It is not necessary specifically to discuss the counterpart of inflationism, namely deflationism. Deflation is unpopular for the very reason that it furthers the interests of the creditors at the expense of the debtors. No political party and no government has ever tried to make a conscious deflationary effort. The unpopularity of deflation is evidenced by the fact that inflationists constantly talk of the evils of deflation in order to give their demands for inflation and credit expansion the appearances of justification—Ludwig von Mises
In this issue:
Decoupling! The BSP Leads Emerging Markets in QE Use! Stock Market Meltup: More Reopening or BSP’s Php 540 billion of QE Injections?
I. The BSP Decouples, Leads the Use of QE in Emerging Markets! The Emerging Market Doom Loop!
II. Quarantine Easing Inspired the Stock Market Meltup? Despite Partial Reopening Mobility Indices Show Substantial Gap from the Normal!
III. Shield Against Deflation: Like in March, BSP’s Php 540 billion QE Injections Powered this Week’s Stock Market Euphoria!
IV. Local Institutions Power Broad-based Gains as PER Rockets!
Decoupling! The BSP Leads Emerging Markets in QE Use! Stock Market Meltup: More Reopening or BSP’s Php 540 billion of QE Injections?
The BSP has diverged or decoupled against its Emerging Market peers. How? While most engaged in Shadow QE, the BSP deployed the most ambitious QE. Soaring debt and QE has heightened the risks of an emerging market “doom loop”.
Reopening equals recovery has been the catchphrase that has rationalized this week’s stock market melt-up. However, despite the easing last June, various mobility index suggests significant underperformance of the economy.
Instead, the recent injections from the BSP’s expanded QE have most likely provided the fuel.
Finally, unlike in June, this week’s newfound euphoria has been most likely driven by local institutions amidst a mediocre or less than impressive backdrop in sentiment and internals.
Let us dive in.
I. The BSP Decouples, Leads the Use of QE in Emerging Markets! The Emerging Market Doom Loop!
Figure 1
Folks, here it is...the decoupling!
No, this decoupling hasn’t been about economic performance. Instead, the Bangko Sentral ng Pilipinas (BSP) diverged in the use of monetary policies relative to its peers!
Bluntly put, the BSP employed direct QE extensively, the most among the emerging markets, to bail-out the domestic financial system!
Emerging market (EM) central banks utilized asset purchases, the IMF’s Blog enumerated, for three reasons.
First, it served as "a tool to improve bond market functioning".
Next, it has been designed "to ease financial conditions and provide additional monetary stimulus, as well as for market functioning and liquidity objectives".
And third and last, it was also meant "to temporarily ease government financing pressure in the face of the pandemic".
In short, central banks intervened through massive injections of liquidity to control markets from revealing risks embedded in it.
And in contrast to the advanced economy contemporaries, secondary markets had been the key source of operations for the BSP. Or, Philippine Treasury holders constituting banks and other financial institutions benefited directly from the BSP’s QE operations, implying that the budget deficit has been a subsidiary concern relative to the health conditions of the banking system.
And while QE supposedly had used a tool to improve bond market functioning, bond trading in the domestic secondary markets collapsed as the BSP siphoned securities away from the markets! So much for creating market efficiencies and improvements in the bond markets.
Of more importance, a variant of the “doom loop” dynamic on emerging markets have amplified the risks of a debt crisis.
According to analysts from Deutsche Bank, emerging central banks have engaged in “shadow QE” or have used banks to intermediate and disguise their asset purchases. EM domestic banks absorbed about 65% of government issuance in 2020.
From the Business Insider Italy (October 23): “Two other analysts of the German bank, Mallika Sachdeva and Oli Harvey, have pointed out that just the shadow QE has granted to many governments in Asia, Latin America and central and Eastern Europe (ceemea) to largely finance their deficits this year, also allowing their respective central banks to avoid the cost of embarking on large QE programs.”
The shadow QE represents part of the EM central bank’s reflation strategy constituting “a mix of leverage of the banking system through political moral suasion, provision of liquidity by the central institution, yield curves so steep as to encourage carry trade, regulatory policies that provide systemic cuts in reserve requirements and cheerful lightening of accountability rules. In addition to the final touch of ratio between loans and deposits in free fall that lighten bank balance sheets thanks to an increase in the savings rate in the face of weak demand.”
Have we not been discussing these repeatedly here?
Yet, these policies signify as “pure alchemy”, writes Mauro Bottarelli of the Business Insider Italy, because “it is unstable as nitroglycerin”…as it is dependent on the “implicit guarantee of the Fed of interest rates at zero for an almost infinite period of time”.
And imbalances from these unravel once “a large-scale return of inflation, in fact, could push the central banks of emerging nations to a drastic and forced rise in interest rates or, alternatively, the withdrawal from the market of the extra-liquidity at almost zero cost that those economies have been enjoying for months.”
The author quotes Deutsche Bank’s Jim Reid analysis, "a similar dynamic would lead to an immediate change in the incentives underlying the concept of shadow QE, which in fact - unlike the classic QE used by central banks in developed countries - is terribly sensitive to price changes".
The crux of the matter is, to avoid risks accompanying QE, EM central bankers try to circumvent these by transferring operations to banks. Aside from the indeterminate ramifications of feedback loops from complexity issues, the problem is, transferring is not the same as extinguishing risks.
On the contrary, through the fostering and nurturing of imbalances from such measures, systemic risks are magnified!
And on the other hand, the BSP underwrites its aggressive gambit on QE operations into the open. Brave souls, are they not? For yet again, after the critical lockdown faux pas, monetary authorities are experimenting with highly risky policies on the local populace!
But guess who pays the most for a losing bet? You can be sure that neither central bankers nor politicians and the bureaucracy will suffer.
As mathematician, philosopher and iconoclast Nassim Nicholas Taleb rightly described in Skin in the Game: Hidden Asymmetries in Daily Life (p.12-13):
Bureaucracy is a construction by which a person is conveniently separated from the consequences of his or her actions…
But the worst casualty has been free markets, as the public, already prone to hating financiers, started conflating free markets and higher order forms of corruption and cronyism, when in fact it is the exact opposite: it is government, not markets, that makes these things possible by the mechanisms of bailouts. It is not just bailouts: government interference in general tends to remove skin in the game.
II. Quarantine Easing Inspired the Stock Market Meltup? Despite Partial Reopening Mobility Indices Show Substantial Gap from the Normal!
Figure 2
From Reuters (October 23): Philippine stocks surged 2% on Friday and were set to end the week with their biggest gain since June, bolstered by the easing of restrictions in capital Manila as new coronavirus cases showed signs of slowing.
While it may be on a downtrend, are COVID-19 cases headed down significantly? (figure 2, upmost pane)
Or has the recent sharp declines been because the Philippine Red Cross (PRC) has suspended testing due to the non-payment of liabilities by the national health provider Philhealth? With the PRC on the sidelines, the nation’s testing capacity fell to a three-month low last week. The PRC accounts for 26% to 40% of the nation’s testing. Will the COVID-19 caseloads revert to its trend once Philhealth settles its debt and when PRC resumes testing next week?
Realizing that lockdowns effectively choked the economy, the National Government has eased on social mobility since June. That is, of course, excepting mid-August when the President granted the plea of health practitioners for a 15-day MECQ in the NCR to relieve them from work-related strains.
Despite being told that the economy is supposed to recover meaningfully from such regulatory easing, mobility indicators from Apple and Google tell of a different story.
Data from Google indicates that following an activity seizure during the ECQ/MEQ, there had been only some 33% improvement in people’s movement since the NG eased health protocols were to accommodate a revival in the economy. (figure 2, middle pane)
On the other hand, based on Apple’s data since June, the recovery has only been about 25% to 30%. (figure 2, lower pane)
That is, recent easing has done little to improve current conditions.
And so while loosening has been the well-received story that has populated media, the economy has been operating substantially below capacity.
For instance, by using cherry-picked and inflated statistics, the public is made to believe that an economy that had been shut, by edict, be reinstated seamlessly.
From the CNN (October 19): Roughly 95% of sectors in the Philippines have been allowed to operate under looser quarantine rules, the Department of Trade and Industry (DTI) said on Monday. At the Laging Handa virtual briefing, Trade Secretary Ramon Lopez said more businesses in the service sector were given the go signal to return to 100% capacity as the government boosts efforts toward economic recovery.
However, aside from Google’s and Apple’s mobility data, entwined with it is the economy of human actions.
For example, would social mobility be restored to pre-COVID-19 levels when the populace has suffered from enormous income losses due to business closures, decreased operating capacity, joblessness, and more? And how would a reduction in access to credit supplement consumer spending? And that’s aside from social effects from the fear of a pandemic.
Yet, don’t worry, be happy.
Although from the GDP perspective, 3Q mobility trends suggest a high single-digit to a low double-digit decline because GDP is more than statistics, but about politics too, 3Q GDP will likely be expected to outperform, like OFW remittances.
Looking ahead, even if the economy should be freed to pre-COVID 19 levels, which represents a slim chance given the predisposition of contemporary politics, the damage created by the shutdown, which compounds the existing malinvestments, will linger and continue to haunt the economic and financial system.
Misperceptions created to boost confidence (animal spirits) will eventually face economic reality.
III. Shield Against Deflation: Like in March, BSP’s Php 540 billion QE Injections Powered this Week’s Stock Market Euphoria!
Regardless of the evidence, this ‘shut-open’ spin has supposedly anchored this week’s monster rally in the PSE.
Are we to believe that the BSP’s QE, which inundates liquidity into the system, would be confined to its designated spheres (financials and the NG only) and have no impact on asset pricing?
But that’s how the mainstream portrays it.
Figure 3
Let us see.
The BSP reportedly approved the National Government’s late September (30) request for a Php 540 billion advance on October 1st. As a sign of the initial infusion, BVAL 1-month rates plunged below 1% on September 30th but subsequently bounced back to its trend after. (figure 3, upmost pane)
While the same rates began to climb through October 14th, it reversed course as the BSP may have resumed injections. The seeds of this week’s fierce stock market ascent became visible ex-post on the 16th. In the meantime, BVAL 1-month rates, used in the BSP’s Open Market Operations, plunged below 1% anew on October 22nd as the bids at the PSE caught fire.
Technically, Php 540 billion of funds injected into the banking system represents a tsunami of cash on an unprecedented scale.
With core operations of collecting amortizations and interest payments suspended via Bayanihan 2.0, the alternative to generating income would likely come from trading. Thus, with idle cash, financial institutions must have collaborated and coordinated a relentless bidding up of domestic stocks resulting in this week’s weekly monster rally of 9.93% of the PSYei.
Figure 4
BSP injections likewise greased the April and June rallies, whether seen from the booming growth in the central bank’s assets or the net claims data. (Figure 3, middle and lower panes)
Since the BSP announced the initial phase of Php 300 billion, the headline index rocketed 10.21% at the nadir of March (27th) and 10.73% on the week ended June 5th. The recent announcement to extend QE by another Php 540 billion put another panic bid on local stocks, but unlike its predecessor, had done little to lower bond yields.
In the 2Q, the trading income of banks soared by an incredible 115.61%, which emerged as a result of the panic bids on local stocks and bonds. Sustained gains in the PSE will likely provide some free money to banks, which comes at the cost of inflating unsustainable asset bubbles. (figure 4, top window)
Of course, the prospects of an asset or collateral deflation, a menace afflicting a bubble economy, morbidly petrifies the BSP for it to accelerate its aggressive use of QE. A subordinate reason is the budget deficit.
Again, the IMF data reveals that the disproportionate use of secondary markets, by the BSP, for its operations, in contrast to the QE of advanced economies, which directly funds (primary market) the central government serves as a testament.
Even the BSP has signaled such trepidation implicitly in media.
From ABS-CBN News (October 24): The Bangko Sentral ng Pilipinas is studying a credit rating model that is not based on collateral for micro, small and medium enterprises, Governor Benjamin Diokno said Friday. The BSP is working with the Japan International Cooperation Agency (JICA) to gather data and to build a model that will help banks push more loans to businesses, Diokno told ANC.
Perhaps, a good start is for the BSP to commence on securitizing promises of politicians and bureaucrats, convert them into cash flows, which could be marketed to the public and then see how it works!
IV. Local Institutions Power Broad-based Gains as PER Rockets!
Figure 5
With less than two weeks before the US presidential elections, global stocks appear to be treading water in the proximity of the recent highs.
Because of the immense gains, the PSYEi was not only Asia’s best performer; the main benchmark grabbed headlines in several international media.
The timing of this week’s monster rally, thus, would seem like an advertisement to attract hot money or portfolio flows into yield chasing pumps on the domestic stocks.
This week’s amazing 9.93% returns signified the third-best in 2020, after the week of June 5’s 10.73% and March 27’s 10.21%. However, in the context of volume and breadth, this week’s gains (average Php 7.9 billion board volume, 213-spread in favor of advancers) have delivered less of an impact than its June predecessor (average Php 8.2 billion, 312-spread) nonetheless, better than the March low (Php 6.3 billion, 196-margin).
With only a single issue down, the outperformance of the top 6 market cap heavyweights levitated the headline index. Although some ancillary issues like LTG (+25.6%), JFC (+21.8%), AGI (+18.3%), and GTCAP (+16.11%) outclassed these. (figure 4, middle window)
With the big leagues in command, the market cap’s balance tilted anew toward Sy-owned firms, which controls 33.7% of the index as of Friday, October 23rd. The top 5-issues, which include Ayala Land, Ayala Corp, and JG Summit, has a cumulative 49.08% share weight of the index, drifting close to the record. Some end session pumps certainly added to the week’s fabulous ramp. (figure 4, lowest pane)
The headline index barely represents the universe of the biggest listed companies, supposedly functioning as a proxy to the economy; it shows rather how selective pumping to bolster the index has incited extensive maladjustments in the financial markets and the economy.
And the monster rally has been all about panic buying by local institutions.
Foreign buying posted a measly Php 20.6 million, with the participation rate at 43.51%, which bounced from a record low of 20% two weeks ago. In the first week of June, the aggregate buying of foreign funds was at Php 2.9 billion, with a participation rate of 44.8%. Foreign money sold a net Php 3.9 billion worth of equities at the close of March, at the low of the year, with foreign trade accounting for 55% of the trade.
Foreign participation has been on a southbound trend, but recent developments have intensified its decline. (figure 5, upmost window)
Nota bene: foreign trade may include subsidiaries of domestic firms domiciled abroad.
Since foreign trade remained subdued while domestic retail participation barely dents on the total, domestic financial institutions may have orchestrated a synchronized audacious buying tempo to push the index substantially higher.
As said elsewhere, rallying Philippine assets (peso, stocks, and bonds) have come in the face of muted trading volume, and importantly, dampened foreign participation, which would seem like tacit capital controls at work. (figure 5, lowest pane)
In the meantime, last week’s colossal rally registered the third-highest average trade (weekly) in history, which suggests intense churning by active trading participants. The biggest occurred at the bounce from the lows during the March sell-offs, which incidentally, registered the second largest. (figure 5, middle window)
The week’s monster rally pushed the PER ratio to 17 based on 2019 eps. But the average eps plunged by 60% in the 1H. And if we assume a 35% discount from 2019 eps, predicated on a stronger bounce by the end of the year, PER will still be at a nosebleed 26.3!!!
With current conditions highlighted by political and economic uncertainties, blindly buying premised on faith could likely lead to horrendous losses.
And it is easy to guess that instead of revenue and income growth, debt expanded materially in the 3Q. Thus, aside from the radical transformation of the economic landscape. More importantly, the cumulative burden of the present debt levels will function as key obstacles to the economy while at the same time increasing the risks of a crisis.
Disclosures of listed firms on their 3Q Financial Statements in the coming weeks will give us a clearer view of the economy.
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