Negative Real Rates and the Business Cycle
Negative real interest (91 day T-Bill rate 2.174%, May 2012 Inflation rate 2.9% from the latest BSP data) may continue to whet the appetite of local investors to speculate or gamble** on the stock markets even when confronted by the increasing risks of economic and earnings based downswing.
By punishing savers and rewarding borrowers and speculators, excessive risk taking or what people call as “greed” are also symptoms of the distortions of people’s incentives, behavior and ethical values through the politicization of interest rate markets.
A brewing property bubble[1] prompted for by the negative real rates appear to be confirming my prognosis of the business cycle in motion, as bank loans to the industry has been ballooning.
From the Bangko Sentral ng Pilipinas[2],
As of end-March 2012, the combined exposure to the real estate sector of universal and commercial banks (U/KBs) and thrift banks (TBs) reached its highest level yet at P538.1 billion. This was up by 3.8 percent from previous quarter’s P518.6 billion and by 21.0 percent from last year’s P444.9 billion. Additional exposure during the quarter came from real estate loans (RELs), which grew by 3.6 percent (P18.3 billion) to P524.1 billion, and investments in securities issued by real estate companies which grew by 9.9 percent (P1.3 billion) to P14.0 billion.
Yet rose-colored glass punters think that the Philippines have become immune to external influences or that they have been ingrained with the notion that interventions would always save the day for the markets.
Such sloppy thinking needlessly exposes oneself to outsized risks.
While it may true that the Philippines may be less affected by an exogenous downturn relative to the others, this does not mean that the domestic stock markets won’t factor them.
Major economic downturns or recessions are manifestations of violent market based adjustments of malinvestments borne out of earlier monetary and fiscal policies and from other forms of government interventions on the marketplace. They represent policy-induced boom bust cycles.
As the great dean of Austrian economics Professor Murray N. Rothbard explained[3],
The inflationary boom thus leads to distortions of the pricing and production system. Prices of labor and raw materials in the capital goods industries had been bid up during the boom too high to be profitable once the consumers reassert their old consumption/investment preferences. The "depression" is then seen as the necessary and healthy phase by which the market economy sloughs off and liquidates the unsound, uneconomic investments of the boom, and reestablishes those proportions between consumption and investment that are truly desired by the consumers. The depression is the painful but necessary process by which the free market sloughs off the excesses and errors of the boom and reestablishes the market economy in its function of efficient service to the mass of consumers. Since prices of factors of production have been bid too high in the boom, this means that prices of labor and goods in these capital goods industries must be allowed to fall until proper market relations are resumed.
The 2007-2008 bear market should be a reminder. The Philippines escaped recession, earnings were hardly scathed, but prices of local stocks more than halved. That’s mainly because of contagion. Yet conventional analysis cannot explain this.
True, today is not 2008. Then, foreign money dominated trading activities. For this cycle, local participants have taken over the leadership role. Nonetheless the share of foreign money remains substantial in terms of trading activities and equity ownership.
So writing off the contagion risk could be hazardous to one’s portfolio.
Foreign Money: Neither Yield Chasing nor Capital Flight
I have also said in the past that capital flight[4] from economies enduring monetary inflation may likely bolster equities of local and of the ASEAN region.
Yield chasing may be a euphemism for capital flight when applied to foreign money.
The Phisix posted a huge jump in net foreign inflows last Friday.
But this had been due to the special block sales of San Miguel Corporation shares which news report attribute to the sale by Eduardo “Danding” Cojuangco Jr. to his trusted allies led by Ramon S. Ang for P37 billion[5].
With a 28 billion pesos NET foreign buying on Friday, this either means that part of Ramon Ang’s allies have been foreign entities or that these ‘allies’ are locally owned corporations with foreign addresses. The human factor behind numbers cannot be explained by statistics alone.
Besides should a capital flight dynamic take hold I believe that this will be a regional phenomenon for the simple reason that no single ASEAN markets can absorb the potentially huge inflows from developed economies.
The Philippines lags the region in terms of traded value and market capitalization. So we are likely to be the least preferred by huge foreign funds in search of safe haven or of greater yields based on their volume.
When viewed from the Asian perspective[6], the Philippine Stock Exchange ranked SECOND to the SMALLEST in terms of traded value (left window). Relative to our ASEAN peers, the PSE is the least liquid.
And similarly the Philippines have been the SECOND to the SMALLEST in terms of market cap in Asia (right window). The relative lack of market depth implies of quantity (lesser number of publicly listed companies) or quality issues (smaller market cap companies listed) or both.
The shortcomings from the lack of market depth and of the dearth of liquidity[7] (the degree of tradability) subjects foreign investors to greater volatility risks[8].
To analogize, the Philippines is like a third tier issue on a stock market exchange.
True, there will always be a distinct story to tell for every political economy, but market exposures by foreign funds are driven by manifold market parameters as liquidity, market depth, transaction costs, hurdle rates, regulations on capital movements and many other factors.
Considering the major constraints on liquidity and market depth issues, fund managers are likely to go for the more liquid and for markets with greater depth as the priority. However they could also possibly deploy a smaller degree of risk exposures on high beta[9] or more volatile issues.
Bring Home the Bacon
I still harbor the suspicion that the local markets have recently been propped up for some unstated (perhaps political) reasons.
The recent strength of the domestic market could be interpreted as having been based on politically colored rationalization[10]: Near record highs shows that the administration successfully delivered the international investment ‘bacon’! (yeah, bring home the bacon are done deals cooked earlier and formalized through Photo Ops)
Perhaps these may have been meant to justify the recent overseas junkets or to generate more approval ratings in preparation for the coming national elections.
So far, the strength of the Phisix seems less about yield chasing from foreign money but more of yield chasing and speculation from domestic investors seduced by the allure of quick buck from a negative interest rate regime. Also I think that current markets have partly been propped up perhaps for political reasons.
Anyway, market sentiment has shown belated signs of improvements along with the rise of the Phisix. The spread of the weekly advance-decline ratio has been widening in favor of the bulls. This extrapolates to a favourable short term momentum.
Also the Phisix is likely to surf on the global ‘EU Summit honeymoon’ sentiment, as well as on the momentum from an imminent RECORD breakout.
Whether this breakaway run will be sustainable remains unclear as global markets will remain volatile on both directions.
The Phisix may continue to outperform but will be subject to the ebbs and flows of political and economic developments abroad.
Avoid from the belief that the Phisix can decouple. We need to operate on proof and theory rather than from faith. Deductive logic says that in today’s globalization, the odds for sustainable divergence seem remote.
Also we need further evidence that in absence of central bank interventions, global economies are on a path to recovery.
Evidence has not been reinforcing this yet.
In fact we have the reverse, that markets are being bolstered by bailouts and pledges even as global economic momentum grinds nearly to a halt.
So do take a cautious or defensive stance.
**In essence stock markets are not about gambling. However the stock market may be transformed into gambling when government interventions distort the pricing efficiency and tilts the benefits to patrons and friends. As I previously wrote[11],
government interventions can tilt or distort any markets away far from its price signaling efficiency. This is where the level of the playing field or the distribution share of the odds are skewed to favor one party over the others, mostly the recipients or beneficiaries from these interventions. Where the governments assume the role as the HOUSE and the beneficiaries as the DEALERS, then all other participants operate as PLAYERS, hence your basic description of a gambling casino.
[1] See The Upcoming Boom In The Philippine Property Sector, September 12, 2010
[2] BSP.gov.ph Exposure to Real Estate of U/KBs & TBs Continues to Rise, June 29, 2012
[3] Rothbard Murray N Economic Depressions: Their Cause and Cure June 25, 2012 Mises.org
[4] See Will Japan’s Investments Drive the Phisix to the 10,000 levels? March 19, 2012
[5] Inquirer.net Cojuangco sells 15% SMC stake to allies June 29, 2012
[6] Asianetrading.com 2010 Exchange Statistics For Asia February 11, 2011
[7] Wikipedia.org Liquidity risks
[8] Wikipedia.org Volatility Risks
[9] Investopedia.com Beta: Know The Risk
[10] Manila Bulletin PNoy’s $2-Billion ‘Bacon’, June 8, 2012
[11] See A Primer On Stock Markets-Why It Isn’t Generally A Gambling Casino, June 18, 2009
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