New Year Fireworks! Global Stocks and the Phisix Storm to Record Heights as Central Banks Tighten

But financial gravity can’t be resisted indefinitely. Although the exact timing and sequence of events are unknown, it will end, as always, in a Torschlusspanik moment — a German word for last minute or literally door-shut-panic — as investors try desperately to exit when they fear that stable instability is tipping over into simple instability.  To paraphrase Trotsky, the impossible will then become inevitable—Satyajit Das, Markets are Less Stable than They Seem

In this issue

New Year Fireworks! Global Stocks and the Phisix Storm to Record Heights as Central Banks Tighten

-Global Stock Markets Sprints to Record Heights

-Global Mania: How We Got Here

-The Global Central Bank Dilemma: To Tighten or Not

-Phisix 8770: Big New Year Week No Guarantee of Big Annual Return

-Risks From BSP’s Winner-Take-All Policies

New Year Fireworks! Global Stocks and the Phisix Storm to Record Heights as Central Banks Tighten

Global Stock Markets Sprints to Record Heights

Wow. Stock markets around the world have virtually been rocketing! They took flight in 2016. The ascent accelerated in 2017. And stock markets have virtually gone parabolic or vertical at the onset of 2018!

 

Price momentum has become of utmost significance. And momentum, brought about by the greater fool and the fear of missing out, has only been rationalized as “fundamentals”

Led by the US, the FTSE All-World Index jumped 2.34%! US major equity benchmarks were euphoric: the Dow Jones Industrials, S&P 500, Nasdaq Composite and the Russell 2000 vaulted by an amazing 2.33%, 2.6%, 3.38% and 1.6% respectively.

Asia was equally ecstatic. The MSCI AC Pacific Index zoomed by 3.2%. Fourteen of Asia’s 17 national benchmarks were up. The average return for the region was a spectacular 1.78%!

Benchmarks of Pakistan (+4.45%), Japan (+4.17%), Hong Kong (+2.99%), Mongolia (+2.96%), Vietnam (+2.89%), the Philippines (+2.47%), Singapore (+2.54%) and China (+2.56%) were the week’s most significant gainers.

The Thailand’s SET’s January 1994 pre-Asian crisis zenith of 1,789 was finally taken out last Friday. The SET closed at 1,795.45 up by 2.38%.

Asian currencies resonated with the epic stock market mania. The JP Morgan Bloomberg Asian dollar index (ADXY) climbed .6%. The ASEAN majors - Malaysian ringgit (+1.21%), the Thai baht (+1.15%) and the Indonesian rupiah (+1.03%) – were the biggest winners.

The Philippine peso also firmed by .13% as the USD fell to Php 49.865 from Php 49.93 at the close of 2017.

Global Mania: How We Got Here

A short backdrop.

The Chinese stock market bubble peaked in July 2015 was followed by a crash.

The Chinese government responded by erecting a firewall through the Xi Jinping Put to prevent an economic contagion. The put comprised of various stock market interventions to cushion or put a floor on the collapse.  The Chinese government likewise implemented huge fiscal support measures and loosened its credit spigot.

Despite blathers of ‘deleveraging’, in 2017 the Chinese government has inundated its economy with more than USD $ 4 TRILLION in Total Social Financing and local government debt!

After the February 2016 G-20 meeting in Shanghai, several central banks announced the imposition of negative interest rates. The G-20 meeting was thus dubbed the “Shanghai Accord”.  Because the Shanghai Accord implicitly and explicitly provided support to risk assets, global stocks advanced.

Through 8 months of 2017, central banks (ex-US Federal Reserve) bought $1.96 trillion, according to Bank of America. Assets of the Swiss National Bank expanded 12% for the year as of November 2017. Part of such expansion included direct purchases of US equities ($90 billion according to Quartz).

In 2016, Brexit and the US presidential elections occurred with the unexpected or unpopular outcomes. Nevertheless, global stocks simply bid off each correction.

Paradoxically, what previously was deemed as potential sources of turbulence became fodder for a meltup. Thus, price declines narrowed in time frame and shallowed in scale. With limited incidences of declines, prices only had one direction: up, up and away!

And since markets were perceived as operating in a singular direction, the bidding wars have only intensified!

Central bank policies have become “too asset-oriented” because of economic ideology (Phillips curve and the wealth effect) and the implicit protection of the banking and financial institutions. Economic pain, as a consequence of asset declines, would not be tolerated. Naturally, central bank’s implicit support has only escalated the public’s moral hazard.

And conditioned to believe that central banks have eviscerated the business cycle, the credit cycle, and the stock market cycle, markets have become bolder and more aggressive.

On the other hand, rising markets have only entrenched central bank dependence to accommodate these. Or, central banks have becomehostaged to the markets.

Even when expectations from economic ideology haven’t materialized, the US Federal Reserve has started to tighten. It has upped the tempo of its interest rate hike (3x in 2017). More importantly, it announced a progressive rollback of its assets. It will first desist from reinvesting the maturing assets.

Then it would commence on the tapering lift-off. From Investopedia.com: (bold mine)

At the Federal Reserve June meeting, committee members stated that once tapering begins they will start by letting $6 billion a month in maturing Treasuries run off, which will slowly increase to $30 billion over the coming months. With regards to its agency debt and Mortgage-Backed Securities (MBS), the Fed laid out a similar plan where it will begin tapering $4 billion a month until it reaches $20 billion.  Additionally, the Fed said the long-run plan is to keep the balance sheet "appreciably below that seen in recent years but larger than before the financial crisis."

And finally, confirmation. On September 20, 2017, the Fed officially announced lift-off. The unwinding of the balance sheet was underway.The $50 billion per month taper would begin in October, and at this rate, the balance sheet would drop below $3 trillion in 2020 at which point the next discussion will be how big should the Fed's balance sheet remain once tapering is over.

The Fed must be taking this stand to build upon ammunition once a downturn reappears. [Updated to add: Reuters Fed official says rates are last resort against financial risks January 6]. They are doing this in spite of unfulfilled expectations from the implanted policies. Outgoing Fed chairwoman Janet Yellen recently admitted that the Fed’s view on inflation and employment could be a mistake. Yet, the acknowledgment has been perceived by the marketplace as an assurance of the perpetuation of the easy money regime.

Baby steps tightening have only cemented the public’s perception that the central bank put will remain in place.

That said, aggressive punts and speculative excesses have been spreading to other spheres such as cryptocurrencies and commodities. Gold posted its eight best runs since 1968.

Mainstream perception of the recent global synchronized recovery represents the ramifications of central bank actions in early 2017.

 

The backpedaling on stimulus has been more than just the FED. The ECB has likewise commenced on halving of its asset purchasing program.  Despite the Bank of Japan’s pronouncement of maintaining its ultra-easy monetary policy, the BOJ has embarked on stealth quantitative tightening (QT).

Interestingly, China’s interbank loan SHIBOR rates suddenly plunged across the curve last week which has most likely been from unannounced liquidity injections by the PBOC. Such interest rate “magic” fueled a rally in the yuan (+.28%) and in Chinese stocks (Shanghai Composite up 2.56%). And the rebound Chinese assets reinforced the levitation of global stocks.

So 2018 should be very interesting.

The Global Central Bank Dilemma: To Tighten or Not

It is my view that central banks have been boxed into a corner. Maintain the current environment, economic maladjustments will be magnified by the escalation of the blowoff phase. Tighten beyond the market’s expectations, the market crashes.

Though central banks are unlikely to extricate themselves from spoon feeding global markets, the current and projected phase of incremental tightening/normalizing would most likely take the wind away from the current parabolic momentum.

Bear in mind, once volatility remerges, it is no guarantee that central banks can control them. If central banks cannot control the upside, then downside actions could hold a similar sway.

Proof?

The CNBC on the FOMC December minutes: “In light of elevated asset valuations and low financial market volatility, a couple of participants expressed concern that the persistence of highly accommodative financial conditions could, over time, pose risks to financial stability," the minutes said.”

Remember that the central bank put has been programmed or hardwired into the market’s psychology such that cumulative marginal changes in expectations can morph into an accident. Greed can transmogrify into fear.

Additionally, markets have become totally anesthetized to any form of risk.

Even more, I see an escalation of geopolitical risks in 2018.

Here are some clues:

“Speaking in front of thousands of troops and over 300 perfectly organised military vehicles, Xi – the Communist Party's General Secretary – ordered his forces to prepare for the event of war.” (Daily Star, Chinese President Xi Jinping orders army to prepare for WAR in chilling footage, January 4,2018)

“The Centers for Disease Control and Prevention (CDC) has scheduled a briefing for later this month to outline how the public can prepare for nuclear war."While a nuclear detonation is unlikely, it would have devastating results and there would be limited time to take critical protection steps. Despite the fear surrounding such an event, planning and preparation can lessen deaths and illness," the notice about the Jan. 16briefing says on the CDC's website, which features a photo of a mushroom cloud.” The notice went on to say that most people don't know that sheltering in place for at least 24 hours is "crucial to saving lives and reducing exposure to radiation." (CBS CDC to hold briefing on how public can prepare for nuclear war January 5, 2018)

Last December, “VLADIMIR Putin has hit out at the “aggressive”new US national security strategy and warned Moscow will react. The Russian president said the US missile defence sites in Romania containing interceptor missiles could also house ground-to-ground intermediate-range cruise missiles, which would be in violation of the 1987 Intermediate-range Nuclear Forces (INF) Treaty. He told the military officials that both the US and NATO have been "accelerating build-up of infrastructure in Europe" and emphasised that the deployment of NATO forces near Russia's borders had threatened its security. (Express.co.uk, Russia's Putin blasts 'AGGRESSIVE' US national security strategy as relations PLUMMET December 22, 2017)

Last November, “Vladimir Putin has warned Russian businesses they should be ready to switch to military production in preparation for war. The Russian President told defence ministry officials on Wednesday that the arms production industry - both private and state owned - needed to be prepared to step up manufacturing at a moment's notice.” (Sky News Vladimir Putin tells Russian arms firms to be ready for war, November 23, 2017)

I do hope that Putin’s war preparation is about puppies, “THE Russian military has unveiled its latest puppy recruits, showing off Vladimir Putin’s forces softer side in its New Year’s message.” Express.co.uk Dogs of war! Putin’s military unveils latest puppy recruits in adorable New Year's video January 3, 2018

Though the good news, “President Donald Trump told reporters Saturday at Camp David that he's open to talking with North Korean leader Kim Jong Un. "Sure, I always believe in talking," he said. "But we have a very firm stance. Look, our stance, you know what it is. We're very firm. But I would be, absolutely I would do that. I don't have a problem with that at all." (CNN Trump on North Korea: 'I always believe in talking' January 6, 2018)

Besides, there are many potential geopolitical risk channels, like protectionism, Middle East war, escalation of cyber war, accidents and more…

Lastly, economic downturns will likely increase incumbent frictions and bring to the surface hidden ones.

Phisix 8770: Big New Year Week No Guarantee of Big Annual Return

Essentially, domestic events have resonated with global developments.

The Phisix surged 2.47% in the first week of 2018. Though it would be facile to point out that such a feat would account for the fifth biggest return since 2017, returns don’t appear out of the vacuum.

The Phisix seemed to have been ‘forced up’ especially on Friday January 5th. However, some forces looked as if they have resisted closing the week with a huge advance similar to 2017. So aside from engineered pumps, there was a pump and dump.

 

Returns have been a function of index levels too.

The huge 5.98% New Year week return of 2009 was an offspring to the 2008’s annual (-48.29%) collapse.

In contrast, 2017’s big move 5.96% came after successive two years of marginal declines: -3.85% in 2015, and -1.6% in 2016. Or, the Phisix closed below 7,000 for two years and was materially down from the April 2015 record of 8,127.48.

The Phisix started 2018 at record 8,558.

That’s not all. With the entrenched gaming of the system, returns have been foisted upon the pseudo-market. In fact, 2017’s magnificent New Year week 5.96% advance was preceded by 2016's end of the year trading week’s awesome gains of 4.22%! That is to say, in two holiday abbreviated trading weeks, the Phisix soared by a stunning 10.18%! These essentially pillared 2017’s 25.11% returns.

Fast forward today.

The Phisix would have closed above 8,820 to 8,850 had some cabal of shysters not dumped a boatload of SM shares last Friday. SM plunged a shocking -4.23% in a flash! SM, which was up by 1.37% before the market intervention phase, found itself suddenly down by -2.86% at the closing bell. Nevertheless, end session pumps on Ayala Corp +.95% and JG Summit 1.2% alleviated the last minute retracement of gains in the headline index from SM.

New Year week’s gain of 2.47% plus end December 2017 advance of 1.5% adds up to 3.97%, still a considerable markup.

As one can see from the above, such has not been evidence of a healthy functioning market.  

Also, New Year week performance does not guarantee a robust annual return for 2018 (lowest pane)

 

The meat of this week’s phenomenal gains accrued from the performance of the second quintile group

Risks From BSP’s Winner-Take-All Policies

While major central banks have been gradually pulling back on the liquidity stimulus, mostly to build upon policies as insurance against financial risk and to reduce financial instability manifested in the euphoric marketplace, the BSP remains wedded to a winner-take-all policy.

If the Philippine economy has been as robust as popularly depicted, why has it been that the BSP’s emergency measures (historically low-interest rates and expanded BSP balance sheets from subsidies to the National Government) remain in place?

Why has the BSP adamantly been resisting normalization of financial conditions? How are emergency measures consistent with a healthy entity?

Most of all, with an “ALL-IN” policy, what ammunition or insurance toolkit does the BSP hold in reserve once financial risk emerges?  Realization of financial risks may be triggered exogenously or endogenously.

If the answer is little or none, what would happen to the Philippine economy under such circumstances? Or has the Philippine economy attained a status where it has become totally immune to risks?

Convincing me is very easy once the above questions are satisfactorily answered or addressed

Yet, let me offer two reasons for the BSP’s recalcitrance.

One. Massive Fiscal Deficits. The huge debt-financed government spending would drain the system’s liquidity. The BSP hopes that through the banking system’s continued credit expansion would offset the liquidity “crowding out” dilemma. The BSP and the DoF have forgotten about prices (interest rates and inflation).

Two. Tax reform. A miscalculation by the DoF on the implementation of the tax reform program would not only be reflected in fiscal balance but also on the affected sectors of the economy. And part of the likely contingent required to address dislocations would entail easy access to money. Therefore, easy money conditions must prevail…

...except that the reason the economy is called as such is that it operates under the premise of “scarcity”. 

And ROP yields of the 10, 20 and 25-year maturities exhibit scarcities in motion! The entire curve has been rising.

So they can pump PSEi at will. But as history has shown, vertical (SSO-BW) prices eventually return to their roots.