Prepare for the unknown by studying how others in the past have coped with the unforeseeable and the unpredictable—General George S. Patton
In this issue
PSEi 6,600: The Unseen Forces Behind the Mammoth Rebound
I. Hyman Minsky’s Financial Instability Hypothesis (FIH) in Action!
II. PSEi 30 6,600: Foreign Money as Drivers
III. Margin Trades by the Domestic Financial Sector? PSE Low Volume Reflects Dwindling Bank Liquidity
IV. Big Returns, Poor Market Breadth and More Signs of Illiquidity
V. Concentrated Gains and Activities Distorts the Marketplace; An Overbought PSEi 30
A Pivot by the Fed and BSP? Financial Easing Equals the Revival of (FOMO and TINA) Asset Bubbles?
PSEi 6,600: The Unseen Forces Behind the Mammoth Rebound
The benchmark PSEi 30 has returned 15% in eight weeks. Many have come to believe that this marks a critical turnaround.
In contrast, we show that this rebound comes with an inferior structure and a flawed premise.
I. Hyman Minsky’s Financial Instability Hypothesis (FIH) in Action!
Philstar.com November 25: Ayala Land Inc. announced a new borrowing program meant to pay old debts and partially fund corporate expenses amid the pandemic. At its meeting on Friday, the company’s board of directors approved a plan to borrow up to P45 billion from investors via retail bonds and/or corporate notes, regulatory filing showed. The property giant also has an option to raise the cash through bilateral term loans. Proceeds from the upcoming fundraising activity will be used to partially finance “general corporate requirements” and settle debts that are falling due soon, Ayala Land said. (bold mine)
This article, "Ayala Land unveils new bond program to pay old debts," validates our observation that the debt represents the only "real" growth area and that in 2022 component members of PSEi 30 have resorted to panic borrowing.
Worryingly, firms have become more articulate about expanding credit to pay down existing debt.
The late economist Hyman Minski theorized an economic credit cycle transitioning from stability to instability through three phases: Hedge, Speculative, and Ponzi financing.
In a nutshell, hedge finance is where firms can meet their contractual obligations from their cash flows.
Speculative finance is where cash flows can cover only interest payments, not the principal. Therefore, firms increase their reliance on the "rollover" of liabilities.
Finally, the final phase is Ponzi finance. At this stage, cash flows are insufficient to pay the principal and interest liabilities. So, firms resort to either borrowing or selling assets for settlement or refinancing debt. Since the system's dependency on sustained higher asset values becomes entrenched, it becomes prone to crashes and defaults.
Mr. Minsky wrote, "the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation amplifying system." (Minsky, 1992)
In a word, instability!
To recall, the non-financial PSEi members raised an unprecedented Php 732 billion in the nine months of 2022.
With PSEi 30 companies increasingly dependent on the capital markets (debt and equity), this requires substantial increases in prices of the asset markets to convey "confidence" or elevate the "animal spirits."
Aside from the above, the recent selloffs in Philippine assets caused the postponement of a Php 28 billion IPO of an infrastructure holding firm and energy firm owned by a tycoon, as well as a sharp (25%) discount on the Energy REIT offering by another taipan.
It stands to reason that the backbone of the mammoth 7-week rally of the PSEi 30 has been symptomatic of Minsky's Financial Instability Hypothesis (FIH).
Are asset bubbles needed to "save" the system?
II. PSEi 30 6,600: Foreign Money as Drivers
Two weeks ago, we wrote about the health conditions of the PSEi 30 rally.
But again, its ascent has been marred by thin volume, mixed breadth, concentrated gains, and poor market internals…
The lesson is that the opportunity cost of the goal of deliberately pushing up the index through concentrated pumps is the lack of participation in the broader markets.
Despite the index breaching the 6,600 level, there has been little change in the said factors from then, except for foreign money flows.
This week's stunning advance of 2.63% pushed the PSEi 30 returns to 15%. It also marks the seventh week of gains in eight from the lows of end-September.
First, foreign money represents the most evident driver of this countercyclical rally. This is what is seen. (Figure 1, top window)
Foreign money flows reached Php 6.29 billion in the last eight weeks. But this week's inflows of Php 2.38 billion have signified the largest since February 2022.
Foreign money flows accounted for 45.8% of the total volume. Though its share has risen from the depths of 2021, it remains below the pre-pandemic levels.
And increasing foreign participation has emerged on the erosion of main board volume. (Figure 1, middle pane)
That is to say, foreign money flows appear to be filling the void from the corrosion of domestic savings. This is the "unseen."
Nonetheless, in today's globalized world, the definition of foreign money is ambiguous. Money flows from local companies registered abroad and-or joint ventures could be considered "foreign."
Thus, such numbers may not provide an accurate picture of the participants.
III. Margin Trades by the Domestic Financial Sector? PSE Low Volume Reflects Dwindling Bank Liquidity
Figure 2
From the local side, with retail players sidelined, financial institutions could have material exposure in bolstering the index.
Bank lending to the financial sector has recently picked up steam. It grew by 9.9% in September. And the PSEi 30's enormous return of 7.2% last October might have been significantly influenced by it.
The correlation between financial intra-industry lending growth rates and the PSEi probably indicates the flow of margin trades supporting the equity benchmark. (Figure 2, upper window) [The scheduled publication of the October update on bank loans by the BSP is next week.]
Besides, as noted above, despite the 15% rally, the main board and gross volume remain depressed. And the low turnover at the PSE can be traced to the diminishing bank liquidity in the banking system. (Figure 2, upper window)
The low turnover also signifies the lack of participation from the retail sector.
Since the 2H of 2021, the main board volume share of the biggest market capitalization (SM, SMPH, BDO, AC, ALI, and JGS) has been on an uptrend. (Figure 2, lower pane)
As previously noted, the thrust to buoy the index through concentrated pumps has resulted in lower participation in the broader market.
This data provides further circumstantial evidence of institutional rather than a wider dispersion of trading activities.
IV. Big Returns, Poor Market Breadth and More Signs of Illiquidity
Market breadth also points to the cosmetic features of this rally.
Believe it or not, a marginal decline in breadth accompanied this week's incredible rebound of 2.63%! While the tilt of the aggregate spread was slightly towards the decliners, the latter led in three of the five sessions last week. (Figure 3, upmost pane)
Moreover, in the last eight weeks, where the PSEi 30 returned 15%, advancing issues only led declining issues by 10!
That's not all. There has hardly been a significant bounce on the average daily traded issues, which recently plumbed the lows of 2016. (Figure 3, middle window)
So, the consequence of stuffing the index has been to expand the constellation of illiquid issues!
The animated index also failed to ramp up the average daily trades, which resonates with the volume. (Figure 3, lower pane)
V. Concentrated Gains and Activities Distorts the Marketplace; An Overbought PSEi 30
Inflating the index requires only big moves on a few market cap heavyweights.
For instance, SM powered mostly last week's 2.63% jump. The gains of SMPH, Metrobank, BPI, PLDT, and Ayala Corp provided flanking support.
Over the past eight weeks, SM, SMPH, ALI, and BDO registered the highest increases in market cap weights. (Figure 4, topmost window)
As of last week, the top 5 issues controlled a commanding 45.25% share of the PSEi 30. (Figure 4, middle pane)
And for this reason, index managers resort to frequent mark-the-close pumps, which contributed substantially to the eight-week rebound. About 39% of this week's 2.63% resulted from this.
Unknown to most, price distortions send false signals to the marketplace and the economy, magnifying the entrenched maladjustments.
In the meantime, the RSI and MACD signal that the PSEi 30 reached overbought conditions. In addition, the primary bellwether has touched the 200-day moving average. (Figure 4, lowest pane)
VI. A Pivot by the Fed and BSP? Financial Easing Equals the Revival of (FOMO and TINA) Asset Bubbles?
Finally, the fundamental premise of this rally is that inflation has "peaked" here and in the US.
And so, the Fed may slow hikes or even "pivot" soon.
We offer another perspective.
Figure 5
In the risk ON phase, the USD, USD-Php, 10-year UST, and Philippine counterparts have been starkly overbought. (Figure 5, topmost and middle pane)
But these benchmarks have also endured retracements. And being close to oversold, a rebound may occur soon.
Naturally, because market trends operate non-linearly, such represents countercyclical moves.
And in contrast to the consensus, Philippine 10-year yields have outperformed their UST counterpart, meaning institutional traders have priced in inflation than yield arbitrage (rationalized by the BSP for their actions). (Figure 5, lowest pane)
Further, demand is likely to amplify from a sustained increase in financial assets, so this should put a floor on inflation.
And unless something in the world marketplace breaks or economies crash into a recession, most central banks are unlikely to slash rates immediately.
The latter scenarios are not conducive to asset bubbles too!
That said, massive bailouts via fiscal and monetary channels should inflame inflation too!
What we are likely witnessing may be just one of the many in-your-face inflationary bear market rallies.
Be careful out there.
___
References
Hyman P. Minsky, The Financial Instability Hypothesis, Levy Institute, May 1992
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