Mark Hanna: The name of the game, move the money from your client’s pocket into your pocket.Jordan Belfort: But if you can make your clients money at the same time it’s advantageous to everyone, corrent?Mark Hanna: No…Mark Hanna: Nobody knows if a stock is going to go up, down, sideways or in circles. You know what a fugasi is?Jordan Belfort: Fugazy, it’s a fake.Mark Hanna: Fugazy, fugasi, it’s a wazi it’s a woozy, it’s [makes a flittering sound] fairy dust.
The above quotes have been lifted from the 2013 movie “The Wolf of Wall Street”[1]. That’s the advice given by Wall Street veteran Mike Hanna (Matthew McConaughey), playing as mentor to neophyte Jordan “Wolf of Wall Street” Belfort (Leonardo DiCaprio).
The above quote is a wonderful example and or a great depiction of the conflict of interests involving market participants. This is known as the principal agent problem[2].
When people talk up their industry while at the same time ignoring or downplaying risks in their framing of their discussions, such could be symptoms of the agency problem at work.
Be careful of fugazies. They may come in the form of Hopium dealers or could be experts afflicted by the Aldous Huxley syndrome.
The Schadenfreude Rally
I noted last week that rallying US bonds (falling yields) could spark a rally on risk assets[3]
the dramatic fall on yields of US Treasuries last Friday due to lower than expected jobs, may buy some time and space or give breathing space for embattled markets. But I am in doubt if this US bond market rally will last.
So ASEAN markets rallied strongly on the prospects of a weak US economic performance. Indonesian stocks soared by 3.7% over the week, while Thailand and the Philippines surged by 3.18% and 2.47% respectively.
Here is an example of how mainstream media described of Monday’s risk ON in Asian markets “Asian stocks outside Japan rose the most in eight weeks after slower growth in U.S. payrolls eased concern the Federal Reserve will accelerate cuts to stimulus.”[4]
Shades of schadenfreude eh? ASEAN financial market speculators would need to wish or pray for sustained stagnation of the US economy in order to keep the bond vigilantes at bay or to prevent UST bond yields from rising in order to see another round of booming financial markets.
But ASEAN markets responded differently to declining UST yields.
Indonesia’s $4 billion global bond sale also played a big part in this week’s magical reversal where the USD-rupiah fell by .6% to 12,091. Indonesian bonds rallied vigorously too, yields of the 10 year local government bonds fell by about 39 bp. So Indonesia’s financial markets went into full risk ON mode.
Thailand’s currency via the USD-baht dropped also by .6% to close the week below 33, particularly 32.81. On the other hand USD-Malaysian ringgit rose sizeably by .8% to 3.2959 as Malaysian stocks as measured by the KLSE fell by .74%
Thailand’s bonds rallied modestly with yields of 10 year local currency government bonds lower by 10 bps, while the yield of 10 year LC Malaysian bonds has been little changed.
Again curiously the mystical effect from the success of Indonesia’s global bond float hardly inspired the Philippine counterpart which also raised $1.5 billion a week back[5].
True yields of one month Peso sovereign bond, which spiked by nearly 200 basis points, last week retraced 75% of the earlier gains. Nonetheless, yields of the short term (1 month) Philippine treasury at 1% have been up 4 times from the lows during October 2013 at .2%. Interestingly, while short term yields fell, yields of 5 year and 10 year (4.3% this week as against 4.24% last week) were modestly up over the week, while 20 and 25 year bonds were little changed.
The USD-Peso even climbed up .6% to 45 to the highest level since September 2010
The “breathing space for embattled markets”, has thus, benefited Indonesian and Thai financial markets most, but had a mixed picture for the Philippine and Malaysian financial assets.
Again I would note, “curiously” because the Philippine government which raised $ 1.5 billion from the global bond markets a few days ahead of Indonesia have shown divergent results from the latter.
It would serve as a convenient pretext to say that perhaps Indonesia might have ran far ahead or has been heavily oversold. Could be. Or the Philippines may have a belated response. Could be too.
But could the present actions in the peso and domestic bond markets been signalling either inflation or incipient signs of credit stress? We will see.
Signs of increasing fissures in the tightly controlled Philippine bond markets and the falling peso are hardly indicators in favor of a bullish case for the Phisix.
Rising rates here or abroad and the falling peso will have negative impact on highly levered companies that should likewise put a strain on loan and asset portfolios of the banking industry. The bulls will need to see a sharp decline of the USD vis-à-vis the Peso as well as lower bond yields for local bonds and the USTs
Whose Fund Flow Data is Correct the BSP or the PSE?
I would like to also raise another of what seems as discrepancy in government-private sector statistics.
The BSP announced this week that foreign portfolio investments reached US$4.2 billion in 2013 which is 8% higher a year ago where 74.7% of inflows where had been funnelled into the PSE-listed securities[6].
I keep tab with the PSE daily quotes and I find that the net foreign inflow data by the PSE and the BSP for 2013 a galaxy apart. Whether I apply 75% on the net inflows or via applying 75% in both gross inflow-gross out outflow, BSP’s inflows would register to USD $3+ billion for 2013. This seems to contradict PSE’s data which shows inflows at a measly USD $ 585.5 million, based on the average end month quote of the Peso for 2013 at 42.65.
This means that foreign inflows constitute only 18% based on PSE data compared to that of the BSP’s data. So what gives?
I hope the PSE will come up with its official figures. But if the PSE’s data remains far from the BSP then this should point to a credibility issue on which party has been reporting patently inaccurate data.
Yet the variances in the above data exhibits two contrasting pictures; if the BSP data is correct, where during the latter half foreign money posted net inflows despite 2 months of Net outflows (August and December), then local selling not foreign selling brought the Phisix into the bear market territory. Could this be a case of Mike Hanna’s ‘Fugazis’ via pump and dump?
But if the PSE data is correct, where consistently every month from August until December showed net foreign selling, then this would be in sync with global trends where foreign funds yanked money out of emerging markets[7].
The Reasons Behind Rising Philippine Bond Yields and Falling Peso
BSP’s data on banking sector loans in November 2013 continues to exhibit the latter’s loan growth expanding faster than the statistical economy[8].
Much of the increase has emanated from the frothy construction and real estate industry which has served as the pillar to the Philippine statistical economic growth. This has been followed by manufacturing, which I don’t see as in a bubble.
An interesting picture is the negative credit growth posted by financial intermediation sector (pink ellipse), which has been the first since 2008. This negative credit growth came amidst the weakening of the Phisix and the Peso last November. It could mean some entities may have closed their credit positions possibly by selling stocks and possibly bought the US dollar out of the proceeds. They could be foreign entities.
Financial intermediation represents only about 9% of overall loans. This means that the credit contraction could easily be offset by gains in the real estate industry. The negative credit growth should also extrapolate to a marginal impact on domestic liquidity growth which has been running amuck. The BSP notes that last November M3 “increased by 36.5 percent year-on-year (y-o-y)…to reach P6.7 trillion”[9]. Gosh 36.5% against a statistical economy growing at 6-7%!
Domestic claims on private sector and other financial corporations constitute about 67.73% of M3.
This fantastic runaway growth in domestic liquidity fuelled by banking credit and the likely return of price inflation, which subsequently may lead to stagflation, is why emerging markets like the Philippines has been vulnerable to capital flow exodus from the so-called US Federal Reserve “tapering”.
And rising domestic bond yields mostly at the middle to the long end of the curve appear to be signalling the return of the risks of price inflation.
So rising rates, which has been signaling shortages of real resources, has been putting strains on an inflating bubble in the real economy. Such has likewise been signaling the possible return of the risks of price inflation. These factors are hardly conducive for bullmarkets
Yet we should expect sharp denial rallies to occur. Inflection points of any markets are typically characterized with high degree of volatility. Big denial rallies or relief rallies represent a common trait of bear markets. Yet a real recovery will only occur unless these factors will be addressed.
Moreover following a breach into the bear market, history doesn’t support a comeback for the Phisix. Since 1980, the best performance by the Phisix having endured a bear market strike following record highs has been denial rallies that recovered the previous highs but eventually faltered into a full bear market as in the case of 1994-97 and 2007[10].
As a Wall Street saw goes, “Bear market descends on the latter of hope”. And that hope is predicated on “this time is different”.
Of course I would not rule out a “this time is different” scenario, if the BSP decides to undertake the same measures as with her developed economy peers.
However the risk is that, unlike developed economies that has muted price inflation, any direct easing moves may spark a upside spiral in price inflation that may bring about political instability.
The Periphery to Core Dynamic
Let me repeat again, bubble cycles are market process induced by government interventions. Since they are a process they undergo distinct stages whether seen from the resource allocation/ production process or from the behavioral perspective. A usual symptom can be seen via the periphery to core dynamic.
Let us take the US crisis of 2008 as an example.
In response to the Greenspan Put[11] (Former Fed chair Alan Greenspan injected liquidity and lowered interest rates from 6.5% to 1%[12]), in 2003-6 real estate and stocks marched higher along with rising yields of US Treasury notes.
Underpinning this inflationary boom has been a massive ramping up of credit by US households, the real estate industry, the mortgage industry, US banks and the shadow banks (via various forms of financial engineering, particularly securitization[13] such as Mortgage Backed Securities, Asset Backed Securitization and various forms of derivatives).
The previously advancing US housing as measured by S&P Shiller 20 Index (upper window red line), peaked in early 2006 and began to decline. Yet US stocks as measured by the S&P 500 continued to climb ignoring the decline in the real estate even as the losses in the real estate and mortgage industry mounted and diffused into the financial system.
Almost a year and a half after the inflection point of the US housing industry, the ascendant stock market reached its inflection point and began its decline. Losses in the real economy from the hissing housing bubble became more apparent. Inflationary boom turned into a deflationary bust. The Wile E. Coyote moment arrived. Divergence became convergence as all assets swooned, except the US dollar and US treasuries. The US housing meltdown morphed into a banking and financial crisis which spread throughout the world.
The Wile E. Coyote moment culminated with the Lehman bankruptcy and the disappearance of the five largest investments banks of the US[14]
The ‘periphery’ then was the housing and mortgage markets and the stock markets. The ‘core’ was the banking and the shadow banking system and the real economy.
Hindsight is 20/20. Today’s dynamic may be different. It may be global. Current strains may be about emerging economies, functioning as the “periphery” with developed economies as the “core”.
The point is massive accumulation of debt in a system that has pillared rising asset prices amidst a vastly complacent “cheerleading” public would likely bring about a ‘periphery to core’ process that would redound to a Wile E Coyote moment elicited by rising rates.
The World Bank recently warned that should the Fed continue to taper or if advanced economies abruptly unwind central bank support then in their “disorderly adjustment scenario”, they see spiralling risks of sudden stops where capital flows to emerging markets may contract by “as much as 80%” which is likely to affect “nearly a quarter of developing countries”[15]
Again the question I will throw is that why should there be “sudden stops” or precipitate capital outflows if emerging market’s economic structures have been “sound”?
The answer is that they have hardly been “sound”. Since 2008, global governments have used interventions via monetary policies and by fiscal means to generate “growth”. And this applies as well to Emerging Asia.
Reports the Wall Street Journal[16]
An environment of falling productivity has arisen in which local authorities have had to plough ever-greater amounts of stimulus into their economies to support growth, amid a lack of concrete structural reforms.
Post crisis governments almost everywhere have used massive build-up of leverage to drive statistical growth, which in return has reduced productivity, and consequently increased the risks of imploding bubbles. The current environment has lead emerging markets to become heavily dependent on low interest rates, rising asset prices and foreign capital flows. Yet such intensive accumulation of debt and the possible adverse consequences from malinvestments has been ignored by the mainstream and in fact glorified as “new paradigms”.
Aside from a global dynamic I think that emerging markets will have their own unique versions of “periphery to core dynamic” where financial asset markets could represent one of the peripheral indicators.
Rising rates have gradually been exposing on such fragilities and frailities.
[1] ‘The Wolf of Wall Street’ Movie Quotes Quotereels.com
[2] Wikipedia.org Principal-Agent Problem
[3] See Phisix: Will a Black Swan Event Occur in 2014? January 13, 2014
[4] Bloomberg.com Asian Stocks Rise as U.S. Payrolls Ease Stimulus Concerns January 13, 2014
[5] See Will an ASEAN Black Swan Event Occur in 2014? January 13, 2014
[6] Bangko Sentral ng Pilipinas Record High Foreign Portfolio Investments Noted in 2013 January 16, 2013
[7] Barrons Blog Are Fund Flow Data From EPFR Global Reliable Readings Of Investor Sentiments? January 17, 2014
[8] Bangko Sentral ng Pilipinas Bank Lending Grows Further in November December 27, 2013
[9] Bangko Sentral ng Pilipinas Domestic Liquidity Rises Further in November December 27, 2013
[10] See Phisix: Don’t Ignore the Bear Market Warnings June 13, 2013
[11] Wikipedia.org Greenspan put
[12] Wikipedia.org Historically low interest rates Causes of the United States housing bubble
[13] Mark Fagan Tamar Frankel MBS, ABS, SPV, CDS, ARM, BBB+: Understanding the Alphabet Soup of Securitization Harvard Kennedy School October 2008
[14] Agora.com Poof! 5 Biggest Wall Street Investment Banks Gone In 6 Months September 29, 2008
[15] Financial Times World Bank warns of capital flow risk to emerging markets January 15, 2014
[16] Wall Street Journal Real Economics Blog Rapid Asian Growth Comes at a Cost January 17, 2014
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