Global Markets And The Phisix: New Year Rally Begins

"Real knowledge is to know the extent of one's ignorance." – Confucius

Here is my guess.

The current correction mode has culminated and that ASEAN equity markets could likely be headed higher going into the first quarter of 2011. In short, the next leg of the New Year rally could be here (See figure 1).

We have earlier asserted that the recent correction phase had simply been a function of profit taking[1] of which many have refused to accept.

Using current events as basis for discerning the cause and effect link to the actions in the marketplace, many mainstream opinion makers contrived unfounded ‘negative or adverse’ conclusions. We further pointed out that most of these rationalizations actually constituted cognitive biases.

Some permabears have even used the recent setbacks to declare a major reversal of the present upbeat trend. Apparently, gloomy predictions based on personal biases have turned out consistently wrong.

Figure 1: Second Wind of ASEAN Equity Markets?

ASEAN equity markets have been Christmas carolling since the 2008 nadir, as the major benchmarks appear to undulate in synchronicity, namely Indonesia’s JCI (yellow), Philippine Phisix (orange), Thailand’s SET (green) and Malaysia’s KSI (red).

And this hasn’t been limited to ASEAN markets, but to almost every major bellwether worldwide (see figure 2).

Figure 2: Global Equity Markets Rebounding

The world markets as seen by the Dow Jones World index (DJW), the Emerging Market index (EEM), Asian-Pacific market (P1-DOW includes ASEAN) and even the crisis affected Eurozone (STOX50) in what looks like a rejuvenation.

And the rally in risk assets has not also been limited to equities but likewise over to a broad range of commodities. (see figure 3)

Figure 3: Commodity Bull Run (stockcharts.com)

Agricultural commodities, represented by Powershares Global Agricultural ETF (PAGG), along with the precious metal group (DJGSP Dow Jones Precious Metals Index), the Industrial metal sector (DJAIN-Dow Jones-UBS Industrial Metals Index) and the Energy Sector (DJAEN-Dow Jones-UBS Energy Index) appears to have caught fire.

The Bond Markets Scream Inflation!

And it does not stop here.

Earlier, the divergence between falling bond yields and rising commodity prices/rising equity prices had been used by deflation exponents to justify of the supposed risks of a debt deflation bust which we have refuted in ad nauseam.

We have argued that bond markets were actively manipulated which means they had been relatively more distorted, while most of the other financial markets were less manipulated. Eventually, market forces will prove mightier than the visible hand of interventionism.

And the tide appears to have turned vastly in my favour (see figure 4).

Figure 4: Rising Bond Yields Amidst QE 2.0

In the US, yields of the longer end sovereign bonds or the US Treasury Notes as seen by the (TNX) 10 year yield and (UST30) 30 year yield have risen markedly amidst the efforts by US Federal Reserve to artificially suppress interest rates via QE 2.0. And rising yields has emerged in spite of the recent rally in the US dollar (USD) contravening the 2008 crash scenario from which many deflationists have anchored their outlook on.

Yet the steepening of the yield curve implies of an accelerating diffusion of inflation expectations from present cumulative policies of major developed economies.

Importantly, inflation protected securities as seen by the iShares Barclays TIPS Bond Fund (TIP) seems to be rising for most this year, which appears to reinforce this inflation cycle.

And rising interest rates presuppose one of the following drivers: increased demand for credit, concerns over credit quality, emerging scarcity of capital or the deepening inflation expectations.

And in looking at the big picture, the cumulative market actions point to the latter as the having the most of the influential factor in driving up interest rates, although demand for credit (even in the US see figure 5) and concerns over credit standings appear to also have some substance.

Figure 5: US Consumer Spends! (Chart from Danske Bank and St. Louis Federal Reserve)

As a consequence of debt deleveraging, mainstream perma bears have perpetually been pounding on the table over the death of US consumers. Yet US consumption has been expanding right after the deflation shock of 2008 (based on month to month changes-left window), even as consumer loans had faltered (right window). Now that consumer loans have exploded to the upside, this should serve as a tailwind for continued growth.

What the mainstream fails to comprehend is that credit, based on unproductive consumptive spending, does not drive growth, savings does. In addition, people respond to prices, which are not captured by model based aggregatism and thus the deflation shock of 2008 appears to have created buying windows which served as a floor.

Stocks Over Bonds

Nevertheless, lady luck seems to smile at me for having to accurately pinpoint on the timely reversal or the seeming inflection point in the US Treasury bond markets.

The excessively negative sentiment exuded by retail participants in the middle of this year prompted for a stampede out of the equity markets, and conversely, a dash for US treasuries. This appears to be the tipping point since the consensus outlook had been predicated on a ‘deflation outcome’. When a flaw in perception[2] (false reality) gets fused with populist actions then the most likely outcome is a trend reversal.

And as I wrote last August[3],

Retail investors are usually called the OPPOSITE of smart money.

That’s because they signify as the extreme of the crowd actions-the HERD.

They usually account for as the frenetic buyers during the euphoric top and panicky sellers during market depressions.

Thus, massive moves by retail investors could likely herald signs of INFLECTION points.

In this case, US retail investors have reportedly been FLEEING stocks and BUYING bonds. I’d suggest that, like always, they are wrong and betting against them (in stocks) would likely be a profitable exercise.

Nevertheless the pristine trend away from bonds and into equities appears to be gaining momentum (see figure 5).

Figure 5: US Global Funds/Weldon Financial: Stocks Over Bonds

As US Global Fund’s John Derrick observes[4],

You can see that the stock breakout over the past several months has finally broken the downward trend. This is a very bullish signal for stocks as money rotates out of Treasuries and back into equities.

For the nth time, none of these actions points to another deflation shock, which has been continually alleged by mainstream perma bears.

Overall, considering that with a few days left before the end of the year, it would be safe to say that my predictions that inflation would pose as a key theme for 2010[5] has been corroborated by the marketplace.

And we should expect such theme to continue and deepen throughout 2011. Central banks of developed economies will continue to remain accommodative and rollout direct and indirect rescue packages to their respective banking, whether it is in Europe, the US, UK or in Japan or elsewhere.

And all these will be vented on the marketplace and will transition into boom-bust cycles as it has always been or a crack-up boom which implies a flight from money towards assets.

For now, this would look like a great opportunity to reenter the equity markets.

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[1] See Tumult In Global Markets: It Is Just Profit Taking, November 14, 2010

[2] George Soros’ description of the sequence of a bubble cycle. See How To Go About The Different Phases of The Bullmarket Cycle August 23, 2010

[3] See US Markets: What Small Investors Fleeing Stocks Means, August 23, 2010

[4] Derrick, John Investors Warm Up to Equities, Cool Down on Bonds US Global Funds

[5] See Following The Money Trail: Inflation A Key Theme For 2010, November 9, 2009.