``A prediction, which makes judgments which are qualitative only and not quantitative, is practically useless even if it is eventually proved right by the later course of events. There is also the crucial question of timing. Decades ago, Herbert Spencer recognized, with brilliant perception, that militarism, imperialism, socialism and interventionism must lead to great wars, severe wars. However, anyone who had started about 1890, to speculate on the strength of that insight on a depreciation of the bonds of the Three Empires would have sustained heavy losses. Large historical perspectives furnish no basis for stock market speculations which must be reviewed daily, weekly, or monthly at least.- Ludwig von Mises, The Causes Of Economic Crisis
It’s been repeated here that inflation has been emerging as the most pivotal factor in driving the pricing and real returns of equity investments[1] or for that matter all other investment activities.
That’s because monetary policies shape the incentives of entrepreneurs in the allocation of resources on the marketplace. Monetary policies also help determine consumption habits of the consumers. Low interest rates, for instance, entice consumers towards an increase in time preferences by indulging in “conspicuous consumption” financed by credit. On the other hand, low interest rates beguile investors to take upon long horizon projects in the expectations of the constancy of such environment which should provide them attractive returns.
Therefore, by influencing price signals, monetary conditions from central bank policies drive business conditions, which influence all other factors including, capital inputs, operating costs, wages, earnings, revenue streams, consumption patterns and etc. Importantly, such falsified pricing signals propel malinvestments which leads to boom bust cycles.
Yet monetary policies have relative effects that creates conflicts over the flow of funds relative to production and to stock markets,
According to Mr. Ludwig von Mises[2], (bold highlight mine)
``Another case, when control of the money market is contested, concerns the utilization of funds made available to the market by the generous discount policy. The dominant ideology favors “cheap money.” It also favors high commodity prices, but not always high stock market prices. The moderated interest rate is intended to stimulate production and not to cause a stock market boom. However, stock prices increase first of all. At the outset, commodity prices are not caught up in the boom. There are stock exchange booms and stock exchange profits. Yet, the “producer” is dissatisfied. He envies the “speculator” his “easy profit.” Those in power are not willing to accept this situation. They believe that production is being deprived of money which is flowing into the stock market. Besides, it is precisely in the stock market boom that the serious threat of a crisis lies hidden.”
Here Mr. Von Mises speaks from the empirical operating conditions during his period, where agriculture remains a large part of the national economy. Although current conditions would reverse the ‘ideological’ priorities, i.e. favouring higher stock markets than higher commodities prices given the larger share of financial industry to the economy, the important message here is that the stock market and production are both highly influenced by monetary conditions and compete in placement of funds.
Therefore it would be misguided to presume that stock markets operate independently from business conditions, or that business conditions are inherently stable so as to narrowly focus on micro barometers such as price earning ratios, book value, debt to equity, return on assets or etc...
Aside from monetary policies, there are massive differences in the structural composition of a political economy that affects real returns (see figure 6)
Figure 6: World Economic Forum[3]: Enabling Trade in Greater Asia
An example can be found on the chart above (higher window), based on imports procedures (or bureaucratic red tape) and irregularities (or corruption) the Philippines ranks as the most bureaucratic and most corrupt among the ASEAN contemporaries. Note the differences of bureaucracy and level of corruption.
In addition, based on the quality of infrastructure (lower window), the differences of the stages of development is noteworthy.
And the nuances are not limited to these, there are many other variables at work, such as degree of market access, regulatory environment, tax regulations and tax rates, access to financing, access to labor, access to communications, foreign currency regulations, labor regulations, policy instability, security, legal framework, efficiency of social institutions, respect for property rights, degree of economic freedom and etc...
Therefore, the greater complexity of regulations translates to lesser efficiency in the marketplace. Alternatively, this means greater complications in establishing the cost-and-return tradeoffs. So why the heck would these economies suffer from lack of investments and high unemployment, if not for the lack of clarity on returns?
Yet the most important factor would be the political spectrum, which ultimately determines how resources are distributed in an economy. For instance, in a closed and highly regulated economy (I am thinking Venezuela), where the distribution of economic opportunities is channelled mainly through politics, returns are determined NOT by market forces but by political connections or concessions. Hence it would be naive and highly erroneous to oversimplistically apply PER, Book Value, debt equity or etc... simply because political privileges determine returns, and at worst, risk money could be arrogated out of political considerations because of the despotic tendencies of the leaders.
So an applicable rule of thumb--micro barometers are dependent on the degree of the market economy, where the more open an economy is, the more reliable these tools are and vice versa.
Bottom line: Oversimplistic assumptions based on equal application of models can be fatal because each markets, like individuals, has their own thumbprint.
MacroAsia Corporation and the Machlup-Livermore Model
MacroAsia Corporation (MAC) is likely to be a good example of what I have been talking about. Figure 7 accounts for the financial highlights of MAC along with the stock price performance.
Figure 7: MacroAsia Corporation[4]
The reason I chose MacroAsia (MAC) is due to its pleasant updated presentation of the financial highlights. As disclosure, I presently don’t own any MAC shares, although it has been part of my watchlist.
MAC is owned by one of the entrenched economic elite, tycoon Lucio Tan. The company is into what we call as “pick and shovel” play or secondary exposure to the airline industry.
Its main business is in-flight catering, ground handling, airline repair and maintenance services, property rental, supply chain management and charter services. The company has also major mining Nickel Lateral claims or concessions in Palawan which currently is undergoing exploration.
The company has one impressive balance sheet; it is very cash rich, has minimal debt, has steady top and bottom line growth, which has virtually been unscathed by the 2008 crisis, issues regular dividends and has a great moat (a monopoly (?) in its industry).
Yet if one looks at the financial graph all indicators have been pointing upwards, since 2005.
However the stock prices seem to be saying differently, MAC has seen a 50% collapse on a peak-to-trough basis even when financial conditions have NOT been affected!
And importantly, since the trough of 2008, MAC’s stock prices has traded for over one year at virtually the same level when the Phisix has jumped by nearly 100% since the 2008 nadir!
Does MAC’s corporate fundamentals reflect on the stock prices? The answer is NO. What has driven MAC’s prices has been the boom bust cycle. MAC belatedly boomed at the near climax of the bull market of 2007 and consequently fell when market sentiment collapsed along with all the rest. Hence, it is safe to discern that MAC’s financial and corporate conditions and stock prices have basically been disconnected.
One would object that, if inflation drives stocks why has MAC’s prices been stagnant? Well the answer to that is that inflation does not impact every issue simultaneously nor does it impact all issues to the same degree. Inflation’s impact is always relative.
Also, since inflation has a psychological aspect, applied to stock markets, stock prices are likely to be driven by fancy storytelling, rationalization, jockeying, the chase for yields and operating rotational effects within the market.
This implies MAC will surely rise sometime in the future, in condition that the advances of Phisix will continue. MAC will then be a beneficiary of the rising tide phenomenon (but perhaps at a much later date?).
Therefore, we have another proof that validates our Machlup-Livermore model.
Finally, from the storytelling department, of course MAC has a great future. If tourism will boom in Asia, as we expect, considering the wealth transfer dynamics from the West to the East, then MAC will definitely be a major beneficiary, since there hardly has been any competition. Let me add that I’m not sure why there hasn’t been a competitor, I would suspect that perhaps political concession could be a factor. Lastly, there is another bonus, the mining department, but full operation will probably commence sometime in the future.
Yet none of this glorious tale is new.
[1] See Why The Philippine Phisix Will Climb The Global Wall Of Worries
[2] Mises, Ludwig von Mises The Causes of Economic Crisis, p.165
[3] World Economic Forum Enabling Trade in Greater Asia
[4] MacroAsia Corporation Corporate Website
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