stabilizers” used [in the case of the US over $10 trillion in guarantees and spending on the banking system and other government spending on parts of the economy], the incentives from the potential impact from a stronger yuan, the varied effects of such policies to the distinct economic and capital structure of global economies, the Bernanke Put or the assurance to the financial markets of government’s continued inflationary support, which signifies as a ‘competitive advantage’ for the US in her nonpareil ability to underwrite reflationary policies through the issuance of liabilities with her own currency, and therefore provide a guarantee of liquidity to a highly complex global system vastly dependent on the US dollar.

As Doug Noland aptly observes,

``U.S. financial assets – hence the dollar – are perceived to benefit from a relative advantage versus other major currencies based upon, on the one hand, the virtual unlimited capacity for the Treasury to run massive deficits and, on the other, the Fed’s seemingly endless capacity to purchase (monetize) U.S. debt instruments and essentially peg interest-rates (short-term, and only to a lesser extent longer-term market yields). This extraordinary capacity and willingness by U.S. fiscal and monetary policymakers to inflate Credit and meddle (in the markets and economy) today bolsters marketplace confidence in the sustainability of economic recovery. As importantly, it cements the view that the soundness of Credit instruments throughout the entire system – Treasuries, mortgages, financial sector debt, corporates, munis, etc. – is underpinned by current and prospective reflationary policymaking.”[6] [bold emphasis mine]

And signs that credit takeup, even in balance sheet constrained economies as the US, seem to be gaining traction as this account from Bloomberg reveals[7],

``Investors are withdrawing from money-market funds at the fastest pace in at least two decades, reducing holdings that peaked at $3.9 trillion in January 2009… ‘The draining of cash from money-market funds shows people are becoming more comfortable taking risk, so equities are going up and bonds are also being well supported and the yield curve is flattening,’ said Christian Carrillo, a senior interest-rate strategist…at Societe Generale SA. ‘Such behavior can give some comfort to the Fed that it’s okay to reduce the size of its balance sheet, which is a pre-requisite for rate hikes.’” [emphasis added]

Rising markets are likely to spur a bandwagon effect, as these would exhibit on the reflexive nature of self-reinforcing mechanism between price signals and real events or the reflexivity theory. This means that bubbles are likely to continue to inflate and would only be compelled upon to reverse by the hands of nature. One sure sign of this would be the rising cost of inputs, higher consumer prices and increasing interest rates.

And as the report says, the hoarded liquidity in the US banking system is starting to find some leakage, as short term money market funds are regaining more confidence or “animal spirits” to redeploy cash into other asset markets in search of higher returns.

And once this seepage turns into a flood, that’s where we should start to worry. But this should take more time, and possibly, based on the cyclical effect of yield curves, inflationary pressures is likely to be more apparent by the last quarter of the year.

Hence, the idea that the current “bubble” will bust soon is likely to be inaccurate.

---

[1] See Why The Presidential Elections Will Have Little Impact On Philippine Markets and Philippine Markets And Elections: What People Do Against What People Say

[2] See Anchoring, Focusing Effect, Wikipedia.org

[3] Stockcharts.com Chart School, Gaps and Gap Analysis

[4] ADB, Asian Bond Monitor, March 2010

[5] See Influences Of The Yield Curve On The Equity And Commodity Markets

[6] Noland, Doug; The Restoration of King Dollar?

[7] Ibid