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Not Nervous! Stocks Always Bounce Back to Its Previous Levels!

I recently came about this stunning feedback (paraphrased):

I’ve learned not to be nervous. Because each time after the stock market goes down, it always bounces back to its previous levels!

Wow.

Observations:

Stock prices have lost its functionality. The role of prices has been diluted and denigrated to mere numbers*! And since numbers have become the ONLY concern - all other things like valuations and risks have been damned to inexistence – hence, numbers can only go UP! 

See, FREE LUNCHES via rising stocks have already reached an ENTITLEMENT status!

* unlike numbers in various gambling formats (similar to those displayed on the colored jerseys of jai alai pelotaris, or saddle towels of horse racers, or on dices) prices embed underlying financial and economic functions

Here, numbers are seen as a function of the recency bias or the rear view mirror syndrome. Numerical patterns have thereby been interpreted or extrapolated as “PAST performance GUARANTEES future outcomes”!

Yet a showcase of past performances…

In two major cycles (the martial law cycle 1970-9 and the EDSA I cycle 1992-1997) over the last 50 years, many have been trapped into such ‘market always bounces back’ outlook. That’s because such popular emotionally driven myths have been debunked with staggering consequences!

When reductio ad absurdum has been rampantly employed to justify or rationalize ticker tape movements, it is a reflection of an entrenched deep-seated faith nestled on complacency! 

Today’s actions may not be a total mania in terms of the depth in public participation**. But when stocks have been acclaimed as having seemingly “reached a permanently high plateau” (Irving Fisher 1929) resonant of convictions from a religious creed, then euphoria or mania is at hand for those involved.

 

An increasingly tunneled vision means that 1995-1996 high PER ratios, market cap/GDP at close to 1996 and vacant space troubles for malls will have no impact or ramifications to the prices and the economy at all!

Wonderful! You see, this time MUST be different!

Notes

**the best observation of the depth in public participation would be in the number of attendees in stock market seminars and the number of actual new accounts opened. If there would be a stampede by retails to join, mania is spreading

Recall that in the two previous cycles (in 1970s and 1990s), public participation was even so much smaller than today. But the dearth of participation didn’t stop the unraveling of inflationary mindset.

*** It’s a TRUISM that markets return to their previous levels. However, such goes contrary to the present boom boom boom entitlement mindset.

Just take a look at the two previous secular cycles.

After a lengthy consolidation at the apex, stock prices REGRESSED almost to the levels which served as its springboard or its genesis. The evisceration of practically almost ALL of the gains had signified a précis of Newton’s Law in motion.

As the legendary Sir John Templeton admonished: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”

1Q 2017 GDP: Price Inflation Weighs on Consumer Spending!

Although I am not a fan of the GDP, which projects the economy something like a factory, that has operated far from reality, I just would like to point out a few interesting data from the report.

Last March I warned that surging prices will impact the everything else in the economy. [See The Mainstream Finally Embraces the Weak Peso… March 12, 2017] 

Moreover, surging real economy prices will mean a redistribution of consumer spending patterns, where the substitution and income effects will take hold. Higher rates will also put a brake on the credit-financed consumer spending. This means disposable income will shrink.

We have seen this story before. [see Street Talk: Reactions of Philippine Residents to the current surge in consumer price Inflation rates Before it’s news June 16, 2014]

Media experts were technically correct when they alluded to consumer spending as having “gained 5.7 percent from a year earlier, the weakest pace since 2014”.  (see above) But they critically dismissed or ignored the severe impact of price inflation on consumer behavior.

It is as if prices in the real economy have no influence in the household or consumer’s marginal utility, opportunity costs, individual preferences, and values and vice versa, to affect the individual's demand and supply schedules.

In their view, because money is neutral, the effect of credit and money supply expansion has little or no impact on prices of the real economy.

For them, inflation represents a superficial manifestation of demand and supply for goods and services. Hence, increases in inflation have been construed as signs of G-R-O-W-T-H.

And inflation equals G-R-O-W-T-H serves as the prime reason why the consensus perceives wild upside price actions in stocks or real estate as something cheer about. 

True, the median estimates of the consensus missed by a small margin. But popular views signify the least of my concerns. Instead, based on the government’s numbers, the internal constructs have been much weaker than broadcasted regardless of the headline figure

Take consumer spending. Nominal consumer spending jumped to 9.0% from the 8.5% last quarter. But because consumer inflation bounced 100 bps to 3.2% from 2.2%, real consumer spending dropped to 5.7% from 6.2%. That’s an 8% drop in growth rates.

1Q 2017’s numbers signify the third successive quarter of decline.

That’s assuming that those survey-based numbers have been close to accurate. Understand that as a political institution, the government’s generation of GDP may be guided by political motives.

Back to the consumer GDP

From the expenditure perspective, consumers accounted for 75% and 69% of NGDP and RGDP respectively.Thus a weak consumer entails a weak economy. That’s how the government projects the GDP to be, which of course differs from how I see it.

And current data of inflation plagued weak consumption has precedents.

In the previous two accounts (in 2013 and in 2014) were GDP household inflation reached 3% (blue area graph), real household spending growth (real = current or nominal MINUS inflation) tumbled. 1Q 2017 was no different (red trend line).

Most importantly, record BSP banking consumer loans have only boosted consumer NGDP which most likely contributed to real economy price pressures.

The BSP tightening in 2014 impelled a consumer lending downturn in 2015 (upper chart). Both consumer NGDP and headline RGDP turned south.

Today, the BSP imposed the EASIEST monetary policy in history in response to 2015. However, unlike the immediate past which responded quickly to such boosters, the present economic reaction to policy has gone against expectations. The economy has instead softened.

 

More on GDP data.

From the expenditure segment, the salient underperformance of the households or consumers had been compounded by the relative government spending (+.2% versus +4.5% Q4 2016) and capital formation (+7.9% vis-à-vis +14.7 Q4 2016).

Thus the mainstream has been yakking about the lack of government spending!

Curiously, in the industry segment, real retail trade grew by 12.27% (+14.4% Q4 2016) even when real HFCE was significantly down! Let me guess. Since a big hole between consumer and trade output emerged, then the ecstatic trade GDP must mean ghost buyers have done a lot of the shopping!

On the other hand, the industrial component of the GDP was bolstered by real GDPs of financial intermediation +6.3% (+5.6% Q4 2016), real estate 9.2% (+9.1% Q4 2016), manufacturing +20.2% (+20.4% Q4 2016), and other services 9.1% (+7.9% Q4 2016).

Let me reiterate: The effect of an overdose of monetary liquidity has been to raise real economy prices significantly. Intense price instability affects the economy in various ways. It affects project budgets (e.g. cost overruns in political spending). It impacts both the topline (gross revenues) AND operating and fixed costs of firms thus placing pressure on profits (1Q eps as evidence). It alters the consumer spending pattern. It reduces the disposable income of consumers. It affects interest rates and the peso.

Thus price inflation has a negative impact on GDP.

To close, it has been amazing to see consumers struggle in the face of the easiest monetary environment in history.

But the most important concern is just how the 1Q GDP slowdown, particularly in consumer spending, will affect the mania fueled 48% surge in shopping mall inventories in 2016????!!!! [see Wow! Mall Vacancies Surfaces in Mainstream Media! Cement Industry’s 1Q woes! 1Q PSEi’s EPS Growth in Dire Straits!May 15, 2017]